E E N B E L A N G W E K K E N D V O N N IS V A N D E U N I T E D S T A T E S S E C U R IT IE S A N D E X C H A N G E C O M M IS S IO N
Inleiding van de R edactie
D e red actie is in h et bezit gekom en v a n een door de U n ited S tates Securities a n d E xch an g e Com mission te W a sh in g to n (U .S .A .) gew ezen vonnis dd. 18 A pril 1949. Zij ac h t dit vonnis, v o o ra l gezien de zorg vuldige en uitvoerige o v erw egingen die aa n d e u itsp raak zijn toege voegd, als afspiegeling v a n de beroep so p v attin g en in de U .S.A . zeer belangw ekkend. D aarom heeft zij besloten to t o n v erk o rte publicatie. H et is een p u n t v a n overw eging gew eest h et verslag v a n de ra p p o rteu r te bekorten; de re d a c tie heeft h ierv a n afgezien, om dat zij m eent, d a t het geheel niet aa n leesbaarheid zou w innen en aa n betekenis v o o r de lezer zou inboeten.
D e U n ited S tates S ecurities an d E xch an g e Com m ission ho u d t to e zicht op de officieel te r beurze gen o teerd e fondsen. K laarblijkelijk heeft zij een lijst aan g eleg d v a n de accountants, die n a a r h a a r oordeel b e voegd zijn om de controle op jaarrek e n in g e n v an ondernem ingen, w a a r v a n de aandelen ter beurze zijn genoteerd, uit te oefenen.
U it het ra p p o rt blijkt d a t een v a n de aldus erk en d e ac co u n tan ts een jaarrek en in g per 30 A pril 1946 heeft gecertificeerd, terw ijl la te r bleek d a t de v o o rra a d „goederen in b ew erk in g ” $ 87.000,— te hoog w as op gevoerd. H ieru it resu lteerd e een te hoge w a ard erin g vo o r hetzelfde b e d rag v an de intrinsieke w a a rd e v an de ondernem ing en een g eflatteerd beeld v an het b ed rijfsresu ltaat vo o r hetzelfde b ed rag in de v ersla g periode. H e t verschil w as relatief belangrijk, gezien de intrinsieke w aarde van ca $ 260.000,—- en het b edrijfsresultaat van ca $ 91.000,—. D e fout k rijgt nog m eer betekenis, nu de jaarrek en in g , voorzien v an de aco u n tan tsv erk larin g , dienst h ad ged aan bij een publieke emissie v an aandelen in v e rb a n d met de om zetting v a n het bedrijf v a n een „ p a rt n ersh ip ” in een „C orporation” .
H e t v erslag v a n de ra p p o rteu r is in de eerste p laats in teressant, om dat hieruit duidelijk de A m erikaanse o p v attin g en ten aanzien v an v o o rra a d - opnem ing en aansprakelijkheid vo o r de v o o rra a d blijken. E n v o o rts om dat uitvoerig w ordt ingegaan op de intern-organisatorische m aatregelen, w elke door g rote acco u n tan tsk an to re n m oeten w o rd en getroffen, ter w aarb o rg in g v a n een v era n tw o o rd e beroepsuitoefening.
In h a a r vonnis ziet de Commissie v an het nem en v a n disciplinaire m aatregelen, zow el ten aanzien v a n de accountantsfirm a als ten aanzien v an de rech tstreek s bij het onderzoek betro k k en accountants, af; zij heeft als een v erzach ten d e om standigheid aangem erkt, d a t het tek o rt v an $ 87.000,—’ door h et acco u n tan tsk an to o r is aangezuiverd. Zij heeft des niettem in openbaarm aking v an het vonnis en v an de overw egingen bevolen.
* *
F indings and O pinion of the Commission in the M a tter o f Proceedings under R ule II (e) o f the R ules o f Practice, to determ ine w hether the privilege o f Barrow, W a d e , C uthrie & Co., H en ry H . D alton and E verett L. M angam to practice as accountants before the Securities and E xchange Commission should be denied, temporarily or perm anently 1)
T h e Com mission having instituted proceedings p u rsu an t to Rule II (e) of its Rules of P ractice on the question w heth er the privilege of practicing as accountants before the Com mission should be denied to B arrow , W a d e , C uthrie & Co., H e n ry H . D alton, an d E v e re tt L. M an - gam;
P riv ate h earings having been held before a h earing exam iner an d the hearin g exam iner having filed a recom m ended decision recom m ending th a t the proceedings be dismissed, that the record in the case be m ade public and th a t the Com mission publish a statem en t indicating in ap p ro p ria te detail the facts in the case and the reasons for the Com m is sio n ’s determ ination;
M otions having been filed by counsel for the respondents an d counsel for the O ffice of the C hief A ccountant of the Commission requesting th a t the Com m ission ado p t the hearing exam iner’s recom m ended decision as the C om m ission’s F indings and O pinion in the m atter an d th a t it be released an d published as an A ccounting Series Release;
an d
T h e Com m ission having duly considered the m atter,
It is ordered that the aforesaid motions be, and they hereby are, granted, and that the hearing exam iner’s recom m ended decision, attached hereto, be, and it hereby is adopted as the Findings an d O pinion of the Commission; and
It is further ordered th at the proceedings be, and they hereby are, dism issed.
RECOMMENDED DECISION OF THE HEARING OFFICER
Appearances:
E dm und H . W o rth y for the O ffice of the C hief A ccountant of the Securities and E xchange Commission.
R obert T . M cC racken and R obert C. W a lk e r for Barrow, W a d e , C uthrie & Co., H en ry H . D alton and E verett L. M angam .
