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From Securities Regulation Daily, December 13, 2013

Three accountants barred from SEC practice for failure to complete surprise examinations

By Amanda Maine, J.D.

The SEC issued an order instituting public administrative proceedings against three accountants who participated in surprise inspections of a registered investment adviser. According to the SEC, the accountants failed to conduct field work, prepare and issue a surprise exam report or file Forms ADV-E, rendering the exams incomplete. In settling the matter, the accountants agreed to be barred from appearing or practicing before the SEC as accountants (In the Matter of Smith, et. al., December 12, 2013).

Background. Freedom One Investment Advisors, Inc., a formerly registered investment adviser, engaged UHY LLP to perform surprise exams as required by the Investment Advisers Act. Under Rule 206(4)-2, (the custody rule) as it was written at the relevant time, required Freedom One to send quarterly account statements to each client for which it maintained funds or securities and to obtain an annual surprise examination by an independent public accountant to verify all of the client funds and securities. Freedom One engaged UHY to complete its surprise exams for 2006 and 2008.

Rodney A. Smith, Michael Santicchia and Stephen D. Cheaney participated in the surprise exams. Smith was a member of the engagement teams for both the 2006 and 2008 exam and was terminated from UHY in November 2008. Santicchia has been a long time parter at UHY and was also a member of the engagement team for both exams. After Smith left the firm, Santicchia assigned Cheaney to replace Smith on the 2008 exam.

Failure to complete exams. According to the SEC, while the engagement team did complete some field work for the 2006 and 2008 surprise exams, it failed to complete them in accordance with standards established by the AICPA and the SEC. Under these standards, the accountant must make a physical examination of securities and obtain confirmation as appropriate, obtain confirmation of funds on deposit in banks, and reconcile the physical count and confirmations to the books and records. According to the SEC, the engagement team, on both exams, did not obtain confirmation of securities or funds held by Freedom One’s custodians and did not send any confirmation requests to Freedom One’s clients. As a result, they also could not properly reconcile the confirmations to the books and records, the SEC alleged.

The SEC also alleged that Smith, Santicchia and Cheaney failed to ensure that reports were issued for the surprise exam, or, alternately, that they failed to withdraw from the engagements and notify the client. In addition, they also failed to file a Form ADV-E with the SEC as required by the custody rule in effect at the time.

Failure to exercise due professional care. According to the SEC, Santicchia and Cheaney failed to exercise AICPA standards of due professional care. They did not have adequate knowledge or understanding of the custody rule and its requirements, the SEC alleged. They had never before conducted a surprise exam and they did not consult with anyone from their own firm who had conducted a surprise exam. Santicchia and Cheaney did not have any prior experience or training regarding the custody rule or surprise exams and they did not determine or consider the requirements for the exams. In addition, Santicchia did not understand that the surprise exam was being conducted pursuant to the custody rule. Santicchia and Cheaney did not even follow their own accounting firm’s quality control, planning and supervisory procedures, the SEC alleged.

Charges and settlement. The SEC instituted administrative proceedings against the three respondents for causing Freedom One’s violations of Advisers Act Section 206(4) and Rule 206(4)-2 for the exams in which they were involved. The SEC also alleged that Smith aided and abetted Freedom One’s 2006 violations of those provisions. In addition, the SEC alleged that Santicchia and Cheaney engaged in improper professional conduct within the meaning of Exchange Act Section 4C and Rule 102(e)(1)(ii) of the Commission’s Rules of Practice.

The Commission accepted the respondents’ offers of settlement, under which they are barred from appearing or practicing before the Commission as accountants. Santicchia and Smith may apply for reinstatement after three years. Cheaney may apply for reinstatement after two years.

The release is No. 34-71070.

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