UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 39045 / September 10, 1997 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 955 / September 10, 1997 ADMINISTRATIVE PROCEEDING File No. 3-9400 ________________________________ :ORDER INSTITUTING In the Matter of :PROCEEDINGS AND OPINION :AND ORDER PURSUANT TO WILLIAM B. SANDERS, CPA, :RULE 102(e) OF THE :COMMISSION S RULES OF Respondent. :PRACTICE ________________________________ : I. The Securities and Exchange Commission ( Commission ) deems it appropriate and in the public interest that public administrative proceedings be, and they hereby are, instituted against William B. Sanders, CPA, ( Sanders or Respondent ) pursuant to Rule 102(e)(1)(ii) of the Commission s Rules of Practice.<(1)> II. In anticipation of the institution of this administrative proceeding, Sanders has submitted an Offer of Settlement which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, Sanders, without admitting or denying the findings set forth herein, except that he admits to the jurisdiction of the Commission over him and over the subject matter of this proceeding, consents to the entry of the findings and to the imposition of the remedial sanctions set forth below. <(1)> Rule 102(e)(1)(ii) of the Commission s Rules of Practice, 17 C.F.R. '201.102(e), provides in pertinent 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 and opportunity for hearing in the matter . . . (ii) . . . to have engaged in . . . improper professional conduct. ======END OF PAGE 1====== III. FINDINGS On the basis of this Order Instituting Proceedings ( Order ) and Sanders Offer of Settlement, the Commission finds the following: A.SANDERS Sanders, 48, a certified public accountant ( CPA ), was a founder and shareholder partner of Hairston, Kemp, Sanders & Stich ( Hairston ), a San Antonio auditing firm with four shareholder partners. Hairston, founded in 1992, was hired by Ponder Industries, Inc. ( Ponder ), to conduct the 1992 and 1993 audits on which Sanders was the engagement partner. In December 1995, Sanders left Hairston to establish a separate CPA firm. B.PONDER Ponder, a public company since 1990, is a Delaware corporation with its principal place of business in Alice, Texas. Ponder has been in the oil well fishing business since 1981, leasing out its specialized tools and providing its expertise to oil producers to remove obstacles clogging oil well bore holes. At all relevant times, Ponder's common stock was registered pursuant to Section 12(g) of the Securities Exchange Act of 1934 ( Exchange Act ) and traded on the National Association of Securities Dealers Automated Quotation System and on the Boston Stock Exchange. For its fiscal year ended August 31, 1995, Ponder reported a net loss of $3.1 million, primarily attributable to a $3.8 million loss from discontinued operations in Azerbaijan. ======END OF PAGE 2====== C.INTRODUCTION AND SUMMARY Sanders engaged in improper professional conduct in connection with the audit of the financial statements of Ponder for its fiscal year ended August 31, 1993 ( fiscal 1993 ). Ponder materially misstated its net income (loss) before taxes and assets in its Form 10-K for fiscal 1993 by improperly continuing to capitalize costs incurred in fiscal 1992 in performing a contract for operations in Azerbaijan. Ponder continued to capitalize such costs at the end of fiscal 1993 even though Ponder had already declared that it considered the contract null and void.<(2)> Sanders knew that, as of the end of fiscal 1993, in order for Ponder to continue to capitalize fiscal 1992 costs incurred in Azerbaijan, generally accepted auditing standards ( GAAS ) and generally accepted accounting principles ( GAAP ) require sufficient competent evidence that such costs had a probable future economic benefit. However, Sanders failed, as engagement partner, to determine that there was sufficient competent evidence, beyond management s assurances and representations. Accordingly, Sanders did not perform the audit in accordance with GAAS and Ponder s financial statements were not prepared in conformity with GAAP as they pertained to the Azerbaijan operations. D.DISCUSSION 1.Ponder Agreed to Provide Services in Azerbaijan In April 1992 Ponder entered into an agreement (the "Contract") with Megaoil U.S.A. ( Mega ), a subsidiary of Vista Group U.S.A., Inc. ( Vista ), to provide services for oil and gas production in Azerbaijan. Vista represented that it had a valid joint venture agreement with the Azerbaijan Oil Company ( AOC ) to drill for oil and rework certain wells in Azerbaijan. Under the terms of the Contract, Ponder's receipt of payment was contingent on several factors. The Contract provided that Ponder was to be paid only from the proceeds of oil produced and such payments were dependent upon the successful production of oil, sale of such oil and conversion of the proceeds into a usable currency. At the time Ponder signed the Contract, Ponder had only oral assurances that arrangements for storage, transportation, sale of oil, or exchange of