UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 41255 / April 5, 1999 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 1123 / April 5, 1999 ADMINISTRATIVE PROCEEDING File No. 3-9864 _____________________________________ : In the Matter of : ORDER INSTITUTING PUBLIC : ADMINISTRATIVE PROCEEDINGS : AND OPINION AND ORDER PURSUANT FREDERICK R. GRANT, CPA, : TO RULE 102(e) OF THE : COMMISSION'S RULES OF PRACTICE Respondent. : _____________________________________: I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest to institute public administrative proceedings against Frederick R. Grant ("Grant"), a certified public accountant, pursuant to Rule 102(e)(1)(ii) [1] of the Commission's Rules of Practice [17 C.F.R. Section 201.102(e)(1)(ii)]. II. In anticipation of the institution of these proceedings, Grant has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purposes of these proceedings and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying any of the findings herein, except that Grant admits the findings contained in paragraph III. B. below and he admits the Commission's jurisdiction over him and the subject matter of these proceedings, Grant has consented to the issuance of this Order Instituting Public Administrative Proceedings and Opinion and Order Pursuant to Rule 102(e) of the Commission's Rules of Practice ("Order"). Accordingly, IT IS ORDERED that proceedings pursuant to Rule 102(e) of the Commission's Rules of Practice be, and hereby are, instituted. III. On the basis of this Opinion and Order, and the Offer, the Commission finds that [2]: A. Sky Scientific, Inc. ("Sky") was at all relevant times a California corporation headquartered in Boca Raton, Florida. Sky's common stock has been registered with the Commission pursuant to Section 12(g) of the Securities Exchange Act of 1934 ("Exchange Act") since August 1990. At all relevant times, Sky purported to be in the businesses of mining and processing precious metals and financial services. Sky's fiscal year end is February 28. B. Grant, age 59, is a CPA licensed in Florida and New York and was previously licensed in Pennsylvania. He is a partner with the Boca Raton, Florida, firm of Grant-Schwartz Associates, CPAs. Grant acted as the engagement partner on the audit of Sky's fiscal 1995 financial statements and on a reaudit of Sky's fiscal 1994 financial statements. Grant practiced before the Commission pursuant to Rule 102(f) of the Commission's Rules of Practice. [3] C. The 1995 Audit The audit performed by Grant for Sky's fiscal year ended February 28, 1995, failed to detect that the financial statements were not prepared in conformity with Generally Accepted Accounting Principles ("GAAP") in connection with issuance of Form S-8 and restricted stock, the carrying value of one mineral property held as an asset, and the values assigned to several other material assets acquired during fiscal 1995. Grant also failed to obtain sufficient competent evidential matter to support the recorded value of each of the above items. 1. Form S-8 and Restricted Stock During fiscal 1995, Sky issued 66,801,763 shares of Form S-8 and restricted common stock, increasing its outstanding common stock by 400% over fiscal year end 1994. Sky issued the Form S-8 stock to purported consultants, and the restricted stock to various individuals including officers of the company, either at no cost to them or at prices far below the prevailing Nasdaq bid. By analogy, Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, ¶ 10, addresses the proper accounting treatment for Form S-8 stock issued to consultants: "Measuring Compensation for Services. Compensation for services that a corporation receives as consideration for stock issued through employee stock options, purchase, and award plans should be measured by the quoted market price of the stock at the measurement date less the amount, if any, that the employee is required to pay." Based on the principles set forth in APB No. 25, Sky improperly accounted for these stock issuances. Sky recorded the Form S-8 stock at the amount of cash received from the consultants rather than at its market value. The difference between the market value of the stock and the recorded amount should have been accounted for as consulting expense, in- creasing Sky's reported net loss from operations from $4,699,573 to $11,533,735. In addition to the Form S-8 stock, Sky issued and recorded 17,889,500 restricted shares at .001¢ per share (or $17,889.50) to an officer of the company and its employees, as well as a stock promoter and his nominees. However, these shares had a market value of approximately, $13,600,000 (before taking a discount due to their restricted nature) on their issue date. Due to the restricted status of the stock, some appropriate discount should have been taken before recording. Assuming a discount rate of 25% to 50%, Sky should have recorded additional compensation expense ranging from approximately $6,800,000 to $10,200,000. This, too, would have been material to Sky's reported net loss from operations of $4,699,573. 