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PCAOB Settles With PwC Partner Who Screwed Up the ArthroCare Audit

Let this case serve as a lesson to all partners in charge: if you don't do good audits, you will be bankrupted and sent to prison for criminally negligent auditing. Oh wait, no you won't. Carry on:

The Public Company Accounting Oversight Board today announced a settled disciplinary order against Randall A. Stone, CPA, of Austin, Texas, a former PricewaterhouseCoopers LLP partner, for violating PCAOB rules and standards in PwC's 2007 audit of ArthroCare Corporation.

Stone was the partner in charge of the 2007 audit. His violations included ignoring or failing to properly address numerous indicators of improperly recognized revenue in significant unusual transactions.

The order bars Stone from associating with a registered public accounting firm — with the right to petition the Board to remove the bar after three years — and imposes a $50,000 civil money penalty and a censure. Stone consented to the order without admitting or denying the findings.

According to the PCAOB, Stone's screwups were many. They claim he "ignored or failed to properly evaluate numerous indicators that should have alerted him to the possibility that ArthroCare was improperly recognizing revenue on its 2007 sales of medical devices to DiscoCare, Inc." It was later revealed that from 2005 – 2008, ArthroCare chicanery cost shareholders upwards of $400 million.

"Revenue often is a key metric for public company investors and is a financial reporting area prone to manipulation by management," said Claudius B. Modesti, Director of PCAOB Enforcement and Investigations.

"When an auditor is confronted with multiple indicators of problematic revenue recognition, as happened here, he or she must get to the bottom of the relevant issues, including digging into management's representations," added Modesti.

In a suit brought by ArthroCare investors, claims against PwC were dismissed on the basis that "PricewaterhouseCoopers did not intend to mislead investors and was itself misled by ArthroCare's executives about the company's questionable accounting practices." That suit was later settled for $8 million:

The suit alleges that ArthroCare and the individual defendants made numerous public statements during the class period — including statements to investors during earnings conference calls, in press releases, and in filings with the U.S. Securities and Exchange Commission — that were materially false and misleading and that failed to disclose a number of fraudulent activities within the company including selling a spinal surgery device to doctors through a scheme that involved patient referrals by personal injury lawyers.

On Feb. 18, 2009, the company restated its earnings from 2004 through the first quarter of 2008 and admitted to the sales scheme and a lack of internal controls. Accordingto court papers, on the the day the restatement was released, ArthroCare’s stock price closed at $4.50 per share, down from a high during the class period of $65.70.

So, basically, all the stuff an audit is supposed to sniff out wasn't sniffed and that's why Stone got slapped by the PCAOB.