UNITED STATES OF AMERICA
`before the
`
`SECURITIES AND EXCHANGE COMMISSION
`
`SECURITIES EXCHANGE ACT OF 1934
`
`Rel. No. 57244 / January 31, 2008
`
`ACCOUNTING AND AUDITING ENFORCEMENT
`
`Rel. No. 2779 / January 31, 2008
`
`Admin. Proc. File No. 3- 12064
`
`
`
`In the Matter of
`GREGORY M. DEARLOVE, CPA
`
`
`OPINION OF THE COMMISSION
`
`CEASE—AND—DESIST PROCEEDING
`
`Grounds for Remedial Action
`
`Causing Violations of Reporting Provisions
`
`RULE 102(e) PROCEEDING
`
`Grounds for Remedial Action
`
`Improper Professional Conduct
`
`Certified public accountant acting as engagement partner engaged in improper
`professional conduct in the audit of the financial statements of a public company and
`caused company's violations of Section 13(a) of the Securities Exchange Act of 1934 and
`Exchange Act Rules 13a—1 and I2b—20. Held, it is in the public interest to order that
`accountant cease and desist from causing any vioiations or future vioiations of Exchange
`Act Section l3(a) and Exchange Act Rules I3a—1 and 12b-20, and to deny the accountant
`the privilege of appearing or practicing before the Commission with a right to reapply
`after four years.
`
`SENJU E;\'Hl'I!IT 2341
`Lupin V Sealju.
`IPR20l5-01097, [l’R2'015~01[|99,
`IPRZIIE-'£..ni Hm A‘, Imnm: m In:
`
`

`
`APPEARANCES :
`
`Josegh V. Sedita, Benjamin M. Zuffianieri, Michelle Merola Kane, and Robert J.
`Fluskey, Jr, of I-ledgson Russ LLP, for Gregory M. Dearlove.
`
`
`Nancy A. Brown, Alistaire Bambach Jack Kaufman, and Panayiota K. Bougiamas, for
`the Division of Enforcement.
`
`Appeal filed: August 30, 2006
`Last brief received: December 4, 2006
`
`Oral argument: July 24, 2007
`
`

`
`TABLE OF CONTENTS
`
`Introduction
`
`Background
`
`III.
`
`IV.
`
`Applicable Professional Standards: The Requirements of GAAS
`
`Netting of Related Party Payables and Receivables
`A.
`Facts
`
`B.
`
`Analysis
`
`C0—Borrowed Debt
`A.
`Facts
`
`B.
`C.
`
`Dearlove's Audit of Adelphia's FAS 5 Detennination
`Adequacy of the Note Disclosure of Adelphia‘s Contingent Liability
`
`VI.
`
`Debt Reclassification
`A.
`Facts
`
`B.
`
`Analysis
`
`VII.
`
`Direct Placements of Stock
`A.
`Facts
`
`The July 2000 Direct Placement
`1.
`The January 2000 Direct Placement
`2.
`Analysis
`
`B.
`
`VIII.
`
`Analysis of Liability and Appropriate Sanction Under Rule 102(e)
`A.
`Liability
`B.
`Denial of the Privilege of Appearing or Practicing Before the Commission
`
`Causing Violations of the Reporting, Recordkeeping, and Internal Accounting Control
`Provisions of the Exchange Act
`A.
`Liability
`B.
`Cease-and—Desist Order
`
`Dearlove's Due Process Argument
`A.
`Facts
`
`B.
`C.
`D.
`
`Dearlove‘s Contentions on Appeal
`Denial of Sixty-Day Extension
`Commission Rule of Practice 360
`
`Conclusion
`
`

`
`1.