2. Carrying Value of Mineral Property Grant failed to detect that the recorded value of the mineral property was not in conformity with GAAP. Sky entered into a mining lease and option to purchase agreement with Danner Mines, Inc. ("Danner"), a closely held private company, on April 14, 1992. The purchase option was exercised on January 28, 1994 and Sky issued 1,400,000 shares of $10.00 per share face value Class "A" Convertible Preferred Stock, non-voting. This stock was never traded and the $10 value was arbitrarily assigned. As additional consideration, Sky issued a promissory note in the amount of $2,000,000 to Danner. Sky recorded the property at its contract price, which was based primarily on the arbitrarily-assigned face value of the Class "A" Convertible Preferred Stock which Sky issued in exchange for the property, plus the face value of the promissory note. Sky's method of valuing the property did not accord with GAAP because the property should have been valued at a reliably determinable fair value, not at the face value of the preferred stock and the note. APB No. 16, ¶67c, provides in pertinent part that: "An asset acquired by issuing shares of stock of the acquiring corporation is recorded at the fair value of the asset - that is, shares of stock issued are recorded at the fair value of the consideration received for the stock.' [footnote omitted]. As further explained in ¶67, when the fair value of an asset received for stock may not be reliably determinable, the asset should be stated at "cost" - i.e., "either by the fair value of the consideration given or by the fair value of the property acquired, whichever is the more clearly evident." Under these circumstances, neither the fair value of the mineral property nor the stock and note issued was reliably determinable. Thus, no value at all, or only a nominal value of say $1.00, should have been assigned to the asset or the stock and note issued for the asset.[4] Grant failed to detect that the recorded value of the Danner Mine was not in conformity with GAAP. As of the end of fiscal 1995, Sky continued to carry the Danner Mine at its previously recorded value of $16,000,000. Grant reviewed the method used to value the Danner Mine as part of his audit, but erroneously concluded that the method conformed with GAAP. Grant's audit work papers reflect that he talked to the predecessor auditor and learned that he had visited the mine. Grant also obtained some 1992 Sky correspondence it received from an accounting firm that discussed the general valuation of mineral properties. Even though the correspondence was not related to the Danner Mine, Grant relied on it to conclude that the Danner Mine was properly recorded. 3. Other Material Assets Sky acquired four material assets during fiscal 1995, totaling $16,017,500 (representing 41% of total assets). [5] Each asset was acquired by issuance of Class "A" Convertible Preferred Stock valued at $10 per share. Grant's audit work papers for three of the assets consisted of a copy of the purchase agreement; there was no purchase agreement or any other documentation in the work papers for the fourth asset. Grant did no audit testing to establish whether the assets were properly valued in conformity with GAAP. [6] 4. Grant's Audit Failed to Comply with GAAS Grant's audit failed to comply with Generally Accepted Auditing Standards ("GAAS") in that he: a) failed to obtain sufficient competent evidential matter to support the carrying value of the Danner mine; b) failed to obtain sufficient competent evidential matter to support the recorded value of the other material assets acquired by Sky, including certain artwork and pre-paid advertising time; and c) failed to comply with the requirements relating to reliance upon the work of a specialist with respect to his audit of Sky's acquisition of the artwork. D. The 1994 Reaudit Grant performed the 1995 audit and issued an audit report dated June 8, 1995 to be included in Sky's 1995 Form 10-KSB. However, Sky's predecessor auditor refused to consent to the further use of his fiscal 1994 audit report for inclusion in Sky's 1995 Form 10-KSB, so Grant was engaged to reaudit Sky's 1994 financial statements. [7] On June 16, 1995, Grant issued an audit report on Sky's 1994 financial statements. Grant performed minimal reaudit procedures for fiscal 1994. He relied almost exclusively on the predecessor's 1994 audit work papers, instead of performing his own audit as required by GAAS, even though Grant knew that the predecessor had refused to consent to the further use of his fiscal 1994 audit report. AU § 9315, Interpretations of AU § 315, Communications Between Predecessor and Successor Auditors, sets forth the applicable auditing standard in this area. [8] AU § 9315.10 states in part that if the successor accepts a reaudit engagement, the predecessor's report, working papers and inquiries of the predecessor in and of themselves may not be considered sufficient competent evidential matter to afford the successor a reasonable basis for expressing an opinion on the financial statements. The interpretation further states that "[t]he successor should plan and