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Case 6-7
Livingston & Haynes, P. C.
This case concerns alleged violations of Section 10A of the Securities Exchange Act by Livingston & Haynes, P. C.
(“L&H”), Howley and Wood in connection with L&H’s 2005 and 2006 year-end audits and quarterly interim
reviews of the financial statements of LocatePlus Holdings Corporation (“LocatePlus”). The SEC filed charges
against L&H, Howley and Wood on June 6, 2011.
L&H is an accounting and auditing firm registered with the PCAOB. The firm provides tax preparation services as
well as services to public companies registered with the Commission and to private equity clients. L&H served as the
auditors on LocatePlus’ audits and interim reviews for the fiscal years 2005 and 2006 from which L&H received
approximately $227,800 in fees.
Violations of Securities Exchange Act of 1934
Howley served as the Engagement Partner and Wood served as the Concurring Partner on the engagements. On
October 14, 2010, the Commission filed a complaint against LocatePlus alleging, in part, that LocatePlus’ former CEO
and CFO fraudulently inflated the company’s publically-reported revenue in its periodic filings with the Commission
for at least FY 2005 and FY 2006. The complaint alleges that, as part of LocatePlus’ fraud, its CEO and CFO were
involved in the following action related to a fictitious customer called Omni Data Services, Inc. (“Omni Data”):
LocatePlus improperly recognized revenue from Omni Data. The improper Omni Data revenue was
included in LocatePlus’ financial statements that were part of quarterly and annual reports for FY 2005
and FY 2006 and were included in filings with the Commission.
In total, LocatePlus falsely reported more than $6 million from Omni Data for FY 2005 and FY 2006,
representing over 25% of LocatePlus’ total revenue for those two years.
The SEC also charged L&H with the following in connection with its audits of LocatePlus for the years 2005 and
2006.
L&H, Howley and Wood failed to include procedures designed to provide reasonable assurance of detecting
illegal acts that would have a direct and material effect on the determination of financial statement amounts
and thus each of them violated Section 10A(a)(1) of the Exchange Act.
L&H, Howley and Wood became aware of multiple allegations of illegal acts at LocatePlus, including
allegations that the Omni Data revenue was fictitious, yet they failed to determine whether it was likely that
an illegal act had occurred. Based on this conduct, each of them violated Section 10A(b)(1) of the Exchange
Act.
During the course of L&H’s 2005 and 2006 year-end audits of LocatePlus, L&H, and Howley became aware
of red flags indicating that the Omni Data revenue was fictitious, yet they failed to ensure that very risk area
was audited properly.
L&H and Howley failed to properly plan the audits, adequately test the Omni Data revenue, obtain sufficient
competent evidential matter to serve as a basis for L&H’s audit reports, exercise due professional care, apply
skepticism, and properly assess the risks of material misstatement due to fraud.
Facts of the Case
LocatePlus is a provider of public information made available via either a CD- ROM based product or via a
proprietary internet accessible database. The LocatePlus product contains searchable information on
individuals throughout the U.S., including, for example, social security numbers, prior residences and real estate
holdings. In addition to direct purchasers, LocatePlus sells its product through "channel partner" arrangements,
by which third parties access their databases in consideration for a royalty.
In 2005 and 2006, LocatePlus claimed to have secured a significant “channel partner” arrangement with Omni
Data, a company that purportedly conducted its business over the Internet. Under the terms of the alleged
agreement, Omni Data had unlimited access to LocatePlus’ data via the Internet in exchange for a royalty fee of
$300,000 per month. The agreement also stated that LocatePlus would build and maintain a website for Omni
Data in exchange for $500,000.
In fact, Omni Data was a sham customer of LocatePlus created by the CFO and CEO to record false revenue.
Through this fraudulent scheme, Omni Data would “buy” services from LocatePlus and make purported
“payments” to LocatePlus. The CFO and CEO then caused LocatePlus to record these fictitious payments as
revenue in its financial results, which were included in periodic filings with the SEC.
To fund these purported payments to LocatePlus, the CFO and CEO funneled approximately $2 million in cash
to Omni Data through a series of transactions which included a “round trip” transaction in which LocatePlus made
a $650,000 payment to an entity controlled by the CFO, who then transferred $600,000 to Omni Data, which then
paid the $600,000 back to LocatePlus as purported payment for services.