P u rsu an t to Rule IX (d ) of the Rules of P ractice of the Securities and E xchange Commission, this recom m ended decision is advisory only and the findings, conclusions and other m atters herein contained shall not be binding upon the commission; and this recom m ended decision is confidential, shall not be made public, and is fo r the use of the com m is sion, the parties and counsel.
T h is proceeding w as initiated under Rule II (e) of the Com m ission’s Rules of Practice which reads as follows;
„ T h e Commission m ay disqualify, and deny, tem porarily or perm anent- 1
1) Accounting Series Release Nr. 67.
ly, the privilege of appearing or practicing before it in any w ay to any person w ho is found by the Commission afte r hearing in th e m atter 1. not to possess the requisite qualifications to rep resen t others; or 2. to be lacking in character or integrity or to have engaged in unethical
or im proper professional conduct” .
Practice before the Commission is defined under subsection (g ) of Rule II to „include the preparation of any statem ent, opinion or other paper by any attorney, accountant, engineer or other expert, filed w ith the Commission in an y registration statem ent, application, rep o rt or other docum ent w ith the consent of such attorney, accountant, engineer or other ex p ert”.
A ccording to this rule it m ust be determ ined w heth er B arrow , W a d e , G uthrie & Co., a partn ersh ip engaged in a general auditing an d ac counting business, and practicing before this Commission, H e n ry H . D al ton, a certified public accountant and former m anager of the Los A ngeles, C alifornia office of B arrow , W a d e , C uthrie & Co., and E v erett L. M an - gam, also a certified public accountant em ployed by B arrow , W a d e , C uthrie & Co. in its Los A ngeles, C alifornia office, or a n y of them, are lacking either in the requisite qualifications to represent others or in ch a racter or integrity, or have engaged in unethical or im proper professional conduct; and w hether they, or any of them, should be disqualified and denied tem porarily or perm anently the privilege of appearing and prac ticing before the Commission.
Basis [or charges
Drayer*— H anson, Incorporated, w as organized under the law s of the S tate of C alifornia on A pril 29, 1946, to acquire th e business and assets of a p artnership composed of four individuals. x) P rior to the o rganisa tion of the corporation, B arrow , W a d e , C uthrie & Co. w as em ployed to m ake an audit of the records of th e partnership.
O n A pril 29, 1946, the corporation filed a registration statem ent w ith the Commission, pursu an t to the requirem ents of the Securities A ct of 1933, covering a proposed public offering of 80,529 shares of its C lass A stock, and up to A pril 16, 1947, a t which time the public offering w as discontinued, 59,030 shares of this stock w ere sold to th e public a t $ 10.00 p er share. T h is re g istra tio n statem en t an d certain am endm ents th ereto contained financial statem ents of D ra y e r—H an so n C orp o ratio n an d certain of its predecessors, w hich statem ents w ere certified by B ar row, W a d e C uthrie & Co. T h e se financial statem ents represented the partnership net w orth a t A pril 30, 1946 to be approxim ately $ 260,000 an d the net earnings of the partn ersh ip for the ten m onths ended A pril 30, 1946 to be approxim ately $ 181,000 for the partn ersh ip and approxi m ately $ 91,000 w hen com puted as though the partn ersh ip h ad been a corporation.
T h e au d ito r’s certificate, accom panying the financial statem ents, filed as a p art of the registration statem ent, om itting certain details not neces sary to be stated here, read as follows:
,,W e h ave m ade an exam ination of (th e financial sta te m e n ts). In connection therew ith, w e have review ed the system s of internal control an d the accounting procedures of the p artnership and of th e corporation 1
1 ) In the Matter of Drayer-Hanson, Incorporated, -— S.E.C. •—, Securities Act
Release No. 3277, Accounting Series Release No. 64.
and, w ithout making detailed audits of the transactions, have exam ined or tested accounting records of the p artnership an d of the corporation and other supporting exidence by m ethods and to the extent w e deemed appropriate. O u r exam inations w ere m ade in accordance w ith generally accepted auditing stan d ard s applicable in the circum stances and included all procedures which w e considered necessary, except as stated in the following p aragraph.
„ W e w ere present only during the taking of a physical inventory, which did not include w ork in process, as at M arch 31, 1946, and satis fied ourselves as to the procedures followed in th e determ ination of inventory quantities as of th at date. W e w ere not in attendance at the physical count of the inventories taken a t the close of each of the years 1942, 1943 and 1944 and w e w ere inform ed th at such procedures w ere not perform ed by an y other independent public accountants. In the absence of a physical inventory of w ork in process at M arch 31, 1946 w e subsequently m ade test inspections of selected items to assure ourselves as to the existence of the inventory and the adequacy of the related accounting data. T h e inventories at the close of each of the years 1942 an d 1944 w ere review ed by us as to the basis of pricing and clerical accuracy and w e inquired into the m ethods used by the corporation employees in determ ining physical quantities to ascertain th a t m ethods w ere em ployed which w ould assure reasonable accuracy. W e w ere inform ed th a t an inventory w as taken as at Decem ber 31, 1943 but we w ere advised th at such inventory w as lost and therefore not available for our inspection. W e w ere inform ed th a t no physical inventory w as taken as at June 30, 1945. O n the basis of the exam inations and tests m ade b y us, w e have no reason to believe th at the inventories as set forth in the accom panying statem ents are unfairly stated.
,,In our opinion, subject to the exception stated in th e foregoing p a ra graph, relating to the limitation of the scope of our exam ination, the accom panying (financial statem ents) fairly p resent th e position of the p artnership as at A pril 30, 1946 and the results of the operations of the partn ersh ip and the predecessor corporation for the three years and four m onths then ended in conform ity w ith generally accepted accounting principles applied consistently during the period under review .”