`
`Introduction
`
`Gregory M. Dearlove, a certified public accountant and formerly a partner with the
`accounting firm Deloitte & Touche LLP ("Deloitte"), appeals from the decision of an
`adrninistrative law judge. The law judge found that Dearlove, who served as the engagement
`partner on Deloitte's audit of the financial statements of Adelphia Communications Corporation
`("Adelphia"), a public company, for the fiscal year ended December 31, 2000, engaged in
`improper professional conduct within the meaning of Rule of Practice 102(e). _1_/ The law judge
`found that Adelphia's financial statements were not in accordance with generally accepted
`accounting principles ("GAAP"), and that Dearlove violated generally accepted auditing
`standards ("GAAS"). 2/ The law judge also found that Deariove was a cause of Adelphia's
`
`1/
`
`17 C.F.R. § 20l.102(e). Rule 102(6) permits the Coinmission to censure or deny,
`permanently or temporarily, the privilege of appearing or practicing before it to persons
`found to have engaged in improper professional conduct. As applied to accountants,
`“improper professional conduct" includes the following:
`
`(A)
`
`(B)
`
`intentional or knowing conduct, including reckless conduct, that results in a
`violation of applicable professional standards; or
`either of the following two types of negligent conduct:
`(1)
`a single instance of highly unreasonable conduct that results in a
`violation of applicable professional standards in circumstances in
`which an accountant knows, or should know, that heightened scrutiny
`is warranted.
`
`(2)
`
`repeated instances of unreasonable conduct, each resulting in a
`violation of applicable professional standards, that indicate a lack of
`competence to practice before the Commission.
`
`Rule l02(e)(l)(iv), l7 C.F.R. § 201 .l02(e)(l)(iv). With the passage in 2002 of Section
`602 of the Sarbanes Oxley Act, Pub. L. No. 107-204, 116 Stat. 745, 794, this language
`was codified in Exchange Act Section 4C, 15 U.S.C. § 78d~3.
`
`no“-..
`
`The law judge concluded that Dearlove engaged in repeated instances of unreasonable
`conduct as well as a single instance of highly unreasonable conduct under
`Rule l02(e)(iv)(B)(1). However, it is unclear which conduct constituted the single
`instance of highiy unreasonable conduct. We therefore decline to consider whether any
`of Dearlove's conduct was "highly unreasonable.“ We limit ourselves to the question of
`whether Dearlove engaged in "repeated instances of unreasonable conduct, each resulting
`in a vioiation of applicable standards, that indicate a lack of competence to practice
`before the Commission." Rule of Practice 102(e)(iV)(B)(2).
`
`

`
`2
`
`violations of the reporting and recordkeeping provisions of the Exchange Act. §j The law judge
`permanently denied Dearlove the privilege of appearing or practicing in any capacity before the
`Commission. We base our findings on an independent review of the record, except with respect
`to those findings not challenged on appeal.
`
`ll.
`
`Background
`
`Adelphia, a cable television company incorporated in Delaware and headquartered in
`Coudersport, Pennsylvania, was founded in 1952 by John Rigas and went public in 1986.
`Adelphia had several large subsidiaries, some of which were public companies, and Adelphia
`consolidated its financial statements with those of its subsidiaries. The Rigas family retained
`control over Adelphia through their exclusive ownership of Adelphia’s Class B shares. fix’
`Whenever Adelphia raised capital by issuing Class A shares, the Rigas family would arrange for
`Adelphia to make a direct placement of Class B shares so that the Rigases' ownership and
`majority voting interests would not be diluted. The Rigases‘ Class B stock was convertible into
`shares of Class A stock. In addition to their controlling ownership of Adelphia, the Rigas family
`held five of nine seats on Adelphia's board of directors.
`
`Members of the family also owned several dozen private companies ("Rigas Entities").
`The largest of these Rigas Entities also were engaged in the cable television business, and
`Adelphia used its own personnel, inventory, trucks, and equipment to provide services to the
`customers of these companies. Adelphia, its subsidiaries, and the Rigas Entities shared a
`centralized treasury system organized using cost centers, in which the cash balances of each
`company were separately maintained. Adelphia charged a fee for providing the Rigas Entities
`management, accounting, and other services.
`
`By 2000, Adelphia was among the largest cable television and telecommunications
`providers in the United States. Adelphia had grown substantially at the end of 1999 by acquiring
`several other cable companies (more than doubling Adelphia‘s cable subscribers), and Adelphia
`continued to grow in 2000. Concomitant with this growth in assets, Ade1phia's debt increased
`significantly. Between 1996 and 2000, Adelphia, its subsidiaries, and some Rigas Entities
`entered as co-borrowers into a series of credit agreements. By 1999, Adelphia and the Rigas
`Entities had obtained $1.05 billion in credit; in 2000, they tripled their available credit and drew
`down essentially all of the funds then available under the agreements.
