Washington, D.C., July 20, 2007 – LAWFUEL – The Law Newswire – The Securities and Exchange Commission today brought settled enforcement actions against four former executives at SmartForce PLC, the company’s former outside auditor, and its former audit engagement partner in connection with the software company’s overstatement of revenue by $113.6 million and net income by $127 million during a 3½-year period ending in mid-2002.
SmartForce, which was based in Redwood, Calif., has since merged into SkillSoft PLC. According to the Commission, SmartForce’s financial statements failed to comply with generally accepted accounting principles (GAAP) by, among other things, recognizing revenue improperly from various types of transactions in which the company engaged, including multiple-element arrangements, reciprocal transactions, and reseller agreements.
The Commission instituted both administrative and civil actions against former SmartForce Chief Financial Officer David C. Drummond and two former vice presidents of finance, Patrick E. Murphy and John P. Hayes. The Commission filed an injunctive action against Patrick T. Chew, former controller of SmartForce’s subsidiary in the United States (“SmartForce US”). The four former SmartForce executives will pay a total of $2.3 million in disgorgement, interest, and penalties.
David P. Bergers, Director of the Commission’s Boston Regional Office, said, “Recognizing revenue without sound, rigorous analysis is a recipe for false financial statements. Officers must ensure the financials are accurate, and cannot hand off that fundamental responsibility to their subordinates, the auditors, or anyone else.”
The Commission also instituted proceedings against Ernst & Young Chartered Accountants and the lead partner on the SmartForce engagement, Denis O’Hogan, for engaging in improper professional conduct in connection with multiple audits and periodic reviews of SmartForce’s financial statements. Ernst & Young Chartered Accountants were censured and agreed to pay $725,000, an amount equal to its audit fees. The firm, based in Dublin and a member firm of Ernst & Young Global, also agreed to make several enhancements in its audit practices of U.S. public companies in areas such as training and staffing of engagements.
“Global audit quality is crucial for the protection of investors, and a key to audit quality is the need for auditors to obtain sufficient evidence to support their audit opinions,” said Walter G. Ricciardi, the Commission’s Deputy Director of Enforcement. “Audit firms anywhere in the world engaged by U.S.-listed companies are required to provide their personnel with sufficient training to fulfill this vital role at the heart of the auditor’s mission, and if they fail, sanctions will be imposed.”
The civil actions against Drummond, Murphy, Hayes, and Chew were filed in the United States District Court of New Hampshire, where SkillSoft PLC, the successor firm to SmartForce following a 2002 merger, is based. Drummond, Murphy, and Hayes each consented to the issuance of a Commission Order and a final judgment in federal court while neither admitting nor denying the Commission’s findings and the allegations in the Commission’s District Court Complaint. Chew consented to entry of the judgment without admitting or denying the allegations of the Complaint.
According to the Commission:
Drummond, as the Chief Financial Officer, was ultimately responsible for SmartForce’s financial statements. Drummond’s violations arose in part out of his failure to determine whether SmartForce was improperly recognizing revenue (which it was) on a reseller agreement in which the reseller of SmartForce’s product was only required to “endeavor” to sell the software. In addition, Drummond failed to communicate certain information about a reciprocal transaction to the appropriate accounting personnel and took no steps to determine whether the accounting for that transaction complied with GAAP. Consequently, SmartForce improperly recognized revenue on the transaction.
As vice presidents of finance, Murphy and Hayes, both Irish citizens, were primarily responsible for the accounting decisions at SmartForce and for making sure that such accounting complied with GAAP. On several occasions, Murphy and Hayes improperly concluded that the company could recognize revenue up-front on software sales, including on agreements with resellers of SmartForce’s products and multiple-element arrangements. They also allowed the company to recognize excess revenue on reciprocal arrangements.
Chew, a resident of Ontario, Canada, was responsible for recognizing revenue on standard agreements at SmartForce US, which generated 70 percent of SmartForce’s business. Chew caused SmartForce to improperly recognize revenue from two non-binding reseller agreements and from a transaction for which no product was delivered to the customer. Chew also made materially misleading statements and omissions to SmartForce’s auditors concerning the circumstances surrounding the non-binding reseller agreements.
The Commission’s sanctions against O’Hogan included a 2-year suspension from practicing before the Commission. O’Hogan and Ernst & Young Chartered Accountants settled their actions neither admitting nor denying the Commission’s findings.