CASE 2.7
GEO SECURITIES, INC.
Synopsis
In the late 1990s, Geo Companies of North America (GNCA), a small Dallas-based company,
organized a wholly-owned subsidiary, Geo Securities, Inc., to market interests in oil and gas
properties that it owned or controlled. Since GNCA was not a public company, it was not registered
with the SEC. However, because Geo Securities was a registered broker-dealer, it was required to
file audited financial statements annually with the SEC.
pay the full amount of that settlement. A few months later, a court-appointed arbitrator ruled that
GNCA, Geo Securities, and the other defendants, who were individuals affiliated with the two
companies, should reimburse the plaintiffs for nearly $1 million of attorneys’ fees that they had
incurred in pursuing the two lawsuits. Each of the defendants was jointly and severally liable for
those fees. Unlike the court-ordered settlement, GNCA did not make a commitment to pay the
arbitration award.
Geo Securities failed to record a loss and offsetting liability for the arbitration award in its
financial statements for the year ended July 31, 2005, which was the fiscal year in which the
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158 Case 2.7 Geo Securities, Inc.
Geo Securities, Inc.—Key Facts
1. In 1996, Dallas-based Geo Companies of North America (GNCA) organized a wholly-owned
subsidiary Geo Securities, Inc.; the sole purpose of Geo Securities was to market oil and gas
properties owned or controlled by GNCA.
2. Neither GNCA nor Geo Securities was a public company; however, because Geo Securities was
3. Frank Sinopoli, a partner with Perkins, Dexter, Sinopoli & Hamm (PDSH), supervised the
annual audits of Geo Securities from 2000 through 2005.
5. In 2004, the court awarded a nominal judgment to the plaintiffs in those civil lawsuits; a few
6. The arbitration ruling was issued during Geo Securities’ 2005 fiscal year; however, after
7. In 2009, the SEC ruled that Geo Securities’ 2005 financial statements were materially misstated
8. The SEC also ruled that Geo Securities’ “computation of net capital schedule” for 2005 was
materially misstated.
9. During the 2005 audit, Sinopoli also relied improperly, according to the SEC, on a
representation made by Geo Securities’ president that GNCA would assume full responsibility for
payment of the arbitration award.
10. The SEC sanctions imposed on Sinopoli included a one-year suspension from practicing before
the federal agency.
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Instructional Objectives
1. To identify key management assertions relevant to contingent liabilities.
2. To examine the responsibilities of auditors to communicate with a client’s outside legal counsel.
Suggestions for Use
Before discussing this case in class, consider requiring individual students or groups of students
to identify recent examples of major litigation cases involving public companies or other audited
entities—this will be an “easy” assignment since the news media are replete with such cases.
Require students to provide brief in-class reports of the litigation cases they uncovered—instruct
Suggested Solutions to Case Questions
1. PCAOB Auditing Standard No. 15, “Audit Evidence,” lists five categories of management
assertions that are relevant to audits of SEC registrants. The assertions that are arguably the most
pertinent to contingent liabilities include the following:
2. AU Section 337, “Inquiry of a Client’s Lawyer Concerning Litigation, Claims and Assessments,”
of the PCAOB’s Interim Standards discusses the responsibility of auditors to communicate with a
client’s external legal counsel. AU Section 337.05 points out that client management is the “primary
source of information about” litigation, claims, and assessments that may have a material impact on
the client’s financial statements. However, the following paragraph adds that, “An auditor ordinarily
160 Case 2.7 Geo Securities, Inc.
3. Auditors’ responsibilities for supplemental information contained in financial statements filed
with the SEC under the Securities Exchange Act of 1934 have been amended since the time frame in
which the key events in this case transpired. Presently, the most directly applicable section of the
PCAOB’s Interim Standards in this context is AU Section 550, “Other Information in Documents
Containing Audited Financial Statements.” In certain circumstances, AU Section 551, “Reporting
on Information Accompanying the Basic Financial Statements in Auditor–Submitted Documents,” is
also relevant in this context as noted in AU 550.07.
4. AU Section 341, “The Auditor’s Consideration of an Entity’s Ability to Continue as a Going
Concern,” of the PCAOB’s Interim Standards is directly relevant to this question. On every audit
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engagement involving an SEC registrant an auditor has a “responsibility to evaluate whether there is
substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of
time, not to exceed one year beyond the date of the financial statements being audited.”
AU Section 341.05 identifies a variety of procedures that auditors can rely on to assess a client’s
going concern status. These procedures are listed below:
If an auditor concludes that there is substantial doubt regarding a client’s going-concern status,
then additional procedures are necessary. Most importantly, the auditor should consider client
management’s plans for dealing with the adverse events or conditions that threaten the entity’s status