The SEC accepted a proposed settlement under which the accountants admitted no wrongdoing but in which Merkley, managing partner from 2005 through 2008, and Price, who was promoted to partner in 2006, accepted suspensions from SEC practice for three years and two years respectively. The charges involve violation of SEC and PCAOB rules of practice. Merkley was engagement partner on the HSOA account from 2003 through 2006. Price was manager on the 2004 and 2005 audits, the 2005 and 2006 reviews and engagement partner for the first two quarters of 2007. The SEC also required the firm to improve its audit processes and required each audit professional take 16 hours of training regarding audits and 8 hours about fraud detection.
Last fall, settlements were accepted with seven individuals, including six former HSOA officers, regarding the alleged fraud in the company's financial statements for 2004, 2005 and 2006. The initial complaints primarily involved the failure of HSOA, a remediation and construction company, to accrue year-end bonuses which were paid out during the following year. KMJ questioned and gave conflicting views on the bonuses, according to the complaint regarding the accountants.
However, the SEC documents noted that the KMJ "partner" sent the company an email with the following message. "I don't feel comfortable this year in allowing this amount to be recorded in 2006 - all my instincts and experience tells me that any reasonable outsider/stakeholder looking at this transaction would believe it to be (and expect it to be) a 2005 transaction. . .. it's now time to get the accounting right."
In this case and in several others the accountants yielded to management positions until finally, KMJ concluded it could not rely on management's statement and resigned as auditor on Feb. 9, 2009. HSOA had been delisted in 2008
Things escalated in 2006, the year KMJ concluded HSOA, then based in Dallas but now headquartered in New Orleans, lacked effective internal controls. However, the SEC said the auditors failed to adequately test revenue from two subsidiaries, which comprised 57 percent of the client's annual income after deciding to rely on percentage of completion accounting, but didn't perform adequate testing. SEC said also that the firm failed to pick up on fictitious and premature revenue from a significant customer, acquisition targets and related parties even though some short-comings should have been easy to detect.
This included the recognition of $8.4 million in revenue from Fireline Restoration Services, just before HSOA acquired the company. The revenue was based on a purported transaction negotiated with Brian Marshall, president of Fireline. Not only did KMJ not question the deal's abnormally high margin, the auditors missed the fact that Fireline's accounts payable and accrued liabilities for June 30 and Sept. 30, 2006 were less than $8.4 million. Fireline also used backdated customer contracts while a series of out-of-sequence invoices appeared for services performed by another subsidiary, Associated Contractors.
The settlement with the executives last year will prove very expensive for them. Former CEO Frank J. Fradella and former CFO Jeff Mattich have to reimburse the company for all bonuses any incentive-based of equity-based compensation and the proceeds of the sale of HSOA stock. The SEC said Fradella dumped about $8.6 million in stock just before the price of shares collapsed in 2006. He also received just more than $1.5 million in bonuses and stock compensation in 2005 and 2006. A Texas Court has yet to assess civil penalties and prejudgment interest.
In December, Rick O'Brien, who was CFO through 2006 and then became COO, agreed to pay a $130,000 penalty while former Fireline controller Stephen Gingrich, a former CPA, agreed to pay a $25,000 penalty and was barred from practicing before the SEC for three years. A class action suit has already resulted in a settlement fund of $3.5 million.
The firm cannot accept new public audit clients until it receives a certificate of compliance of SEC terms or March 11, whichever is later. The firm must designate a partner who is responsible for risk management. KMJ has to improve policies and procedures regarding sampling, consultation and documentation. It has to ensure its policies are likely to detect illegal client activity and report such activity and procedures comply with PCAOB Auditing Standard No. 7, Engagement Quality Review.