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From Securities Regulation Daily, December 18, 2014

Auditors OK'd financial statements that did not adequately disclose related-party transactions

By Rodney F. Tonkovic, J.D.

An audit firm and two of its principals were sanctioned for improper professional conduct regarding related-party transactions. During an audit, an audit firm and two of its principals failed to respond appropriately to information that the company had engaged in 176 related-party transactions in 2009. Contrary to GAAP, the firm's financial statements did not disclose these transactions, but the auditor nevertheless issued an audit report containing an unqualified opinion on the company's 2009 financial statements. The Commission issued a cease and desist order and monetary sanctions, and the principals were suspended from practice as accountants (In the Matter of Baker Tilly Hong Kong Limited, Andrew David Ross, CPA, and Kwok Laiha Helena, CPARelease No. 34-73862, December 17, 2014).

Background. Baker Tilly Hong Kong Limited is a PCAOB-registered audit firm located in Hong Kong. Andrew Ross and Kwok Laiha Helena (a/k/a Helena Kwok) were Baker Tilly directors, the equivalent of a partner at a U.S. firm. In 2010, Baker Tilly was retained to audit the December 31, 2009 financial statements of China North East Petroleum Holdings Limited (CNEP), a Nevada corporation that operated in China.

In mid-2010 CNEP's audit committee learned of material related-party transactions among CNEP, its CEO, the CEO’s mother, and others. The company retained a forensic accounting firm and accepted the resignation of the CEO and his mother, who was also a CNEP director. The forensic accounting firm's report identified 176 related-party transactions and found numerous red flags and deficiencies in CNEP's internal controls. The Commission charged CNEP with fraud arising out of these transactions in late 2012.

Violations. According to the Commission, Ross, Kwok, and the engagement team received the forensic report, but did not adequately review it, revise their audit planning on fraud risks, or audit the related-party transactions in accordance with PCAOB standards.  When CNEP's financial statements were filed as part of its 2009 Form 10-K, the related-party transactions were not described in detail, disclosing only that the company owed a stockholder $89,269. Baker Tilly, however, issued an audit report containing an unqualified opinion that was filed with CNEP’s financial statements.

Sanctions. The Commission found that the respondents engaged in improper professional conduct by failing to plan, design, and carry out audit procedures to identify the company’s material, related-party transactions that required disclosure in its financial statements. Baker Tilly, Ross, and Kwok were ordered to cease and desist from violations of Exchange Act Section 10A(a)(2), which covers audit procedures to identify related-party transactions. The firm was censured, and Ross and Kwok were suspended from practice as accountants for three years. Baker Tilly was ordered to disgorge $75,000, plus prejudgment interest of $9,101. Ross was ordered to pay a civil penalty in the amount of $20,000, and Kwok was ordered to pay $10,000.

Antonia Chion, an Associate Director in the SEC’s Division of Enforcement said: "Auditors play a critical gatekeeper role in our financial markets, and Baker Tilly failed to uphold U.S. auditing standards and exercise appropriate professional care and skepticism with regard to numerous related-party transactions."

The Release is No. 34-73862.

Companies: Baker Tilly Hong Kong Limited; China North East Petroleum Holdings Limited

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