Some time in June, 1947 the Commission w as advised by D ra y e r—■ H anson, Incorporated and by Barrow, W a d e , C uthrie & C o. th at an error had been discovered in the balance sheet as of A pril 30, 1946 and the p artnership income statem ent for ten m onths ending th a t date, which statem ents had been certified by Barrow, W a d e , C uthrie & Co. and included in the registration statem ent and prospectus. T his error con sisted of an overstatem ent of approxim ately $ 87,000 in an inventory item designated „w ork in process and prefabricated p a rts”, and resulted in an overstatem ent of the partnership net w orth at A pril 30, 1946 and the partnership net income for the ten months ended A pril 30, 1946 in the same amount.
T h ereafte r, the Commission m ade an investigation pu rsu an t to Section 8 (e) of the Securities A ct of 1933 to determ ine w hether the registration statem ent filed by D ra y e r—H anson, Incorporated violated any of the provisions of th a t A ct. O n M arch 18, 1948 the Commission issued its report of the investigation. 2)
2) In the Matter of Drayer-Hanson, Incorporated, — S.E.C. —, Securities Act
Release No. 3277; Accounting Series Release No. 64.
O n O ctober 22, 1948 the Commission ordered the p resent private p ro ceeding to determ ine the tru th of certain inform ation obtained from its official records concerning the filing of the registration statem ent by D ra y e r—H anson, Incorporated and certain related m atters, and certain inform ation reported by the staff as to the m isleading character of the financial statem ents included in the said registration statem ent and the appended certificate by B arrow , W a d e , C uthrie & Co. and the negligent an d im proper professional conduct of the auditors in making this audit, particularly in the execution of the auditing procedures adopted.
A t the hearing which w as opened on N ovem ber 16, 1948, the respon dents stipulated th at the statem ents of fact and conclusions based hereon as set forth in the report of the Commission on the investigation in the m atter of D ra y e r— H anson, Incorporated, A ccounting Series Release N o. 64 m ay be considered as evidence in these proceedings, thus in effect adm itting all of the facts pleaded in the order directing these proceedings. T h e respondents then offered evidence of their m ethods of operations in the past and of changes m ade in the organisation and operation of B arrow , W a d e , C uthrie & Co. to prevent a recurrence of a situation similar to the D ra y e r— H anson, Incorporated audit. T h is leaves for con sideration in the present proceeding the rem aining question as to the qualification of the respondents to appear and practice before the Com mission an d w hether they, or any of them, should be tem porarily or p er m anently disqualified from or denied the privilege of practicing before th e Commission.
Barrow, W a d e , C uthrie & Co., organisation, operation and policy in 1947 and prior thereto
Barrow, W a d e , C uthrie & Co., a partnership, w as organised in 1883 an d has been in continuous operation ever since as an accounting firm. In 1946 and a t the present time it m aintains 15 branch offices and tw o sub-offices in the principal cities of the U nited S tates, w ith one in C anada. Its main or head office is in N ew Y ork, N .Y . In 1946, a t the time of the D ra y e r—H anson, Incorporated m atter, eight of the offices of Barrow, W a d e , C uthrie & Co. w ere under the m anagem ent or control of a p a rtn e r an d seven offices, including the office in Los A ngeles, C ali fornia, w ere m anaged and controlled by a local m anager w ho w as not a partn er. A t the present time, ten of its offices are m anaged by partners an d only five are under the control of a local m anager w ho is not a p artner. In 1946 and at the present time, Barrow, W a d e , C uthrie & Co. have 31 p artn e rs assigned to the various offices. In offices w here there are several partn ers, one of them acts as m anaging p artner.
In 1946, at the time of the D ra y e r—H anson audit, B arrow , W a d e , C uthrie & Co. had an E xecutive Com m ittee composed of four partners. T h e sole function of this committee w as to handle general policy pro blems, financial m atters, the opening or closing of offices and the hiring of key personnel. E ach of the branch offices of B arrow , W a d e , C uthrie & Co. w as set up as an autonom ous unit either under the m anagem ent of a partn er or partners or a local m anager not a p artner.
sary for the proper conduct of the practice in their territory. Such local p a rtn e rs or m anagers w ere responsible for the assignm ent of w ork in the offices, the supervision of all employees or p artn ers assigned to the office, the m aintenance of relations w ith the clients, and w ere further charged w ith the responsibility of outlining the procedures to be followed on each particular job and to see th at they w ere followed, to review the w orking papers and prepare the reports w ith the assistance of the em ployee in charge of th at particular job. T h ere w as no requirem ent th at an y of these m atters be referred to the Executive Com mittee, th e head office, or an y other partner.
T h e m anagers of branch offices w ere selected w ith the sam e care as p artn ers and w ere qualified only after a long record of em ploym ent w ith the partnership or sim ular experience w ith other accounting firms. D uring 1946 and thereafter, all partn ers and m anagers of branch offices w ere certified public accountants, and, w ith the exception of one p artn e r w hose duties did not relate to the accounting and auditing w ork of the p a rtn e r ship, they w ere also members of the Am erican Institute of A ccountants. In 1946 and 1947, and for some time prior thereto, it w as the policy of the partnership to issue circular letters at intervals calling attention of partn ers and m anagers to im portant developm ents in the accounting circles, the responsibility assum ed by th e partn ers in certifying accounts for the purpose of registering securities under the A cts adm inistered by this Commission. T h e partnership also directed the attention of all p a rt ners, m anagers and employees to the considered opinions of the C om mittee on A ccounting Procedure and the Com m ittee on A uditing P roce dure of the A m erican Institute of A ccountants as reflected in the Institute bulletins and statem ents and em phasised the necessity of reading and referring to the accounting releases of the Securities and E xchange Com mission and the need for following carefully the rules, regulations and instructions relating to the preparation of financial statem ents and sche dules for registration statem ents. O ne of these regulations (R egulation
S -X ), contains the following pertinent requirem ents: ..Rule 2-02. A ccountants C ertifica te s”.
