- The SEC Erred In Applying GAAS Audit Requirements To Potts' Conduct.
Having erroneously concluded that SECPS guidance for concurring review was part of GAAS, the SEC majority then erroneously construed the duties of an SECPS concurring partner, and imposed on Potts the responsibilities of a partner-in-charge under GAAS. It was his failure to do what he was not required to do that the majority held was sanctionable misconduct. For example, the SEC majority asserted that Potts, as concurring partner, was required to:
"Probe" the partner-in-charge, Melsen, to test the reasonableness of Melsen's assessment that Kahler was committed to disposal of UPH after Melsen met with Kahler's audit committee. Potts, slip op. at 14.
Suggest that Melsen speak directly with the potential buyers of an interest in UPH. Id.
Ask Melsen for documentary evidence supporting his statements. Id.
Ascertain that sufficient competent audit evidence relating to valuation of UPH supported Kahler's deferral of UPH operating losses, although the Top File included a document prepared by a Touche Ross senior manager verifying the valuation of UPH, and Melsen had communicated that Kahler's audit committee was comfortable with the valuation. Id. at 15-16 & n.35.
Conclude that formal audit committee minutes in the Top File, reflecting the numbers and assumptions that committee concluded were reasonable with respect to the valuation, was insufficient competent evidential matter of Kahler's intent to sell, under Standard of Field Work 3 applicable to auditors.
Challenge Melsen's statement that changes in the UPH valuation were made to correct errors in the valuation by Touche Ross's Chicago Valuation Office. Id. at 16.
All these measures — even if the majority were correct that they should have been taken — are not the responsibilities of a concurring partner under the SECPS guidelines. The SECPS's guidance as to the duties of a concurring partner describes a limited range of duties which do not include participation in the audit itself:
The concurring reviewer's responsibilities should include reading the financial statements and the firm's report thereon and making an objective review of significant accounting, auditing or reporting considerations. Such review should ... include discussions with the partner-in-charge of the engagement and review of selected working papers. The extent of working paper review is a professional judgment which has to be made by the reviewer and will vary with the particular circumstances of each engagement.
AICPA, SECPS, Appendix E (October, 1988). The majority does not suggest that Potts failed to comply with these guidelines in themselves. See Potts, slip op. at 23 n.55. The findings all erroneously measure Potts' conduct by GAAS's audit requirements, and every finding of misconduct is accompanied by citation to GAAS, promulgated by the AICPA and applicable, in terms, to auditors.
The majority concedes that
[a]s an initial matter, we agree with Potts that he, as concurring partner on the audits, did not act unreasonably when he was satisfied initially with his partner Melsen's indications that Kahler intended to dispose of its entire interest in [UPH]. We also agree that Potts, upon becoming aware of audit documentation and his partner's concerns that Kahler planned to sell only a partial interest, acted reasonably in meeting first with [Kahler's CEO] and then in directing Melsen to inquire further about Kahler's intentions regarding the hotel.
Potts, slip op. at 13-14. The misconduct found by the majority consisted only in Potts' failure to take additional steps after the partner-in-charge had investigated, with Potts' supervision, their concerns regarding the accounting treatment of UPH, and had explained to Potts that he was satisfied. The additional steps required by the majority would improperly substitute Potts' judgment for that of the partner-in-charge, and would impose upon Potts the undelegable responsibility of the partner-in-charge.
The error of the SEC majority's analysis of Potts' conduct under GAAS is highlighted by its insistence that Potts should have applied "professional skepticism" to the statements made to him, not by Kahler, but by the partner-in-charge, Melsen. Under the SECPS guidelines, the concurring reviewer is not to assume the partner-in-charge's responsibility, but to act in an advisory, concurring capacity. The "objective review" and "discussion" referred to in the guidelines did not mandate that Potts replace the partner-in-charge's judgment with his own as the result of a skepticism as to Melsen's candor or his ability to perform his duties. Such an audit of the audit is neither required nor permitted by the SECPS guidelines.
Further, the majority's repeated insistence that Potts should have obtained audit evidence graphically illustrates the majority's confusion of the responsibility of the audit engagement team with that of the concurring partner. Under the SECPS guidelines, the extent of the concurring partner's review of the evidence obtained is left to his professional judgment in the circumstances. The duty to obtain "sufficient competent evidential matter" (1 AICPA, AICPA Professional Standards, AU 150.02 (1997)), or to obtain further evidence in certain cases (id. 150.04), or to assess its source (id. 326.19), remains that of the audit team and ultimately the partner-in-charge. The SEC majority found noncompliance with each of these inapplicable duties to be improper professional conduct by Potts. See, e.g. , Potts, slip op. at 14 & n.30, n.31, n.32.
In all of this, the SEC effectively announced and applied a changed set of standards for reviewing partners, unintended by the SECPS regime and inconsistent with it. Those new standards offer no useful guidance to reviewing partners except that they can only be safe if they largely re-do the audit. That, in turn, prohibitively overburdens the reviewing partners, their firms, their clients who must pay for the redundant work, and those firms whose resources make such an endeavor impractical and are thus foreclosed from auditing public companies. And it undermines the most important single safeguard of the integrity of the audit process — the undiluted authority and responsibility of the CPA partner-in-charge who signs the audit opinion.
THE SEC ERRED IN FAILING TO CONSIDER WHETHER POTTS' CONDUCT PRESENTED A FUTURE THREAT TO SEC PROCESSES.
The current Commission is divided on the question of what state of mind is required for sanctions of accountants under Rule 2(e).7 See Potts, slip op. at 27; Checkosky, Exchange Act Release No. 31,094, 52 S.E.C. Docket 1122, 1133, 1992 WL 211479, at *12 (Aug. 26, 1992) (Checkosky I ); Checkosky v. SEC, 23 F.3d 452, 454 (D.C. Cir. 1994); Checkosky, Exchange Act Release No. 38,183, 63 S.E.C. Docket 1691, 1700, 1997 WL 18303, at *10 (Jan. 21, 1997) (Checkosky II ); see also Carter, Securities Act Release No. 17,597, [1981 Transfer Binder] Fed. Sec. L. Rep. (CCH) 82,847, at 84,172-73 (Feb. 28, 1981).