SEC censures Schulman Lobel for deficient audit engagements

SL was registered with the Public Company Accounting Oversight Board (PCAOB) up until March 10, when it withdrew its registration. Prior to its withdrawal, SL served as QFOR’s auditor from April 2015 until resigning in October 2016 and completed audits of QFOR’s financial statements for the years ended 2013, 2014, and 2015 and reviews of QFOR’s interim financial information for each quarter of 2015 and the first two quarters of 2016. SL also completed an audit of QFOR’s amended financial statements contained in the 2015 Form 10-K/A filed in September 2016.

According to the SEC’s April 15 administrative proceeding, between at least June 2012 and November 2016, QFOR CEO Nandu Thondavadi and CFO Dhru Desai “used several fraudulent means to overstate QFOR’s revenue, overstate its assets, understate its liabilities, and conceal their misappropriation of at least $4.1 million. Among other things, they caused QFOR to enter into undisclosed related-party transactions, misstated the terms of various acquisitions, and concealed liabilities through a variety of means.”

In April 2015, QFOR’s previous auditor resigned after discovering that QFOR had issued fraudulent invoices and that unknown individuals affiliated with QFOR had returned false audit confirmations to them. That’s when QFOR engaged SL.

SL ultimately resigned as QFOR’s auditor in October 2016, “citing concerns about the firm’s ability to rely on management’s representations.” Thondavadi and Desai were arrested on federal charges, including wire fraud and certifying false financial reports in November 2016, and resigned from QFOR shortly thereafter.

After the arrests, QFOR filed a Form 8-K in December 2016 announcing that the board of directors had concluded that QFOR’s financial statements for the previous three years did not fairly present the financial condition of the company, required restatement, and should no longer be relied upon. No restatement occurred.

In June 2017, the SEC charged QFOR, Thondavadi, and Desai in the accounting fraud scheme. That same month, QFOR filed for bankruptcy and has since been liquidated.

SL audit failings

The SEC administrative order goes into significant detail about how SL failed to comply with PCAOB standards on numerous fronts. Specifically, according to the administrative proceeding, SL failed to:

• Obtain sufficient appropriate audit evidence;
• Conduct appropriate procedures to obtain reasonable assurance that the financial statements were free of material misstatements caused by fraud;
• Conduct appropriate procedures upon the subsequent discovery of facts existing at the date of a previous audit report;
• Conduct appropriate procedures in connection with a review of interim financial information;
• Properly plan the audit and assess and respond to risks of material misstatement;
• Conduct proper engagement quality reviews;
• Exercise due professional care and professional skepticism; and
• Maintain an adequate system of quality control, including policies and procedures regarding engagement acceptance and continuance as well as supervision, review, and approval.

Additionally, the administrative proceeding stated that SL willfully violated Section 10A(a)(2) of the Exchange Act when it conducted the 2013 and 2015 Form 10-K/A audits without including procedures that were adequately designed to identify related-party transactions and willfully violated Rule 2-02(b)(1) of Regulation S-X when it stated that the 2013, 2014, and 2015 Form 10-K/A audits were conducted in accordance with PCAOB standards when they had not been.

Deficient policies and procedures

According to the SEC, in 2014 SL hired a new director of quality control who, along with SL’s managing partner, was responsible for administering and monitoring SL’s system of quality control. The director of quality control, however, had “limited experience conducting public company audits, and SL’s managing partner had no public company audit experience.”

Thus, SL’s policies and procedures regarding engagement acceptance and continuance were deficient, “because they placed the ultimate authority for decisions on engagement acceptance and resignation, as well as engagement staffing, with personnel who lacked the experience and expertise necessary to make those decisions,” the administrative proceeding stated.

The SEC also described how SL failed to adopt and implement adequate policies and procedures regarding audit planning and risk assessment, as well as adequate policies and procedures governing supervision, review, and approval. SL further failed to adequately monitor the design and application of its system of quality control, the administrative proceeding stated.

Additionally, the director of quality control, for every audit engagement, reviewed and maintained copies of workpapers that the engagement partner or engagement principal was required to sign to document approval of the release of an audit report. “These workpapers were incomplete for each of the QFOR audit engagements,” the administrative order stated. “The director of quality control knew or should have known that the engagement team had not documented the engagement principal’s approval of the release of the audit report for any of the QFOR audits, as required by the firm’s quality control document, yet he took no action.”

SL must pay the SEC disgorgement in the amount of $24,500; prejudgment interest of $4,010.29; and a civil money penalty of $70,000.