`
`Deloitte served as the independent auditor for Adelphia, one of its largest audit clients,
`from 1980 through 2002. The audits were complex. Several of Adelphia's subsidiaries filed
`their own Forms 10-K, and Adelphia frequently acquired other companies. For several years,
`Deloitte had concluded that the Adelphia engagement posed a "much greater than normal" risk of
`
`3/
`
`4/
`
`15 U.S.C. §§ 78m(a), 78rn(b)(2)(A).
`
`Class A shares each received one vote; Class B shares each received ten.
`
`

`
`3
`
`fraud, misstatement, or error; this was the highest risk category that Deloitte recognized. Risk
`factors that Deloitte specifically identified in reaching this assessment for the 2000 audit included
`the following:
`
`-
`
`°
`
`-
`
`-
`
`'
`
`Adelphia operated in a volatile industry, expanded rapidly, and had a large
`number of decentralized operating entities with a complex reporting
`structure;
`
`Adelphia carried substantial debt and was near the limit of its financial
`resources, making it critical that the company comply with debt covenants;
`
`Management of Adelphia was concentrated in a small group without
`compensating controls;
`
`Adelphia management lacked technical accounting expertise but
`nevertheless appeared willing to accept unusually high levels of risk,
`tended to interpret accounting standards aggressively, and was reluctant to
`record adjustments proposed by auditors; and
`
`Adelphia engaged in significant related party transactions with affiliated
`entities that Deloitte would not be auditing.
`
`To help manage the audit risk, Deloitte planned, among other things, to increase Deloitte‘s
`management involvement at all stages of the audit "to ensure that the appropriate work is planned
`and its perfonnance is properly supervised.“ It also proposed to heighten professional skepticism
`"to ensure that accounting estimates, related party transactions and transactions in the normal
`course of business appear reasonable and are appropriately identified and disclosed."
`
`In 1999 and 2000, the American Institute of Certified Public Accountants ("AICPA")
`required that member firms rotate an engagement partner off the audit of a public company after
`seven years to bring a fresh perspective and maintain auditor independence. §/ To replace Don
`Cottrill, the engagement partner who had conducted Adelphia's audits from 1993 to 1999,
`Deloitte asked Dearlove to assume responsibility as engagement partner for the audit of
`Adelphia's 2000 financial statements.
`
`Dearlove, at Deloitte partner since 1986, had been an accountant working for the firm
`since he graduated from college in £976. In 1997, Dearlove had become the managing partner
`for Deloitte's Buffalo and Rochester offices. Dearlove had served as the engagement partner on
`ten public company audits and the concurring review partner on several others. Nevertheless,
`Dearlove had no prior experience auditing companies in the cable television industry, and did not
`
`§/
`
`_S_§_e AMERicAN INSTITUTE or CERTIFIED PUBLIC ACCOUNTANTS ("AICPA"), SEC
`PRACTICE SECTION REFERENCE MANUAL § l000.08(e).
`
`

`
`-4
`
`immediately accept the assignment because Dearlove had not dealt before with audits of
`Adelphia's "complexity or sensitivity." Dearlove testified that, prior to the Adelphia audit, he
`"had never been in a greater than normal risk environment." After meeting with Cottrill and
`others on Adelphia's audit team, reviewing Adelpliia‘s most recent financial statements and
`quarterly reports, and reading trade publications about the cable industry, Dearlove accepted the
`assignment in October 1999.
`
`Dearlove began by shadowing Cottrill as he worked on Adelphia's 1999 financial
`statements. When the 1999 audit was completed, Deloitte's senior manager on the Adelphia
`audit team reviewed Ade1phia‘s 1999 financial statements with Dearlove and explained the
`theory and history behind the accounting presentations therein. Dearlove also participated in the
`audit of the 1999 financial statements of one of Ade1phia’s subsidiaries that was considered to
`present the least sensitivity and risk. Dearlove assumed full responsibility for Adelphia's audit
`beginning with the quarterly review for the first quarter of 2000. Deariove and other Deioitte
`partners agreed that the "much higher than normal risk" assessment continued to apply to the
`2000 audit.