perform the reaudit in accordance with generally accepted auditing standards. The successor should not assume responsibility for the work of the predecessor . . . Furthermore, the predecessor is not a specialist as defined in AU Section 336, Using the Work of a Specialist . . ." Grant's reaudit of Sky's 1994 financial statements violated GAAS by his undue reliance on the original audit work performed by the predecessor auditor. Grant had no audit program, no audit work papers except for those documenting two adjustments, and no attorney representation letters. Grant performed both the 1995 and 1994 audits of Sky by himself, without assistance or review of his work. Grant had no prior mining company audit experience before he accepted the Sky engagement. Thus, Grant performed an audit for a company in an industry with which he was unfamiliar without taking appropriate steps to educate himself about the industry or without input or oversight of an experienced colleague familiar with the industry. This did not comply with the requirements of AU § 230, Due Care in the Performance of Work. In connection with the reaudit of Sky's 1994 financial statements, Grant failed to assure that Sky's financial statements complied with GAAP in that the financial statements failed to properly account for the value of Sky's issuances of Form S-8 stock, and also failed to properly value three mineral assets obtained by Sky in exchange for preferred stock in the same manner previously discussed for fiscal 1995. Grant's audit failures include failure to detect the improper accounting treatment of the Form S-8 stock issued during the reporting period. [9] Despite being aware of the predecessor auditor's concern for Sky's accounting for certain stock transactions, Grant did not evaluate whether the Form S-8 stock was properly recorded. As discussed earlier for the 1995 audit, this stock was recorded without regard to market value. Consequently, Sky understated consulting expenses by approximately $3,458,000. Accordingly, Grant failed to ascertain that the financial statements as they related to these stock transactions were prepared in conformity with GAAP, and his audit in this area was not conducted in accordance with GAAS. Grant also made no adjustments to Sky's 1994 valuations of the mineral properties. Grant testified that the methods used by the predecessor auditor during his audit were adequate and the resulting valuations were proper. Thus, Grant's GAAP and GAAS departures in this area were that he failed to determine that the valuations of the mineral properties were wrong and that the supporting documentation was inadequate. E. Based on the foregoing, Grant engaged in improper professional conduct. IV. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer of Settlement submitted by Grant and accordingly, IT IS HEREBY ORDERED, effective immediately, that Frederick R. Grant is denied the privilege of appearing or practicing before the Commission as an accountant. By the Commission. Jonathan G. Katz Secretary **FOOTNOTES** [1]: Rule 102(e)(1) provides in relevant part: The Commission may censure a person or deny, temporarily or permanently, the privilege of appearing or practicing before it in any way to any person who is found by the Commission after notice of and opportunity for hearing ... (ii) ... to have engaged in unethical or improper professional conduct.... [2]: The findings herein are made pursuant to Grant's Offer and are not binding on any other person or entity in this or any other proceeding. [3]: Grant was previously suspended from practice before the Commission as an accountant pursuant to Rule 102(e) in an unrelated matter. The Commission's Order provided for the right to apply for readmission after 3 years. See In the Matter of Frederick R. Grant, CPA, AAER No. 876 (February 5, 1997). [4]: See, Statement of Financial Accounting Concepts No. 5, Recognition and Measurement in Financial Statements of Business Enterprises, paragraphs 58, 64-68 and 75-77. [5]: These assets were artwork, ownership interests in two businesses and prepaid advertising airtime. [6]: For the artwork, Grant's work papers noted that he had reviewed an appraisal valuing it at more than the recorded amount. However, Grant did not retain a copy of the appraisal nor did he contact the appraiser to develop an understanding of the appraiser's assumptions or qualifications, in violation of AU 336, Using the Work of a Specialist. [7]: The predecessor auditor refused to consent to the continued use of his audit report because Sky management had not provided him with the information he requested, subsequent to his audit, to verify that the common stock issued during fiscal 1994 was properly recorded. [8]: This interpretation, an explanation of an existing auditing standard, was issued in April 1995, before Grant's audit opinion of June 16, 1995. [9]: Grant did adjust the financial statements for the issuance of restricted stock, using a 50% discount rate. Grant made this adjustment because he was specifically aware that the predecessor auditor had questioned Sky's accounting for restricted stock.