SEC ISSUES SANCTIONS FOR ALLEGED IMPROPER PROFESSIONAL AUDIT CONDUCT,
IGNORING “RED FLAGS” AND FRAUD RISKS INVOLVING
TWO PUBLICLY TRADED CLIENTS
Online Editor’s Note: Footnotes are in (parentheses and in bold)
I. SUMMARY OF THIE FACTS
Over several years, Grant Thornton LLP (“GT”) served as auditor for two publicly traded clients, Assisted Living Concepts, Inc. (“ALC”) and Broadwind Energy, Inc. (“BE”) (1) In 2014, the SEC instituted administrative cease and desist proceedings against ALC’s CEO and CFO, alleging violations of the antifraud, books and records, internal controls, reporting and other Exchange Act violations. (2) In early 2015, the SEC settled an administrative action against BE and its former CEO and CFO for failure to record and disclose a $58 million impairment charge prior to a January, 2010 public offering, and other books and records violations. GT issued audit reports containing unqualified opinions for years 2009 through 2011 for ALC. GT performed 2009 Third Quarter and year end 2009 audits for BE.
On December 2, 2015, the SEC issued Accounting and Auditing Enforcement Release No. 3718 (the “SEC Release”), instituting administrative cease and desist proceedings, making findings and imposing remedial sanctions as part of an offer of settlement (“Order”) with GT. (3) In the SEC Release, the SEC charged GT with knowing violations of Exchange Act Rule 102 (e) and 4(c) for improper professional conduct by its licensed accountants, and multiple failures to comply with PCAOB auditor standards, including:
- Failure to properly plan the audit (AU §§ 311, 312, AS 8, 9);
- Failure to exercise due professional care and skepticism ((AU §§ 230, 316, 722 and AS 13);
- Failure to obtain sufficient evidence (AU §§ 326, 333, AS 13, 14, 15);
- Failure to properly supervise the engagement team (AU §§ 311, AS 10);
- Failure to make additional inquiries or perform additional procedures (AU §§ 722);
- Failure to prepare required documentation (AS 3); and
- Violation of Quality Control Standards (QC 20 and 40).
The SEC’s Release describes the details of GT’s alleged deficiencies and claimed facts establishing the engagement partner was aware of “red flags” concerning deficiencies and concerns regarding the client’s books, records, work papers, calculations, and supporting materials. As to BE, the SEC documented declines in actual and forecasted results and GT’s failure to document BE’s overstatement of revenue, ignoring the client’s many misrepresentations and omissions in SEC filings, and improperly reviewed BE’s impairment assessment.
II. THE UNDERTAKINGS MANDATED IN THE SEC SETTLEMENT
The significance of this accounting and auditing enforcement administrative proceeding lies in the scope and nature of undertakings to which GT agreed. (4) Such undertakings are useful for consideration as an “After Action Report” (AAR) for other public accounting firms and engagement partners in order to assure “red flags” in the reporting Company’s books and records uncovered during the course of the audit are not ignored. As David Glocknor, Director of the SEC’s Chicago regional office, stated, auditors should not accept “faulty explanations as the truth and fail to demonstrate adequate professional skepticism or obtain corroborating evidence.”
The first Undertaking obligates GT to perform a review, to be completed within 120 days, which evaluates the adequacy of GT’s quality controls, including audit and interim review policies and procedures covering fourteen (14) itemized audit procedures and standards (“the Review”).
Second, within 60 days of completing the Review, GT must deliver a detailed report to the SEC that evidences compliance with the undertakings. GT further agrees to provide additional evidence of compliance upon additional SEC requests.
Third, an independent Consultant’s review of the firm’s policies must also be conducted to determine the “reasonable assurance of compliance with all relevant commission regulations and PCAOB standards and rules.” Within 90 days after such review, the Consultant must provide GT with a written report (“IC Report”) summarizing the review and making recommendations to ensure GT’s policies assure compliance. The Consultant must provide a copy of the IC Report to the SEC. (5)
Fourth, GT must adopt all recommendations made in the IC Report, with the ability, within thirty (30) days, to counter the Consultant’s recommendations with GT’s own proposed alternative policy or procedure to achieve the same objectives. GT must abide by the Consultant’s recommendations if the firm cannot reach agreement on alternative policy or procedure.
Fifth, GT’s CEO must issue a certification to the SEC within sixty (60) days after receiving the IC Report that it has (or will) implement the Consultant’s recommendations or the agreed alternative policy. The CEO must certify by year end 2016 that the training regime and disclosure to its audit professionals of what is read in the IC Report has been accomplished, “supported by exhibits sufficient to demonstrate compliance.”(6)
Sixth, an audit-professional training program, comprising a minimum of 32 hours of audit-related training, must be completed before November 30, 2016. This program is required to cover each of 14 topics highlighted as deficiencies in GT’s audit procedures and standards. The Order further specifies the minimum number of hours to be devoted to identified auditor responsibilities.(7) All of the firm’s audit professionals are required to be informed of the Order’s terms and conditions within ten (10) business days.
Finally, for the years 2017 and 2018, GT’s National Managing Partner, Audit Risk Management, must provide Annual Certifications to the SEC of the adequacy of the firm’s revised policies and procedures through implemented testing, to assure compliance with Commission regulations and PCAOB standards and rules.
III. OTHER SANCTIONS
In addition to the Undertakings, GT agreed to additional sanctions which included the following:
- “cease and desist” from violations of section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13, thereunder;
- Disgorgement of $1,305,396, representing profits and $273,174.19 pre-judgment interest; and a
- $3 million civil penalty.
The two individual GT audit managers who settled with the SEC were penalized through temporary suspensions from SEC practice and financial penalties.(8)
IV. AFTER ACTION REPORT CONCLUSIONS
The Undertakings reflected in the SEC Order (and agreed to by GT) provide public accounting professionals with a roadmap of the Commission’s settlement requirements for audit professionals.
From this case, the following conclusions can be drawn:
- The SEC’s Enforcement Division staff applies its ‘resources’ and technical accounting knowledge in a fashion that enables it to prevail in complex public accounting and auditing enforcement cases, and settlements can be expected to be wide ranging to meet the scope of alleged deficiencies.
- The SEC Enforcement Division takes seriously the role of accountants as ”gatekeepers.” When serious audit failures occur over a long-period of time, involving reporting companies, the SEC views such alleged conduct as “aiding” the public reporting company’s financial fraud. Consequences to the individual audit principals and the firm can be expected to be serious. The costs of an independent consultant and the effort involved to finalize the required Report should also be considered.
- If an accounting firm has been the subject of repeated enforcement efforts involving reporting company audit work,(9) an immediate assessment of firm audit policies and procedures and audit staff practices should be conducted.
- In addition to remaining vigilant during the course of an audit whenever “red flags” are apparent, accounting firms should review their long-term relationships with reporting company clients to assure “independence.” The engagement partners and audit staff must maintain their “professional distance” and act in accordance with PCAOB Accounting and Audit Standards.
The SEC will accept no excuse for the multiple failures by audit professionals who need to be aware of the SEC ‘s views on the subjects discussed.
If you have questions about this case or SEC-related questions,
please contact Paul A. Lieberman at (212) 561-3628 or firstname.lastname@example.org.
 Conduct involved GT’s Wisconsin practice.