..(b ) R epresentations as to the audit. T h e accountant’s certificate (1) shall contain a reasonably com prehensive statem ent as to the scope of the audit m ade including, if w ith respect to significant items in the finan cial statem ents any auditing procedures generally recognised as norm al have been om itted, a specific designation of such procedures and of the reasons for their omission; (2) shall state w hether the audit w as m ade in accordance w ith generally accepted auditing stan d ard s applicable in the circum stances; and (3) shall state w hether the audit m ade om itted any procedure deemed necessary bij the accountant under the circum stances of the particular case.
,,In determ ining the scope of the audit necessary, appropriate conside ration shall be given to the adequacy of the system of internal check and control. D ue w eight may be given to an internal system of audit regularly m aintained by means of auditors employed on the re g istra n t’s own staff. T h e accountant shall review the accounting procedures followed by the person or persons w hose statem ents are certified and by appropriate m ea sures shall satisfy himself th at such accounting procedures are in fact being followed.
,,N othing in this rule shall be construed to imply authority for the omission of any procedure which independent accountants w ould ordina
rily employ in the course of an audit m ade for the purpose of expressing the opinions required bij p arag rap h (c) of this ru le”.
It w as the established policy of B arrow , W a d e , C uthrie & Co., and all of its employees w ere specifically instructed, to follow the procedures as to inventories prescribed by the A m erican-Institute of A ccountants in the Extensions of auditing P rocedure of O ctober 1939, which is no. 1 in a series of formal S tatem ents prepared and issued by the Com m ittee on A uditing P rocedure of the A m erican Institute of A ccountants. T his statem ent w as also approved by the m em bership of the Institute. It states on p age 6: „ T h a t hereafter, w here the in dependent certified public accountant intends to rep o rt over his signature on the financial sta te m ents of a concern in w hich inventories are a m aterial factor, it should be generally accepted auditing procedure, that, in addition to making auditing tests and checks of the inventory accounts and records, he shall, w herever practicable and reasonable, be present, either in p e r son or by his representatives, at the inventorytaking an d by suitable ob servation and inquiry satisfy himself as to the effectiveness of the m ethods of inventorytaking and as to the m easure of reliance w hich m ay be placed upon the client’s representations as to inventories and upon the records thereof. In this connection the independent certified public ac countant m ay require physical tests of inventories to be m ade under his observation”.
O n P ag e 11 in discussing the accountant's report or certificate, the statem ent continues: „If, on the other hand, such ... (explanation of p rocedures follow ed) are m ade b y reaso n of a n y reserv atio n o r desire to qualify the opinion, they become exceptions and should be expressly stated as such in the opinion p arag rap h of the au d ito r’s report. A s p re viously stated, if such exceptions are sufficiently m aterial to negative the expression of an opinion, the auditor should refrain from giving any opinion at all, although he m ay ren d er an inform ative rep o rt in which he states th a t the limitations or exceptions relating to the exam ination are such as to m ake it impossible for him to express an opinion as to the fairness of the financial statem ents as a w hole”.
In December, 1942, the Com mittee on A uditing P rocedure in S ta te m ent N o. 17, P hysical Inventories in W artim e , in discussing the tem pora ry concessions m ade necessary by the overriding requirem ents for w ar production observed: „ N o am ount of supplem entary w ork by the in d ependent accountant can thus com pletely rem edy the basic w eakness resulting from the client’s failure to provide some form of physical in v en to ry ” . See also the Com m ission’s A ccounting Series Release N o. 30, January, 1 9 4 2 .3)
H e n ry H . D alton
From D ecem ber 1, 1937 to O ctober 31, 1947 D alton w as m anager in charge of the Los A ngeles, C alifornia office of B arrow , W a d e , C uthrie & Co. A fter a high school and business college education, he passed the interm ediate exam ination of the A ssociation of C h artered A ccountants of the Province of Q uebec, C an ad a in 1921. In 1932 he w as licensed to practise as a certified public accountant in the S ta te of C alifornia. H e becam e a member of the A m erican Institute of A ccountants in 1936. F or nine years he w as em ployed by a firm of ch artered accountants in C an ad a
3) Zie de bewerking van deze „Statements on auditing procedure” door Drs D. E.
Beutick in het M.A.B. van Juni 1947 (21 e jaargang no. 6).
and on Decem ber 3, 1925 he entered the services of Barrow, W a d e , C uthrie & Co. as a junior accountant in the N ew Y ork office w here he rem ained four years. H e w as then m ade assistan t m anager of their San Francisco office, which position he occupied for seven years. In 1936 he w as m ade com anager of the Los A ngeles office an d on D ecem ber 1, 1937 w as prom oted to m anager of th a t office. O n O ctober 31, 1947 he w as removed as m anager of the Los A ngeles office and rem ained in a som ew hat inactive status until 1 M ay, 1948, a t w hich time he resigned his position w ith Barrow, W a d e , C uthrie & Co. an d entered a p a rtn e r ship w ith other accountants in Los A ngeles. H is auditing experience covers m any types and kinds of business, bu t in his letter of July 23, 1946 to one of the partners, he stated ,,W e have been faced w ith m any problem s not encountered by either of us prior to this tim e.”
E ve rett L. M angam
From 1931 to 1936 M angam had a varied business experience. H e entered the accounting profession in 1936, at first engaging in a small practice. In January, 1937 he w as employed by B arrow , W a d e , C uthrie & Co. in their U tica, N ew Y ork office as a junior accountant and re mained in th a t office in various capacities until 1940 w hen he w as m ade assistan t m anager and in 1942, acting m anager. D uring his entire expe rience in the U tica office he a t no time acted independently but all of his w ork w as under the supervision and direction of the m anager of th at office.