LocatePlus made numerous false and misleading statements regarding, among other things, its revenue in a
number of periodic filings with the Commission. For FY 2005 and FY 2006, LocatePlus improperly recognized
$3.6 million and $2.7 million, respectively, in fictitious revenue from Omni Data. This caused LocatePlus to
overstate its 2005 annual results by 46 percent and its 2005 quarterly results by 53 percent for the first quarter, 44
percent for the second quarter and 43 percent for the third quarter. LocatePlus overstated its 2006 annual results by
28 percent and its 2006 quarterly results by 41 percent for the first quarter, 34 percent for the second quarter and 36
percent for the third quarter.
L&H performed LocatePlus’ 2005 and 2006 year-end audits and quarterly reviews. The audit reports issued for
both years included an explanatory paragraph (i.e., emphasis of matter) stating that LocatePlus’ substantial net
losses raise substantial doubt about the Company’s ability to continue as a going concern.
Auditor Resignation
On December 10, 2004, LocatePlus’ former auditor, resigned. In a resignation letter addressed to LocatePlus’
audit committee chairman, LocatePlus’ former auditor cited “concerns about the timeliness of information we
received and about the reliability of certain representations of your company’s management.”
In January 2005, Howley was contacted to inquire about L&H becoming LocatePlus’ new auditors. On
February 16, 2005, Howley and Wood visited the former auditor’s offices and met with the partner formerly
responsible for the LocatePlus engagement. The former auditor’s audit partner detailed multiple reasons for
its resignation, including: (1) difficulty getting information from management; (2) management providing
contradictory explanations to its questions; (3) management providing unsigned contracts as audit evidence;
and, (4) difficulty getting management to accept its proposed audit adjustments.
After L&H’s meeting with LocatePlus’ former auditor, Howley, Wood and L&H’s president met and determined
to accept LocatePlus as a client. Because of the concerns expressed by LocatePlus’ former auditor, however, L&H
determined to “use extensive care” and treat LocatePlus as a high risk audit client.
Audit Difficulties
During the 2004 audit, L&H had difficulties getting information from LocatePlus’s management about significant
transactions, to the extent that, on April 11, 2005, L&H pulled out of the field because they were unable to remain
productive with the amount of information they had to work with.
Red Flags Discovered
During the course of its 2005 interim reviews of quarterly filings, L&H became aware of multiple red flags
concerning the revenue recognized from Omni Data and the resulting receivable on LocatePlus’ balance sheet. In a
June 1, 2005, e-mail from Howley to Fields, Howley noted that: (1) L&H was unable to find records for Omni Data
on the Connecticut Secretary of State’s website (i.e., the state where Omni Data was purportedly located); (2) that
the alleged President of Omni Data was not listed for any of the Omni Data entities that they did find; and (3) that
L&H could not locate a website for Omni Data, despite the fact that Omni Data was purportedly a business doing
data sales over the Internet.
Howley accepted management’s explanations for the inconsistencies. For example, in response to an L&H
inquiry about the scarcity of information available on Omni Data, LocatePlus’ in-house accountant told Howley in a
June 7, 2005 e-mail that “we don’t make it common practice to research companies extensively with which we do
business.” In addition, in a June 9, 2005 e-mail, Fields claimed that “[Omni Data] does not have a corporate web
site because they are trying to keep a low profile” and that Omni Data’s web site was, in fact, under the name
“findyourpeeps.com.”
As of June 30, 2005, the Omni Data receivable was approximately $1.8 million reflecting revenue of the same
amount recognized in 2005. No collections had been received as of June 30, 2005 from Omni Data for revenues
earned in 2005.
Allegations of Illegal Acts
On or about August 26, 2005, Howley received a message that a former LocatePlus Board member (“the informant”)
wanted to speak with him. During a telephone conversation with Howley shortly thereafter, the informant made a
number of allegations of wrongdoing by LocatePlus, and members of management. Among other things, the
informant questioned the validity of the Omni Data transactions and indicated that the alleged President of Omni
Data was a former girlfriend of the former CEO and chair of the board of directors. Shortly after the telephone
conversation, Howley relayed the substance of the informant’s allegations to Wood.
Between at least December 2005 and March 2006, the informant contacted Howley via telephone and e-mail on
numerous occasions regarding his concerns about fraud at LocatePlus. During the course of multiple e-mail
exchanges with Howley, the informant provided the following information:
Omni Data revenue was phony and there was no evidence that Omni Data existed.