proceeds would ever be made, and had no assurances of the productivity of the wells. Ponder began reworking oil wells in Azerbaijan on May 15, 1992, but was forced to stop work two months later following a change in the Azerbaijan government. <(2)> The Commission issued a cease-and-desist order against Ponder, its Chairman and Chief Executive Officer, Mack Ponder, and its Chief Financial Officers, Charles E. Greenwood and Michael A. Dupre, finding, among other things, that the respondents in that proceeding violated or caused violations, variously, of Sections 10(b), 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder. See In the Matter of Ponder Industries, Inc., Admin. Proc. File No. 3-9349, Exchange Act Rel. No. 38858, Accounting and Auditing Enforcement Rel. No. 938 (July 22, 1997). ======END OF PAGE 3====== In December 1992, Ponder filed its Form 10-K for its fiscal year ended August 31, 1992. Ponder reported $2.12 million in capitalized costs associated with Azerbaijan, including $1.63 million of expenses incurred in performance of the Contract. During the audit, Ponder also reversed $2.22 million of revenue from the Contract which Ponder had previously recognized in its Form 10-Q for the quarter ended May 31, 1992. Ponder attributed the reversal of revenue to restrictions placed on the movement of oil by the new Azerbaijan government. In the workpapers for the 1992 audit, Sanders concluded that Ponder could not recognize the revenue because "there [was] not sufficient economic substance to Mega. . . ." 2.Ponder Deemed the Contract Null and Void But Continued to Capitalize Costs In its Form 10-Q for the second quarter of fiscal 1993, Ponder reported that "further investigation" revealed that no valid joint venture agreement existed and, therefore, Ponder considered the Contract "null and void." Ponder also reported that it had obtained a new joint venture agreement without Mega and that Ponder was negotiating a new service contract directly with the AOC. However, by the end of the 1993 audit, Ponder's negotiations with the AOC had not proceeded beyond a draft service contract which contained no provision for the recovery of costs incurred by Ponder in performance of the Contract with Mega. In addition, Ponder had not heard from Mega since November 1992, and Ponder was not aggressively pursuing recovery from Mega of costs incurred in performance of the Contract. In its fiscal 1993 Form 10-K, Ponder reported $2.95 million in capitalized costs for operations in Azerbaijan, consisting of $1.63 million of expenses incurred in fiscal 1992 in performance of the Contract, as well as additional expenses incurred in fiscal 1993 in negotiating a new joint venture agreement and service contract and in maintaining equipment. As discussed below, according to GAAP, by the end of fiscal 1993 Ponder should have recognized as unrecoverable the $1.63 million of capitalized costs incurred in fiscal 1992 in performance of the Contract and should have treated those costs as an expense. As a result, Ponder should have recorded a loss before taxes of $2.81 million instead of a loss of $1.18 million. Ponder's non-GAAP treatment resulted in an overstatement of assets by 14%, $13.55 million instead of $11.92 million. 3.Accounting Principles and Auditing Standards Compliance with GAAS includes planning appropriate audit procedures, exercising due care in the execution of the audit, maintaining the proper level of professional skepticism and not placing undue reliance on management's representations regarding matters of major significance. GAAP requires that assets be recognized when future economic benefits can be reasonably expected based on available evidence or logic. Financial Accounting Standards Board ( FASB ) Statement of Concepts ( CON ) No. 6, 25 and n. 18. Specifically, FASB CON No. 6, defines assets as "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events." Id. at 25. "Probable" is defined as "that which can reasonably be expected or believed on the basis of available evidence or logic but is neither certain nor proved." Id. at n. ======END OF PAGE 4====== 18. "[U]ncollectible receivables do not qualify as assets." Id. at 177. Incurring costs does not, by itself, establish the existence of an asset. "The ultimate evidence of the existence of assets is the future economic benefit, not the costs incurred." Id. at 180. Uncertainty about the actual future economic benefit of an expenditure may preclude recognition of an asset and warrant that it be recognized as an expense or a loss. Id. at 175. Examples of items that may be recognized as expenses or losses because of uncertainty about economic outcomes include research and development activities, the development of new markets and the opening of new branches or divisions. Id. GAAS requires an auditor to obtain sufficient competent evidential matter through inspection, observation, inquiry and confirmation to afford a reasonable basis for an opinion regarding the financial statements under audit. Codification of Statements on Auditing Standards ("AU") 326.01. The auditor must be thorough in his search for evidential matter and unbiased in his evaluation. The auditor should give consideration to relevant evidential matter regardless of whether it appears to corroborate or contradict assertions in the financial statements. AU 326.23. While management representations are part of the evidential matter an auditor may obtain, such representations are not a substitute for applying sound auditing procedures. AU 333.02. 