T h e U tica office of Barrow, W a d e , C uthrie & Co. w as com paratively small and nearly all of its clients had em ployed the p artnership for a num ber of years and procedures had been developed over this time in handling the w ork. P rior to M an g am ’s undertaking an audit, the m anager of the U tica office alw ays review ed the preceding y e a r’s papers with him and outlined the procedures to be followed in the current audit, and supervised the audit as it progressed. M angam had never previously been confronted w ith a situation com parable to th e D ra y e r—H anson m atter. T h is w as particularly tru e w ith respect to making an audit w ith out a prior com plete physical inventory.
In Decem ber, 1942 M angam w as commissioned in the U .S. N avy w here he rem ained until January, 1946. D uring this period he w as em ployed in the C ost Inspection Service, N av y C ost Inspection, T erm ination Specialist and as a member of the A rm y -N av y Lecture T eam on A ccount ing. A fter his disch arg e from the N a v y he re tu rn e d to B arrow , W a d e , C uthrie & Co. as a senior accountant in F ebruary, 1946 attached to the N ew Y ork office. O n A pril 1, 1946 he commenced services a t the Los A ngeles office in charg e of the D ra y e r—H an so n au d it u n d er the direc tion and supervision of D alton.
M angam w as licensed as a certified public accountant in O hio in July, 1940 and in C alifornia in January, 1947. H e has been a m em ber of the A m erican Institute of A ccountants since 1941, the O hio Society of C er tified Public A ccountants since 1940, the N ational A ssociation of C ost A ccountants since 1938 and of the C alifornia Society of C ertified Public A ccountants since 1947.
D ra yer—H anson, incorporated audit
audit of the books and accounts of a p artnership know n as D ra y e r— H anson w hich w as engaged in the business of designing, m anufacturing and selling heat transm ission equipm ent. D alton w as inform ed th at the partnership w as to be reorganised as a corporation and proposed to m ake a public offering of its securities in the S tate of C alifornia. S hortly a fte r the audit w as commenced an d some time prior to th e com pletion thereof, he w as advised th a t the offering would be registered w ith the Securities and E xchange Commission. A t his first conference w ith the D ra y e r— H anson m anagem ent, D alton, am ong other things, stressed th e necessity of taking complete physical inventories including ra w m aterials, fabricated parts, w ork in process an d finished goods an d it w as agreed by th e D ra y e r—H anson partn ersh ip th a t this w ould be done. A cting w ithin the scope of his au th o rity as m anager of the Los A ngeles office, and w ithout notifying the head office of B arrow , W a d e , C uthrie & Co., D alton accepted this engagem ent.
O n M arch 27, 1946 D alton w as first inform ed th a t the m anagem ent of D ra y er-H an so n had decided not to take a physical inventory of the w ork in process. H e advised the m anagem ent of the probable necessity of a qualification in the acco u n tan t’s certificate in the absence of this inventory. A t this conference, D alton, after a ra th e r casual exam ination of some of the accounting records an d relying in p a rt on inform ation given by the m anagem ent, agreed to proceed w ith the audit w ithout requiring a com plete physical inventory of w ork in process, although he knew th a t previous inventories by D ra y er-H an so n h ad no t been taken in the presence of an y independent accountant and th a t no physical in ventory of w ork in process h ad been taken since D ecem ber 31, 1944. H e also knew th a t no exam ination of the accounts of D ra y er-H an so n or its predecessor h ad been m ade by any independent accountant prior to this time. M oreover, he testified th a t in his opinion the taking of a physical inventory of w ork in process w as practicable an d reasonable. D alton did no t com m unicate his decision to th e main office of B arrow , W a d e , C uthrie & Co. or to an y of its p artn e rs until July 23, 1946, a t which time he forw arded to the main office d ra fts of financial statem ents and a copy of th e proposed certificate to be issued an d referred to some of the difficulties encountered in this audit.
M angam did not rep o rt for d u ty at the Los A ngeles office until A pril 1, 1946 an d took no p a rt in an y of th e prelim inary conferences or in the decision th a t the w ork in process w ould no t be inventoried. H e w as placed in charge of the audit an d continued until its com pletion in the latter p art of July, 1946. A m ong other things, he prepared an au d it program for th e engagem ent w hich included a stu d y of the system of internal check and control an d th e cost accounting system m aintained b y D ray er- H an so n and its predecessors. H e knew th a t the inventory of w ork in process h ad no t been ta k e n bu t stated th a t he u n d ersto o d „ th a t our opi nion w ould be qualified.” H e assigned the w ork to be done on the audit to his assistants and supervised such w ork b y review ing the w orking papers prepared by them. H e personally perform ed certain of the auditing procedures which he believed to be necessary to perform the engagem ent in accordance w ith w hat he reg ard e d as generally accepted auditing s ta n dards, and a t the conclusion of the audit prepared a d ra ft of the required financial statem ents an d in collaboration w ith D alton prepared a d ra ft of the firm ’s rep o rt or certificate.
tory of the w ork in process, as outlined by the Commission in its report of in v estig atio n 4) w ere determ ined by M angam after spending several days making a survey of D ra y e r-H a n so n ’s system of internal check and control. T h is survey disclosed a num ber of m aterial w eaknesses in the system , especially w ith respect to the recording of transactions having an effect, directly or indirectly, upon the am ount of w ork in process in ventory show n in D ra y er-H an so n 's accounting records.
M angam discussed these m atters w ith D alton from time to time, and he testified, ,,I expressed my dissatisfaction w ith the situation from the very first day, because I could see th a t it w a sn ’t going to be an easy m atter to do very much w ith the w ork in process unless a physical in ventory w as available. I held to th a t opinion day afte r d a y ” . B ut M a n gam also indicated (see p. 16 of A ccounting Series Release N o. 64) that he believed he would be able to use alternative procedures to assure him self, w ith respect to w ork in process, th at the inventory w as there.
