The SEC’s Operation Broken Gate: Holding Gatekeepers Responsible

The SEC’s Operation Broken Gate: Holding Gatekeepers Responsible

 Operation Broken Gate is the SEC’s effort to hold gatekeepers accountable. In announcing the initiative, the agency filed three actions involving auditors. Two were settled while a third is in litigation.

The action which will be set for hearing is against sole practitioner John Kinross-Kennedy, In the Matter of John Kinross-Kennedy, CPA, Admin. Proc. File No. 3-15536 (Filed Sept. 30, 2013). He is a PCAOB registered auditor. Since 2009 Mr. Kinros-Kennedy has served as an independent accountant for 23 public companies. The proceeding focuses largely on audits and reviews for six of those issuers. All of Respondent’s reports were issued in 2011 and 2012 while the periods range from 2009 through 2010.

The Order alleges improper professional conduct within the meaning of Rule 102(e)(1)(iv)(B)(2) of the Commission’s Rules of Practice. The charge is based on alleged willful violations of Exchange Act Sections 10A(j) regarding audit partner rotation and 10A(k) regarding reports to the audit committee as well as the pertinent rules.

The underlying conduct centers on a failure to comply with the pertinent professional standards which include:

Due care: Respondent did not have the required degree of skill commonly possessed by auditors and failed to exercise due care. This was evidenced by his failure to communicate with the predecessor auditor and the audit committee as well as his unfamiliarity with certain changes in GAAP. In addition, at times he used outdated audit templates and used client personnel to perform audit steps.

Failure to obtain sufficient competent evidential matter: While the pertinent audit standards require that the auditor obtain sufficient competent evidential matter to afford a reasonable his for his opinion, Respondent here did not. For example for a review for one issuer he failed to perform any audit procedures prior to issuing his opinion.

Audit risk: Professional standards require that the auditor plan and perform the work to obtain a reasonable assurance about whether the financial statements are free of material misstatement due to error or fraud. For three issuers Respondent failed to obtain sufficient evidence.

Work papers: Professional standards require that the auditor document his work sufficiently to enable an experienced auditor to understand the nature, timing, extent and results of the procedures performed, the work done and the conclusions. Although Respondent performed much of the work himself, he failed to prepare adequate documentation.

Engagement quality review: Audit standards require that the auditor obtain an EQR and concurring approval to issue the engagement report for each audit and interim review engagement. While Wilfred Hanson (see related action below) was engaged to undertake this function for five of the 40 audit reports he issued for fiscal years beginning on or after December 15, 2009, for the same period he did not obtain any such reviews for 35 other engagements. In addition, he did not determine if Mr. Hanson was actually qualified to conduct the reviews assigned to him.

Communication with audit committee: Professional standards require that the auditor have certain communications with the audit committee. The subjects include the auditor’s responsibility under PCAOB standards; significant accounting policies; management’s judgment’s and accounting estimates and other items. Here Respondent failed to undertake these communications.

Communication with predecessor: The applicable standards also require that the auditor communicate with the predecessor auditor or obtain sufficient competent evidential matter to afford a reasonable basis for his report. Here, for example, Respondent included an issuer’s prior year financial statements in his report without obtaining that evidence or communicating with his predecessor so that a review of that firm’s work papers could be undertaken.

Other failures: The Order also alleges that Respondent failed to evaluate the adequacy of the issuer’s disclosure of related party transactions, to control the confirmation process and to follow the auditor rotation requirements.

In the Mater of Wilfred W. Hanson, CPA, ADm. Proc. File No. 3-15537 (Filed Sept. 30, 2013) is related to the action against Mr. Kinross-Kennedy. Mr. Hanson, who at one time was an auditor for Arthur Young & Co., has since 2009 provided forensic accounting and litigation support for a forensic firm. The Order alleges that Mr. Hanson is not qualified to serve as an engagement partner, has not participated in an audit of a public company for over 35 years, has never worked on such an engagement under PCAOB standards and is not competent to serve as the engagement quality review partner. In conducting those procedures, as noted above, he failed to exercise due professional care. The Order thus alleges violations of Rule 102(e)(1)(ii) and 102(e)(1)(iv)(B)(2). To resolve the proceeding Mr. Hanson consented to the entry of an order which denies him the privilege of appearing or practicing before the Commission as an accountant with the right to request reinstatement after five years.

The third action is In the Matter of Malcolm L. Pollard, CPA, Adm. Proc. File No. 3-15535 (Filed Sept. 30, 2013) which is a proceeding naming as Respondents Mr. Pollard and his firm, Malcolm L. Pollard, Inc. The Order centers on his work for three issuers and alleges improper professional conduct in violation of Rule 102(e)(1)(ii) and of Exchange Act Sections 10A(a)(1) and (b)(1) and the related Rules. The underling conduct centers on allegations that Respondents failed to comply with the pertinent professional standards by: Repeatedly failed to prepare and maintain adequate work papers; consider and document fraud risks; obtain engagement quality review; and obtain written management representations. Respondents resolved the proceeding by consenting to the entry of an order directing them to cease and desist form violating the statutory Sections cited in the Order as well as the pertinent Rules. Accordingly the Respondents are denied the privilege of appearing or practicing before the Commission as an accountant.

For more commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.

For more information about LexisNexis products and solutions connect with us through our corporate site.