`
`The staffing of Deloitte‘s audit team for the 2000 audit remained largely unchanged from
`prior years. The team consisted of about twenty staff accountants and tax professionals, divided
`into subgroups that were supervised by ten Deloitte managers and headed by senior manager
`William Caswell, who reported directly to Dearlove. Several of the Deloitte managers had
`significant prior experience auditing and reviewing Adelphia‘s annual and quarterly reports:
`Caswell had spent six years working on Adelphia engagements; Ivan Hofmann and Robert
`Fitzgerald, both audit managers, had each spent five years.
`in addition, Michael Lindsey served
`as the concurring partner as he had on Adelphia audits since 1996, and Stephen Biegel was
`assigned as risk review partner after serving in that capacity for the 1999 Adelphia audit.
`Dearlove had once met Caswell at a firm meeting but did not otherwise know any members of
`the Adelphia audit team when he assumed his role as engagement partner.
`
`Deloitte devoted an estimated 2l,000 hours to the audit of Adelpl1ia's 2000 financial
`statements and related accounting advisory activities; Dearlove himself spent over 700 hours.
`Dearlove spent a total of ten to fifteen days on-site in Coudersport with the audit team. Dearlove
`participated in discussions with the team, reviewed workpapers and underlying Adelphia
`documents when the team brought them to his attention, and "worked through the issues" with
`his staff in what Dearlove characterized as a "consultative process." At the end of the audit,
`Dearlove looked at certain workpapers and drew conclusions as to whether the team completed
`its review. Dearlove testified that he also consulted Deloitte's national office on a number of
`
`accounting issues during the course of the audit, mostly involving revenue recognition.
`
`On March 29, 2001, Deloitte issued its independent auditor's report, signed by Dearlove,
`which stated that it had conducted its audit in accordance with GAAS and that such audit
`
`

`
`5
`
`provided a reasonable basis for its opinion that Adelphia's 2000 financial statements fairly
`presented Adelphia's financial position in conformity with GAAP. Q/’
`
`In January 2002, following the collapse of Enron Corporation, the Commission released
`guidance clarifying the disclosures that issuers should consider making with respect to, among
`other things, related party transactions. 2/ In reaction, Adelphia disclosed for the first time in a
`press release the extent of the Rigas Entities‘ co-borrowed debt. The disclosure alarmed
`investors and analysts, leading to a formal investigation by a special committee ofAdelpl1ia‘s
`board of directors into related party transactions between Adelphia and the Rigases that resulted
`in the public disclosure of the Rigas family's related party transactions as well as various
`accounting irregularities. Adelpl1ia‘s stock price declined from about $30 per share in January
`2002 to $0.30 per share in June 2002, and the stock was delisted from the Nasdaq market. After
`defaulting on various credit agreements, Adelphia filed for bankruptcy under Chapter 11 in June
`2002.
`
`In the wake ofAdelpl1ia's decline, the Department of Justice brought criminal fraud
`charges against several members of the Rigas family and other Adelphia officials. §/ The
`Department of Justice declined to file criminal charges against Adelphia as part of a settlement in
`which Adelphia agreed to pay $715 million in stock and cash to a victims’ restitution fund once
`the company emerged from bankruptcy. 2/
`
`The Commission also brought several actions related to the decline of Adelphia. On
`April 25, 2005, Adelphia, John Rigas, and Rigas's three sons settled a civil injunctive action in
`which the respondents, without admitting or denying the allegations against them, were enjoined
`from committing or causing further violations of the antifraud, reporting, recordkeeping, and
`
`6/
`
`2/
`
`8/
`
`Dearlove resigned his position with Deloitte in September 2001 and accepted an offer of
`employment to serve as a senior vice president and chief financial officer of a public
`company. There is no evidence in the record to suggest that the Adelphia audit was a
`cause of Dearlove's departure from Deloitte.