In spite of the w eakness disclosed by his survey, M angam em ployed such altern ate auditing procedures as he himself considered necessary in the absence of a physical inventory, in an inadequate m anner.
Supervision by D alton
D alton m ade a general review of the w orking papers to ascertain the m ethods used and the proof obtained w ith respect to the results and w hat had been done in the various tests and checks in order to ascertain the authenticity of the financial statem ents. H e review ed all of the w orking papers in detail w ith M angam and questioned him specifically on the survey he had m ade of the system of internal check and control, the w ork done an d the results obtained from the audit of the w ork in process inventory, the exam ination m ade of the general journal entries, especially those related to finished goods, w ork in process, and cost of sales, and on any other points th a t did not appear to be clear. A s m anager of the office it w as his responsibility to supervise and check all of the w ork of his subordinates and to satisfy himself th a t the audit had been m ade in accordance w ith accepted auditing standards.
Some time in M ay, 1946, w hile the field w ork on the audit w as in p ro gress, one of the partn ers of B arrow , W a d e , C uthrie & Co. w as in the Los A ngeles office on other business for the firm. W h ile there, he ac com panied D alton to the D ray er-H an so n plant. D alton inform ed this p artn e r generally of the problem s w ith respect to the engagem ent but did not inform the p artn e r of the specific problem s which had arisen and of the fact th at the audit w as being m ade w ithout a com plete physical in ventory.
A fte r D a lto n ’s review of the w orking papers and financial statem ents, he and M angam prepared a d ra ft of a certificate to cover the financial statem ents. T his d ra ft certificate w ith the related financial statem ents and a covering letter dated July 23, 1946 w ere sent to the Philadelphia office of Barrow, W a d e , C uthrie & Co. for criticism and suggestions and for the further purpose of discussing w ith th e staff of the Securities and E xchange Commission the m anner in which certain facts should be reflected in the financial statem ents. T h is letter of July 23, 1946 w as the first notice to an y p artn e r or to the head office of B arrow , W a d e , C uthrie
4) In the Matter of Drayer-Hanson, Incorporated, Securities Act Release No. 3277,
Accounting Series Release No. 64.
6 Co. th a t the audit of D ra y e r—H anson w as m ade w ithout a physical inventory of the w ork in process.
A fte r the receipt of the letter of July 23, 1946, one of th e p artn ers of B arrow , W a d e , C uthrie & Co. discussed certain m atters w ith members of the Com mission’s staff, an d on July 31, 1946 th e p artn e r w rote a letter to D alton inform ing him of certain com ments b y m em bers of the Com m ission’s staff an d m aking certain suggestions including several dealing w ith the inventory situation. Follow ing the p a rtn e r’s letter of July 31 the certificate w as changed so as to include an exception phrase a t the end of the last sentence of th e first p arag ra p h of the certificate an d to include an exception in the opinion p arag ra p h as to the fairness of the presentation of the statem ent as a result of the lim itation on the scope of the au d it as to inventories. O n A ugust 12, 1946, D alto n fo rw ard ed a copy of the D ra y e r—H anson registration statem ent, as filed, to the
Philadelphia office of B arrow , W a d e , C uthrie 6 Co.
M e a n s taken to strengthen and centralize the control o f functional operations o f Barrow , W a d e , C uthrie 6 Co.
A s a resu lt of the D ra y e r— H an so n case, an d the consequent re v e la tion of the failure of the partn ersh ip policy to provide th e public w ith the resources of experience an d skill of the p artn ersh ip as such, certain changes have been m ade in the personnel, the policy an d procedures of
B arrow , W a d e , C uthrie & Co. as follows:
(1 ) A new m anager has been placed in charge of th e Los A ngeles office an d th e sta ff im plem ented by the addition of a second certified public accountant.
(2 ) All p artn e rs an d m anagers w ere notified of A ccounting Series R elease N o. 64 w ith the suggestion th a t it receive careful stu d y an d staff members and assistants be im pressed w ith the responsibilities assum ed b y the firm in certifying financial statem ents for registration purposes an d the degree of care which m ust be exercised in review ing the system of internal control an d in th e physical verification of all inventories.
(3) A „M an u al of A uditing P rocedure", prepared over a period of several m onths b y a com m ittee of partn ers, has been distributed and discussed throughout the firm. T h e m anual is to be supplem ented and revised periodically.
(4) P a rtn e rs an d m anagers in field offices have been instructed th a t the policy on the exam ination of the financial statem ents for inclusion in registration statem ents will be to have the p artn e r or a non-p artn er branch m anager in charge of an assignm ent consult w ith other partners or branch m anagers on m atters relative there to. T h e N ew Y ork executive office is to be notified of all registration w ork undertaken. T h e acceptance of new clients m ust be approved by a t least tw o p artn ers or tw o non p artn e rs branch m anagers, an d financial statem ents to be included in a registration statem ent m ust likewise be so approved prior to their release. W h e re such statem ents are prepared in an office having only one p artn e r or a n o n -p artn er branch m anager, the executive office m ust be notified an d an o th er p a rtn e r will be assigned to co-o p erate an d rev iew the w ork.
work. T h e Com m ittee will be divided into sub-comm ittees, each respon sible for one or more of the functions referred to. A n adm inistrative committee will be charged w ith seeing th a t functions of the operating committee will be carried forw ard.
(6) P artn ers are now located at all except five field offices. It is planned eventually to have a partn er or partn ers in each office, accor ding to the needs of the business.
Conclusions
I find th a t D ra y e r—H anson, Incorporated, filed its registration sta te m ent w ith the Commission as alleged.