Omni Data contract was signed five months before Delaware incorporation records showed that the
company was incorporated.
The alleged President of Omni Data was a “stooge set up by the CEO” to mask phony sales and was, in
fact, a ballet teacher and the CEO’s former girlfriend.
The CEO told the informant that Omni Data was a start-up that “might not be around.”
LocatePlus’ Audit Committee Chairman had a conflict of interest because he had pledged assets to secure
a loan to the CEO.
The CEO had been buying off LocatePlus’ Audit Committee Chairman through extending him high
interest loans made to the company (at 30 percent to 40 percent).
Wood read the informant's e-mails and discussed them with Howley prior to and during the course of the 2005
year-end audit. Wood also discussed the allegations with L&H's President. Howley forwarded the e-mails from the
informant to LocatePlus’s audit committee chairman. In e-mail correspondence Howley recommended to
LocatePlus’s audit committee chairman that the audit committee chairman should plan a meeting with the informant,
the audit committee’s legal counsel and Howley to address the informant’s allegations. The meeting never occurred.
A major issue in this case is the failure of L&H to adequately test the Omni Data revenue and receivable. The issue
involves both inappropriate accounting and the failure of the audit to identify material misstatements in the financial
statements.
2005 Audit
L&H identified numerous risk factors indicating that LocatePlus had a high risk for fraud during the 2005 year-end
audit. In a fraud “brainstorming” memo included in L&H’s 2005 audit work papers, L&H specifically identified
overstated and/or fictitious revenues/accounts receivable relative to Omni Data. The memo went on to state that
“L&H will approach the audit with much skepticism.”
Despite having identified the Omni Data transactions as a high risk area and being aware of the allegations that
Omni Data was fictitious, L&H, under Howley’s direction, failed to obtain sufficient competent evidential matter
that LocatePlus had delivered its product to Omni Data.
Although L&H tested delivery of products and services for other LocatePlus’s customers, it did not test delivery
to Omni Data even though it accounted for approximately one-third of LocatePlus’ revenue. For other customers,
L&H compared the amounts billed and recognized as revenue to LocatePlus’s data usage logs to ensure that the
customer had agreed to purchase the product and had actually used it.
However, L&H never looked at the usage logs for Omni Data. Had L&H reviewed Omni Data’s usage logs,
they would have discovered that there was no activity or usage in 2005. Instead, L&H relied upon the executed
agreement between LocatePlus and Omni Data and confirmation received from Omni Data regarding the monies
earned and owed.
2006 Audit
Questions persisted at L&H throughout the 2006 year-end audit of LocatePlus about the existence and collectibility
of the growing Omni Data receivable balance. As of December 31, 2006, the Omni Data receivable balance was
$5.1 million representing approximately 88 percent of LocatePlus’s total receivables. In a work paper included in
L&H’s 2006 year-end audit work papers, L&H noted “there is questionability regarding the Omni Data receivable
and the existence of Omni Data (whether it is a viable entity).”
The purported Omni Data agreement had been amended, as of October 1, 2006, to extend Omni Data’s payment
terms to $45,000 per month for the approximately $4.2 million outstanding balance. Under the original contract
terms, payments were due thirty days from the invoice date. As a result of the amendment, LocatePlus reclassified
$3.8 million dollars of the Omni Data receivable from current accounts receivable to long-term accounts receivable.
It also recorded a discount and an allowance on the receivable, which was approximately $1.9 million as of
December 31, 2006.
Despite these developments and the open question as to whether Omni Data was a viable entity, L&H failed to
obtain sufficient competent evidential matter that the Omni Data transaction was properly stated in the financial
statements.
Failure to Adequately Plan the 2005 and 2006 Year-End Audits
L&H, under Howley’s direction, failed to adequately plan the 2005 and 2006 year- end audits of LocatePlus by
designing procedures that would account for the heightened risk of fraud and, specifically, for the possibility that the
Omni Data revenue was fictitious, as had been alleged.
L&H’s testing procedures for the Omni Data revenue included relying on the confirmation process and the
existence of an executed contract and checking cash receipts. Omni Data, however, was not paying within its
contract terms and, as Wood acknowledged during October 6, 2010, testimony before the Commission, if
LocatePlus “set up a dummy company,” as had been alleged, then the confirmation process “would not be
adequate evidence.”