`
`Statement About Management's Discussion and Analysis of Financial Condition and
`Results of Ogerations, 67 Fed. Reg. 3,746 (Jan. 25, 2002).
`
`James Brown, Adelphia's vice president of finance, and Tim Werth, Adelphia's director of
`accounting, both pled guilty. John and Timothy Rigas were convicted and sentenced to
`lengthy prison terms by the United States District Court for the Southern District of New
`York. The Court of Appeals for the Second Circuit affirmed the convictions on all but
`one of twenty-three counts and remanded the case for sentencing.
`_S__e_e_ United States V.
`Timothy J. Rigas and John J. Rigas, 490 F.3d 208 (2d. Cir. 2007).
`
`9/ E United States v. Rigas, 371 F. Supp. 2d 474 (S.D.N.Y.), affd, 409 F.3d 555 (2d Cir.
`2005); In re Adelphia Commdns C011}, 327 BR. 143 (Bankr. S.D.N.Y. 2005).
`
`

`
`6
`
`internal controls provisions of the federal securities laws. _l_Q/ The next day, the Commission
`instituted and settled administrative proceedings against Deloitte under Rule l02(e). _1___lu/ Without
`admitting or denying the Commission’s allegations, Deloitte consented to the entry of findings
`that it engaged in repeated instances of unreasonable conduct with respect to the audit of
`Adelphia's 2000 financial statements. Deloitte also consented to a finding that it caused
`Adelphia's violations of those provisions of the Exchange Act that require issuers to file annual
`reports, make and keep accurate books and records, and devise and maintain a system of
`sufficient intemai controls. Deloitte agreed to pay a $25 million penalty and to implement
`various prophylactic policies and procedures. The Commission also settled a civil action based
`on the same conduct in which Deloitte agreed to pay another $25 million penalty. l_2/ Senior
`manager Caswell consented to Commission findings that he committed repeated instances of
`unreasonable conduct and agreed to a bar from appearing or practicing as an accountant before
`the Commission with a right to apply for reinstatement after two years. §/
`
`[EL
`
`Applicable Professional Standards: The Reguirements of GAAS
`
`In determining whether to discipline an accountant under Rule 102(e)(l)(iv), the
`Commission has consistently measured auditors‘ conduct by their adherence to or deviation from
`GAAS. l_4/ There are ten fundamental generally accepted auditing standards, consisting of three
`
`l_0/
`
`_S_e_e In re Adelphia Commc'ns Cog:_i., 327 B.R. at 156-58; SEC and U.S. Attorney Settle
`Massive Financial Fraud Case Against Adelphia and Rigas Family for $715 Million,
`Press Rel. No. 2005-63 (Apr. 25, 2005), available at http://www.sec.gov/news/press/
`2005—63.11tm.
`
`l / E Deloitte & Touche LLP, Securities Exchange Act Rel. No. 51606 (Apr. 26, 2005), 85
`SEC Docket 1111.
`
`i2/
`
`13/
`
`14/
`
`_S_e§ SEC v. Deloitte & Touche LLP, No. 05—Civ.-4119 (PKC) (Apr. 26, 2005 S.D.N.Y.);
`SEC Charges Deloitte & Touche for Adelphia Audit, Press Rel. No. 2005-65 (Apr. 26,
`2005), available at http://www.sec.gov/news/press/2005-65.htrn.
`
`
`§§§ William E. Caswell CPA, Exchange Act Rel. No. 52538 (Sept. 30, 2005), 86 SEC
`Docket 1257.
`
`See, e.g., James Thomas McCurdy, CPA, 57 SEC. 277, 295 (2004) (basing Rule 102(e)
`finding on auditor's deviation from “fundamental principles of auditing," which included,
`among other things, failure to obtain sufficient competent evidential matter, render an
`accurate audit report, maintain an attitude of professional skepticism, and exercise due
`care), gfifi, 396 F.3d 1258 (D.C. Cir. 2005); Bag C. Scutillo, 56 SEC. 714, 746 (2003)
`(basing Rule l02(e) finding on auditor's "{r]eck1ess failures to comply with auditing
`standards," including, among other things, failure to maintain professional skepticism and
`(continued...)