4.Costs Incurred in Fiscal 1992 in Performance of the Contract Should Have Been Written Off in Fiscal 1993 According to GAAP, in order for Ponder to continue to classify the costs incurred in performance of the Contract as an asset, those costs must have had a "probable future economic benefit" as of the end of fiscal 1993. The $1.63 million of costs which Ponder incurred in connection with the Contract did not have a probable future economic benefit, and, therefore, should have been written off in fiscal 1993. Ponder incurred those costs in the performance of the purported Contract. However, in its Form 10-Q for the second quarter of fiscal 1993, Ponder had already reported that it considered that Contract null and void. Consequently, there existed no valid contract under which any party was obligated to reimburse Ponder for the costs incurred, or to pay fees billed, pursuant to the Contract. At the time of the fiscal 1993 audit, Ponder had not heard anything from Mega for nearly a year. Ponder did not intend to pursue aggressively recovery of those costs from Mega until Ponder had a new service contract in place. Although Ponder was attempting to negotiate a new service contract with the AOC, the draft service contract did not contain any provision for the recovery of costs incurred, or fees billed, by Ponder in the performance of the Contract. Accordingly, the costs incurred in performance of the Contract did not have a probable future economic benefit, and, therefore, should have been treated as an expense in fiscal 1993. ======END OF PAGE 5====== E.Sanders Failed to Exercise Due Professional Care in the Conduct of the Audit for Fiscal 1993 Hairston audited Ponder's financial statements for fiscal 1992 and 1993. In its audit report for fiscal 1993, Hairston certified that its audits were conducted in accordance with GAAS and that the financial statements were prepared in conformity with GAAP. Thus, Hairston certified that Ponder's capitalization at the end of fiscal 1993 of $1.63 million of costs incurred during fiscal 1992 in performance of the Contract was consistent with GAAP. In fact, Ponder's capitalization of such costs was not consistent with GAAP, and, accordingly, Hairston's audit was not conducted in accordance with GAAS. Sanders, as engagement partner for Hairston, failed to exercise the required due professional care in the performance of the audit and the preparation of the audit report for Ponder. AU 230.01. Sanders was the engagement partner for the 1993 audit, and therefore, was responsible for the conduct of the audit and issuance of the audit report. It was Sanders' responsibility to determine that there was sufficient competent evidence to afford a reasonable basis for an opinion regarding the financial statements. Sanders failed to exercise due professional care because he never determined that the costs incurred under the Contract had a probable future economic benefit, as GAAP requires. Nevertheless, Sanders took no exception to Ponder's continued capitalization of the Contract costs. Sanders understood that, under GAAP, costs incurred must have a probable future economic benefit in order to be classified as an asset. In the 1993 workpapers, Sanders noted that the only accounting guidance on the issue of when costs incurred may be classified as an asset is the "FASB concepts" cited above. Sanders also had advised Ponder that, in order to capitalize costs incurred under the Contract, Ponder had to obtain a new contract which would provide for recovery of such costs. During the 1992 audit, while Ponder was purportedly attempting to obtain a new joint venture agreement, Sanders explained to Ponder in writing that Ponder could capitalize costs incurred under the Contract "provided a valid contract is obtained in hand. . . . The new contract needs to have specific provision for the recovery of these costs." Sanders also understood that reasonable uncertainty about the recovery of the costs should require charging those costs to operations. In the 1993 workpapers, Sanders wrote, "[i]f there is reasonable uncertainty that future operations will not be profitable and that such costs cannot reasonably be expected to be recovered then such costs should be charged to operations." Even before Sanders began the 1993 audit, he was aware that the transactions under the Contract were material to Ponder and that Ponder had declared that it considered the Contract null and void. To support the continued capitalization of costs in fiscal 1993 Sanders considered drafts of contracts and management's projections regarding