An Old Case Is Returning to Haunt Auditors
The New York Times
March 1, 2002
FLOYD NORRIS
There is a rhythm in the law, in
which principles and precedents
from one era can lie fallow for decades
only to be rediscovered as conditions
become similar to those that prompted
a judge's decision in the first place.
So it is now with the 32-year-old case
of United States v. Simon, in which
three auditors were found guilty of
fraud after they certified the
fraudulent financial statements of a company, the Continental Vending Machine
Corporation, which soon went bankrupt.
The conviction was upheld by the United States Court of Appeals for the Second
Circuit, in an opinion by Judge Henry J. Friendly. When he died in 1986, Judge
Friendly was praised by Richard A. Posner, another appellate judge, as "the most
distinguished judge in this country during his years on the bench."
In the Simon case, the auditors had expert witnesses from leading accounting
firms testify that they had complied with generally accepted accounting principles
and that such compliance was all that could be expected. But the court found
otherwise.
"Judge Friendly held that if literal compliance with GAAP creates a fraudulent or
materially misleading impression in the minds of shareholders," Harvey L. Pitt, the
chairman of the Securities and Exchange Commission, said in a recent speech,
"the accountants could, and would, be held criminally liable."
The fact that Mr. Pitt is citing the case has drawn a lot of
attention from accountants. So did a statement by Charles
Niemeier, the chief accountant of the S.E.C.'s enforcement
division, that broached the same principle without
mentioning the Simon case.
Some find the idea outrageous. "I am troubled by the
S.E.C.'s recent assertion that one can violate S.E.C. laws
even while fully complying with GAAP," said
Representative Cliff Stearns, the chairman of a House
subcommittee, as he opened a hearing on the accounting
issues raised by Enron (news/quote)'s collapse. He
complained about a "burdensome standard" for auditors.
But it is the law.
The Simon decision received a lot of attention when it was
issued in 1970, a time when falling stock prices and
accounting frauds had outraged the public, but it largely
fell from view as the 1990's bull market advanced. "The
social context is everything," said Jack Coffee, a securities
law professor at Columbia University. "It does not surprise
me that Simon is being resurrected a couple of years after
a bubble."
There are echoes of the Simon case in Enron. A footnote
in Continental Vending's annual report disclosed just
enough to arguably comply with the accounting rules but
left out information crucial to understanding what had
truly happened. "The jury," Judge Friendly wrote, "could
reasonably have wondered how accountants who were
really seeking to tell the truth could have constructed a
footnote so well designed to conceal the shocking facts."
The same could be said about the Enron footnotes
regarding partnerships run by its chief financial officer at
the time, Andrew S. Fastow.
Although you wouldn't know it from listening to
accountants moan about the Simon revival, there is a rule
- Article 203 of the accountants' Code of Professional
Conduct - that says auditors may depart from GAAP to
prevent financial statements from being misleading. It may
be the most ignored rule in accounting.
The defendants in the Simon case - Carl J. Simon,
Robert H. Kaiser and Melvin S. Fishman, all auditors with
Lybrand, Ross Bros. & Montgomery, a predecessor of PricewaterhouseCoopers -
paid small fines and were eventually pardoned by President Richard M. Nixon. But
the echoes of that case now provide a warning to auditors that it is risky to certify
misleading financial statements, even if the company has found ways to twist
accounting rules.
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