`
`

`
`7
`
`General Standards, three Standards of Field Work, and four Standards of Reporting. _l_§_/' As
`explained by the Division of Enforcement‘s (“Division's“) expert,
`
`[t]lie General Standards require the auditor to have adequate technical training and audit
`proficiency, maintain independence and exercise due professional care. The Standards of
`Fieldwork set forth the requirements for adequate planning and supervision of assistants,
`gaining an understanding of the company's internal controls, and gathering sufficient
`competent evidential matter. The Standards of Reporting provide that the auditor‘s report
`state the financial statements are presented in accordance with GAAP and if not, it must
`identify circumstances where GAAP is not observed.
`
`These ten fundamental standards are amplified by Statements on Auditing Standards issued and
`codified by AICPA's Auditing Standards Board.
`
`GAAS require auditors to pian the audit adequately and to properly supervise any
`assistants. fi/ Auditors must exercise due professional care in performing an audit and preparing
`a report. 11/ They must maintain an attitude of professional skepticism, which includes "a
`questioning mind and a critical assessment of audit evidence." _1_§/ They must obtain sufficient
`
`14/
`
`15/
`
`la'‘'‘-~-..
`
`I:'‘‘‘-~-.
`
`00
`l»—A‘‘‘-~-.
`
`(. ..continued)
`
`to exercise due care); Michael J. Manic CPA, 56 S.E.C. 760, 791-93 (2003) (basing Rule
`102(e) finding on auditors‘ reckless failure to conduct the audit in accordance with
`GAAS, including their failure to exercise professional skepticism and to obtain sufficient
`competent evidential matter), rev‘d on other grounds, 374 F.3d 1196 (D.C. Cir. 2004)
`(reversing based on retroactive application of amended rule but noting that the
`requirements of GAAS to exercise due care and professional skepticism and to obtain
`sufficient evidential matter are “standards to which all accountants must adhere“) (citing
`Potts v. SEC, 151 F.3d 810, 813 (8th Cir. 1998)).
`
`As discussed in Section IX, the question of whether Deariove caused Adelphia‘s
`violations of the reporting provisions of the securities laws is also informed by the degree
`to which he departed from the applicable standard of care, i_.e_., whether he acted
`negligently.
`
`AICPA, CODIFICATION or STATEMENTS or AUDITING STANDARDS § 150.02 (2000)
`(hereinafter, "AU § 1'‘).
`
`AU §§311_0i,311.11.
`
`AU§230.0i_
`
`AU §§ 230.07»O8.
`
`

`
`8
`
`competent evidential matter to afford a reasonable basis for an opinion with respect to the
`financial statements under review. l_9_/'
`
`Certain audit conditions require auditors to increase their professional care and
`skepticism, as when the audit presents a risk of material misstatement or fraud. 2_O/ When an
`audit includes review of related party transactions, auditors must tailor their examinations to
`obtain satisfaction concerning the purpose, nature, and extent of those transactions on the
`financial statements. §/ Uniess and until an auditor obtains an understanding of the business
`purpose of material related party transactions, the audit is not complete. 2_2/ As we have
`previously observed, these standards can overlap somewhat, and one GAAS failure may
`contribute to another. 2_3_/
`
`Dearlove urges us to compare the reasonableness of his conduct to a somewhat different
`standard. Dearlove argues, citing pattern jury instructions used by New York state courts in
`professional negligence cases, that the standard for determining negligence by an accountant
`should be based on whether the respondent "use{d] the same degree of skill and care that other
`[accountants] in the community would reasonably use in the same situation." Dearlove asks us to
`evaluate his actions in the context of the large, complex Adelphia audit and to determine whether
`Dearlove exercised the degree of skill and care that a reasonable engagement partner would have
`used in similar circumstances. Dearlove contends that this analysis "necessarily includes .
`.
`.
`conclusions previously reached by other professionals," a reference to the Adelphia audits
`Deloitte conducted from 1994 through 1999. Dearlove asserts that he could place some reliance
`on audit precedent. Moreover, in his view, the fact that prior auditors reached the same
`conclusions is "compelling evidence" that Dearlove acted reasonably.