the economic viability of such contracts. The workpapers included a draft of a service contract between Ponder and the AOC which Ponder was seeking to finalize. Sanders noted in the workpapers that Ponder was "optimistic that contract negotiations are moving forward" and that a signed agreement would soon be forthcoming. However, Sanders also noted that many details of the draft agreement, including how Ponder would be paid, needed to be "worked out." Moreover, Sanders knew that even the draft contract contained no provision ======END OF PAGE 6====== for the payment of fiscal 1992 costs already incurred, or fees billed, in connection with the Contract. Sanders acknowledged that Ponder was not aggressively pursuing payment of those costs until new contracts were finalized. Based on the evidence available during the 1993 audit, Sanders could not, and indeed did not, conclude in the workpapers that the costs incurred under the Contract had a "probable future economic benefit." Rather, Sanders noted in the 1993 workpapers that "future recovery of this cost thru [sic] profitable operations still is uncertain. The recovery is dependent upon the Company successfully obtaining contracts, performing services, receiving payment for such and converting the payment into a hard currency." Sanders concluded in the workpapers, "Information currently available does not indicate that 'more than likely' that this cost will not be recovered. There is not sufficient indications [sic] that such costs will not have a future benefit at this time and therefore it is not reasonable to write off." Hairston nevertheless certified financial statements that continued to capitalize all of Ponder's costs of operations in Azerbaijan, including those costs incurred in fiscal 1992 under the Contract, that were not in conformity with GAAP. Rather than require Ponder to account for the fiscal 1992 costs in conformity with GAAP, Hairston included a disclosure in the audit report of some of the uncertainties underlying recovery of those costs. The audit report noted that the ultimate realization of the deferred costs was dependent upon Ponder s successful attainment of future contracts and the necessary related financing to enable Ponder to perform such contracts. The audit report also noted that Ponder was dependent on the successful settlement of accounts due for services and expenses related to the Contract. The audit report also referred to similar disclosures in the footnotes to the financial statements. Although the audit report disclosed some of the uncertainties, the financial statements did not properly reflect the effect of those uncertainties. To be in conformity with GAAP, the financial statements should have reflected a write-off of the deferred costs incurred under the Contract in fiscal 1992. No amount of supplemental disclosure, whether in the audit report or in footnotes can justify the use of improper accounting.<(3)> GAAP requires that elements that qualify for recognition be recognized in the basic financial statements and provides that footnote disclosure is not an adequate substitute for recognition.<(4)> The inclusion of the uncertainty paragraph did not relieve Sanders of the responsibility to obtain sufficient, competent evidential matter to support the capitalization of costs. GAAS makes it clear that an uncertainty paragraph is inappropriate where there has been a departure from GAAP. AU 508.16-22. <(3)> U.S. Securities and Exchange Commission, Accounting Series Release 4, April 25, 1938. See Codification of Financial Reporting Policies, '101. <(4)> FASB CON No. 5, &9. ======END OF PAGE 7====== IV. CONCLUSION On the basis of Sanders departures from GAAP and GAAS, as described above, the Commission considers that Sanders engaged in improper professional conduct as an independent accountant. V. Based on the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer of Settlement submitted by the Sanders and accordingly, IT IS HEREBY ORDERED, effective immediately, that: A.Sanders is denied the privilege of appearing or practicing before the Commission as an accountant for a period of nine months. B.Nine months from the date of this Order, Sanders will be permitted to resume appearing or practicing before the Commission as an independent accountant provided that: 1.Sanders, or any firm with which he is or becomes associated in any capacity, is and will remain a member of the SEC Practice Section of the American Institute of Certified Public Accountants Division for CPA Firms ( SEC Practice Section ) as long as he appears or practices before the Commission as an independent accountant; and 2.Sanders complies with all applicable SEC Practice Section requirements, including the requirements for periodic peer reviews, concurring partner reviews, and continuing professional education, as long as he appears or practices before the Commission as an independent accountant. By the Commission. Jonathan G. Katz Secretary ======END OF PAGE 8====== i:\public\share\schonfel\ponder\docs\sndrord6.doc ======END OF PAGE 9======