T h a t the Commission initiated the proceedings under Section 8 (e) of the Securities A ct of 1933 on the registration statem ent filed by D ra y e r—H anson, Incorporated and released its report on M arch 18, 1948.5)
T h a t the registration statem ents and am endm ents thereto contained financial statem ents of D ra y e r—H anson and certain of its predecessors, certified to by Barrow, W a d e , C uthrie & Co.; and th at the respondent, E verett L. M angam , in collaboration w ith H en ry H . D alton prepared the financial statem ents; and, th a t the respondent, H e n ry H . D alton signed on behalf of the respondent Barrow, W a d e , C uthrie & Co. the certification appended to the financial statem ents.
T h a t the financial statem ents included in the registration statem ent referred to above and the appended certificate of Barrow. W a d e , C uthrie & Co. w ere inaccurate an d misleading.
T h a t the balance sheets included in the registration statem ent w ere m aterially m isleading for the reason th at the w ork in process inventory as of April 30, 1946 w as overstated approx. $ 87,000; an d th at the profit and loss statem ent for the ten m onths ended A pril 30, 1946 included in the registration statem ent w as misleading for the sam e reason.
T h a t D alton by his acquiescence in the decision of representatives of the re g istra n t not to take a physical inventory of w ork in process a t M arch 31, 1946 and Barrow, W a d e , C uthrie & Co. by their failure to object ultim ately to D a lto n ’s decision, failed to acquire sufficient inform ation to w a rran t an expression of an opinion w ith respect to w ork in process inventories a t M arch 31, 1946 and A pril 30, 1946.
T h a t Barrow, W a re , C uthrie & Co. and D alton w ithout justification implied in their certificate th at the system of internal check and control and the cost accounting system in operation at D ra y e r— H anson and certain of its predecessors furnished reliable costs w ith respect to cost of sales and raw m aterials, w ork in process, and finished goods invento ries.
T h a t the statem ent in the certificate of Barrow, W a d e C uthrie & Co. th a t ... (th e auditors) have no reason to believe th a t the inventories as set forth in the accom panying statem ents are unfairly s ta te d ” is w ith out justification and misleading.
T h a t respondents M angam and D alton w ere negligent in the conduct of the audit; M angam , because of the inadequate m anner in w hich he employed alternate procedures, considered by him to be necessary under the circum stances, in the absence of a physical inventory; D alton, for the reason th at the auditing procedures adopted and followed under his supervision w ere not em ployed w ith due professional care. 5
5) Securities Act Release No. 3277; Accounting Series Relase No. 64.
T h a t Barrow, W a d e , C uthrie & Co. failed to supervise the au d it in th e m anner required by existing circum stances.
T h a t each of the respondents acted in an im proper professional m anner in ignoring an d disregarding generally accepted auditing stan d ard s an d procedures applicable in this case an d applicable rules and regulations an d long settled decisions of the Commission w ith respect to the m atters referred to above.
Recom m endations
T h e p artnership of B arrow , W a d e , C uthrie & Co. has been engaged in the accounting business since 1883. T h ey have reported upon financial statem ents of issues publicly offered and covered b y effective re g istra tion statem ents filed w ith the Commission pu rsu an t to the Securities A ct of 1933 in the ag g reg ate am ount of n early one billion dollars an d have also certified financial statem ents for m any brokers and dealers registered w ith this Commission. T h e re is no evidence th a t an y m aterial error has ever been m ade by Barrow, W a d e , C uthrie & Co. in any of said financial statem ents, w ith the exception of those prepared for D ra y e r—H anson. All of the p artn ers are certified public accountants, w ith long years of experience.
H e n ry H . D alton had been an accountant for over th irty years and had been em ployed by Barrow, W a d e , C uthrie & Co. for the p ast tw enty- two years. H e h ad participated in very difficult an d com plicated account ing work, some of which h ad been supervised an d review ed by p artn ers of Barrow, W a d e , C uthrie & Co. and his w ork had alw ays been highly satisfactory. D uring all of this time th ere w as no evidence th a t he lacked an y of the qualifications of an able an d efficient accountant or th a t he lacked ch aracter or integrity.
E verett L. M angam w as em ployed by B arrow , W a d e , C uthrie & Co. as an accountant for five years w hen he entered the U .S. N avy. H e rem ained in the N av y on accounting w ork until shortly before the D ra y e r—H an so n audit. H e had been a certified public accountant for about six years. D uring the time he w as in th e em ploy of B arrow , W a d e , C uthrie 6 Co, his w ork had been highly satisfactory an d no question had ever been raised as to his qualifications, character or integrity.
I conclude th a t all of th e respondents possess the requisite qualifica tions to represent others an d th a t they, an d each of them , are not lacking in ch aracter or integrity.
T h is leaves the rem aining question under Rule II (e) as to w hether the respondents, or an y of them, en g ag ed in unethical or im proper profes sional conduct in the handling of the D ra y e r— H an so n audit.
Barrow, W a d e , C uthrie & Co.
papers w ere retained by D alton in the Los A ngeles office. In his letter of July 23, 1946 to an eastern p a rtn e r D alton did no t call atten tio n to the m anner in which the audit w ork w as done, or, of course, th a t he h ad ignored and disregarded generally accepted auditing stan d ard s and procedures pertin en t in this audit. In reply to D a lto n ’s letter of July 23, 1946, the p artner, in his letter dated July 31, 1946, how ever inadequate the comm ents may have been, did suggest certain procedures considered necessary b y him in the absence of a physical inventory of the w ork in process. A t this time the partn ers of B arrow , W a d e , C uthrie & Co. had full confidence in D alton. N o charge has been m ade th a t the p a rtn e r ship deliberately and willfully engaged in unethical or im proper pro fessional conduct. It is clear from the evidence th a t the general policy of the p artnership of not requiring supervision by p artn ers of the w ork of the various offices ignored and disregarded applicable an d long settled opinions of the Commission in th a t it functioned w ithout centralized supervision of th e field offices an d in this case exercised n o t even a local control. 6)
M oreover, the evidence indicates th a t the firm received inform ation of such sufficiency th a t it should h av e im pelled a m ore positive stan d to w a rd com pliance w ith professional sta n d a rd s an d the C om m ission’s rules. In an y event, an d w holly a p a rt from these considerations, the p artn e rsh ip having clothed its m anager w ith full au th o rity to bind it m ust accept full responsibility for his conduct.