`
`The complexity of the Adelphia audit, the number of accountants assigned to it, the risk
`that Deloitte attributed to it, and the conclusions of prior auditors certainly provide context to our
`review. However, we reject any suggestion that the conduct of prior auditors should be a
`
`i9_/
`
`AU § 326.22.
`
`2_0/
`
`AU §§ 312.17, 316.27.
`
`;2__1_/
`
`AU § 334.09.
`
`_2_g/
`
`AU § 334.09(a) & n.6.
`
`g;s_/
`
`McCurdy, 57 SEC. at 286 (“For example, a failure to maintain professional skepticism
`about information obtained from management can result in a failure independently to
`verify that information and gather sufficient competent evidential matter. Similarly, if an
`auditor fails to exercise due professional care, he may not obtain sufficient competent
`evidential matter to support an audit conclusion that the financial statements were
`prepared in compliance with GAAP.").
`
`

`
`9
`
`substitute for the standards established by GAAS. GAAS are the fundamental standards of
`auditing promulgated by auditors themselves. AICPA membership approved and adopted the ten
`fundamental auditing standards, E, the General, Field Work, and Reporting Standards. fix’
`AICPA‘s Auditing Standards Board has developed and issued subsequent auditing standards
`"through a due process that includes deliberation in meetings open to the public, public exposure
`of proposed {standards}, and a formal vote." El These standards apply to audits of all sizes and
`all levels of complexity and describe the conduct that the accounting profession itself has
`established as reasonable, "provid[ing] a measure of audit quality and the objectives to be
`achieved in an audit." 2_6/ We therefore decline to create a separate standard of professional
`conduct for auditors that depends in each case on the behavior of a particular auditor's
`predecessors. The accounting profession itself has already prescribed the applicable standards.
`
`Moreover, as required at the time by AICPA, Dearlove was assigned to the Adelphia
`audit to replace the incumbent engagement partner for the specific purpose of bringing a fresh
`perspective to the audit. The rotation of audit partners assigned to the audits of public companies
`has long been required of most independent auditors by AICPA and, more recently, by federai
`law. 21/ Deloitte itself recognized that audit partner rotation is "vital" to an auditor's objectivity
`and that "[t]he impartiality of the external audit is a critical component of the function auditors
`perfonn for issuers, their investors, and their potential investors, and measures that militate
`against complacency and reinforce the external auditor's professional skepticism can protect that
`impartiality." 2_S/ Reliance on prior audit conclusions, especially in areas of high risk, without
`
`3/
`
`AU § 150.02.
`
`g§/
`
`AU § 150.03.
`
`fix’
`
`QI
`
`
`AU § l50.0l. See also SEC v. Dain Rauscher Inc., 254 F.3d 852, 857 (9th Cir. 2001)
`(noting that GAAS are a "time-honored standard set by an authoritative source recognized
`and followed throughout the profession" against which auditors‘ conduct can be judged);
`
`Potts v. SEC 15i F.3d at 812 (stating that GAAS are "well—established norms of the
`accounting profession").
`
`§_e_e AICPA, SEC PRACTICE SECTION REFERENCE MANUAL § 1000.08(e) (promulgated in
`1977 and requiring members, excepting small firms with few public-company clients, to
`rotate engagement pa11ner from audit of public company every seven years); Sarbanes—
`Oxley Act of 2002, Pub. L. No. 107-204, § 203, 116 Stat. 745, 773 (codified at 15 U.S.C.
`§ 78j—l(j)) (making it unlawful for registered accounting fmns to audit public companies
`if the lead audit partner or reviewing partner performed audit services for the company for
`the five preceding years).
`
`28/
`
`Deloitte & Touche LLP, Comment Letter of Deloitte & Touche LLP on the Commission's
`
`Proposed Rule lrnplementing Sections 201, 202, 203, 204, and 206 of the Sarbanes—OXley
`(continued...)
`
`

`
`10
`
`questioning whether that reliance was appropriate under the circumstances, defeats the purpose
`of auditor rotation — Q, to preserve auditor independence and encourage critical thinking. 2_9_/
`
`On the record before us, we find that prior Deloitte audit conclusions offered little
`support for the conclusions reached in the 2000 audit. The record does not describe how the
`audits of prior financial statements were performed or what evidential matter supported those
`audit conclusions. Moreover, Dearlove's expert, while arguing that partner rotation does not
`require the new auditor to perform a "de novo audit of the client,“ nevertheless explained that an
`engagement partner "would perform .
`.
`. new audit procedures or GAAP research and
`consultation .
`.
`. to address changed conditions or professional standards." In 2000, Dearlove
`was presented with markedly different circumstances from those presented to prior teams: since
`1999, Adelphia had tripled its co-borrowed debt, doubled its revenues and operating expenses,
`and acquired more cable subscribers. The changes implicated areas of the Adelphia audit that
`Deloitte had specifically identified as posing high risk, namely, its rapid expansion, substantial
`debt load, and significant related party transactions. Therefore, we reject Dearlove‘s argument
`that the similarity of prior audit conclusions lends reasonabieness to his own audit, and we find
`no reason to reject GAAS as the standard by which we judge all audits.
`
`IV.
`
`Netting of Related Pam Payables and Receivables
`
`A.
`
`Facts
`
`Since the company went public in 1986, Adelphia netted, or offset against each other,
`accounts payable to and receivable from various Rigas Entities on its consolidated financial
`statements. Adeiphia calculated its net receivable balance by subtracting the balances of all
`accounts payable that Adeiphia and its subsidiaries owed to Rigas Entities from the balances of
`all the accounts receivable that the Rigas Entities owed to Adelphia and its subsidiaries.
`Dearlove testified that when he was transitioning onto the Adelphia audit engagement in the
`spring of 2000, he discussed Adelphia's practice of netting with the Deloitte senior manager who
`had worked on Adelphia's 1999 financial statement audit. Deariove "iearned about the history of
`it," and testified that netting wasn't "something that I dealt with often in my history." Dearlove
`"hadn't had a client that did that" before, at least not one that "had these types of related parties
`that netted." Dearlove testified that, in approving Adelphia‘s use of netting in the 2000 financial
`statements, he relied on the fact that prior Deloitte auditors, whom Dearlove considered "highly
`technically competent," had permitted it in the past. He also took "some comfort from the fact
`that the concurring partner and the risk partner in '99 were going to be the concurring partner and
`
`_2_§/
`
`(...continued)
`Act of 2002 (Jan. 10, 2003), available at http://www.sec.gov/rules/proposed/374902;’
`deloittel .htm#P400_1 2761 9.
`
`_Q/
`
`Strengthening the Commission's Requirements Regarding Auditor Independence, 68 Fed.
`Reg. 6,006, 6,0l7 (Feb. 5, 2003).
`
`

`
`11
`
`. coming up to speed. They had
`.
`risk partner in 2000," because Dearlove “was the only one .
`already gotten there. The issues were similar, the client was similar. The industry was the
`same."
`
`Dearlove had been told by Adelphia management that they were concerned about the
`growing net receivable balance in the second quarter review, and that they would seek to reduce
`it through additionai related party borrowing. Indeed, the audit team reviewed the net receivables
`Adelphia presented during each quarterly review and knew that Adelphia‘s net related party
`receivables were reported as $178 million at the end of 1999, $254 million at the end of the first
`quarter in 2000, $263 million at the end of the second quarter, and $19 million at the end of the
`third quarter. Ultimately, a line item titled "Related Party Receivables - Net" on Adelphia's
`balance sheet and Form l0—K. for 2000 reported $3,071,000.
`
`Adelphia's 2000 year—end gross related party accounts payable and receivable, however,
`totaled more than $1 billion each. Dearlove was aware of the dramatic reduction of the net
`
`balance and testified that the balance had dropped "as we expected it." However, Dearlove could
`not recall whether or how the audit team tested Adelphia‘s affiliate receivables, could not explain
`how his team tested managements explanations for the fluctuations in Adelphia's reported net
`bal