T h e changes m ade b y the p artn ersh ip since the D ra y e r—H a n so n au d it to stren g th en an d centralize the control of functional operations of the firm as hereinabove m entioned indicate th a t the p artn e rsh ip recognizes the deficiencies in its form er policy. W h e n the e rro r in th e in v en to ry of w ork in process w as later discovered by B arrow , W a d e , C uthrie & Co. th ey called the m atter to th e atten tio n of the Com m ission a n d contributed to D r a y e r —H anson, In co rp o rated $ 87,500 w hich w as th e approxim ate am ount of the in v en to ry erro r.
T h e evidence conclusively establishes th a t B arrow , W a d e , C uthrie & Co. has been sufficiently im pressed w ith the inad eq u acy of their form er policies an d has m aterially revised them . T h e ir conduct in prom ptly rep o rtin g this m atter to the Com m ission an d th eir cooperation in developing all of the facts an d in prom ptly offering to con trib u te th e full am ount of the in v en to ry sh o rtag e is com m endatory. C onsidering all of these facts, an d in view of the ad v e rse publicity w hich th e firm has received in A ccounting S eries R elease N o. 64, I find no reaso n to recom mend th at the privilege of B arrow , W a d e , C uthrie & Co to practice before the Commission be suspended tem porarily or perm a nently, an d I th erefo re recom m end th a t the proceeding as to B arrow ,
W a d e , C uthrie & Co. be dismissed. H e n ry H . D alton
T h e Los A ngeles office of B arrow , W a d e , C uthrie & Co. had for some time p rio r to the D ra y e r—H an so n au d it been u n d erstaffed . D uring the w a r y ea rs an d subsequent thereto, D alton w as the only certified public acco u n tan t in the office an d the en tire responsibility for all o f the w ork of th a t office had rested on him. H e h ad h ad no re g u la r v acations for eight y e a rs an d in 1946 a t the time of this audit, he w as
6) In the Matter of Interstate Hosiery Mills, Inc., 4 S.E.C. 706. See also In the
Matter of McKesson & Robbins, Inc., Accounting Series Release No. 19.
m entally an d physically exhausted. In the reco rd in this case th ere is no evidence th a t he w as ever ch a rg ed w ith an y professional m iscon duct. In addition, the absence of m ore a p p ro p riate suggestions from his superiors, the o p p o rtu n ity for w hich clearly existed, m ust be view ed as highly im portant.
From my o bservation of D alto n a t the h earing an d his frankness in fully adm itting his faults in this case, I am satisfied th a t he has been sufficiently im pressed as to the seriousness of this m atter an d th a t fu r th e r disciplinary action is n o t n ecessary. C onsidering his p a st record, th e evidence of his m ental an d physical exhaustion a t the time of the D ra y e r—H an so n au d it an d the penalties to w hich he has a lre a d y been subjected, I believe the Com mission m ight w ell dism iss the p resen t p ro ceeding as to him, an d I so recom m end.
E ve rett L. M angam
T h e evidence establishes th a t M angam w as negligent in his ap p lica tion of the alte rn a te auditing p rocedures w hich he h ad outlined. H o w ever, he w as no t responsible for proceeding w ith the au d it w ithout requiring a physical in v en to ry because such pro ced u re w as established a t the time he en tered upon this engagem ent. H e testified th a t this w as th e first time he h ad ev er conducted an au d it w ith o u t requiring com plete physical inventories. W h ile he w as recognized by B arrow , W a d e , C u th rie & Co as being a capable an d efficient accou n tan t, this high re g a rd m ust of course be view ed in th e light of the recom m endation for his assignm ent to the Los A ngeles office in a su b o rd in ate capacity. W h e re the circum stances w ere such as has been disclosed in this case, a n d a p a rt from w h a te v er norm al p ractice m ight be, it seem s clear th a t M angam h ad the rig h t to expect th a t such p rocedures as he outlined a n d the execution of them as he re v ealed them w ould be carefully su p er vised an d checked by his superior. T h e re is no indication th a t M angam w ithheld a n y inform ation from his superior. H e d irected the atten tio n of his superior from time to time to the conditions w hich co nfronted him an d to the difficult problem s w ith w hich he w as confronted. H av in g in m ind th a t this w as his first experience on a com plicated an d difficult auditing engagem ent, an d th a t he h ad good reason to feel th a t such steps as he took w ere being su pervised an d checked by, presum ably, a capable an d able superior, he m ight w ell h av e believed th a t he had p roceeded as far as w as p roper a n d necessary . U n d e r all of the circum stances, I do no t believe M a n g a m ’s conduct w a rra n ts an y disciplinary action b y the Commission.
W h ile recom m ending th a t the proceedings a g a in st all of the resp o n dents be dism issed, it seems highly d esirable th a t the public, an d p a rtic u larly the accounting profession, be inform ed th a t w h ere a firm of public acco u n tan ts perm its a re p o rt or certificate to be executed in its nam e the Commission will hold such firm fully accountable. If the proceedings a re dism issed, it is m y fu rth e r recom m endation th a t th e Com m ission m ake public the en tire reco rd in this case an d publish a statem en t in dicating in ap p ro p riate detail the facts in the case an d the reasons for th e C om m ission’s determ ination.
