In one of the cases discussed in class, Locate Plus claimed fraudulent revenue from a fictitious customer. The auditor was willfully blind with respect to the fraud, Define willful blindness and explain the likely motivation for the auditor to be willfully blind in this case.?

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 aucliting firmi registered with the PCAOB. The firm prowides 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 und 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 Locate Plus 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 86 million from Onni 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 Locatellus 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( 1) of the Exchange Act. L&TT, 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 cletermine whether it was likely that an illegal act had occurred. Based on this conduct, each of them violated Section 10A(D) (1) of the Exchange Act. During the course of L&H's 2005 and 2006 year-end audits of LocatePlus, L&T, and Trowley became aware of red flags indicating that the Omni Data revenue was fictitious, yet they failed to ensure that very risk arca was audited properly. L&H and Howley failed to properly plan the audits, adequately test the Omni Data revenue, obtain suflicient competent evidential matter to serve as a basis for L&H's audit reports, excrcise duc 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 hised product or via a proprietary internet accessible database. The LocatePlus product contains scurchable information on individuals throughout the U.S., including, for example, social security numbers, prior residences and real estate hollings. 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 agreemenl, Onni Dala had unlimited access to LocalePlus' dala 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 shan customer of LocatePlus created by the CFO and CEO lo 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 find these purported payments to Locatellus, the CFO and CEO finncled approximately $2 million in cash to Omni Data through a series of transactions which included around 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 $300,000 back to LocatePlus as purported payment for services, LocatePlus made numerous faise and misleading statements regarding, among other things, its revenue in a number of periodic filings with the Commission Tor FY 2005 and FY 2006, LocatePlus improperly recognized $3.6 million and S2.7 million, respectively, in fictitious revenue from Onini 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 perfomed LeatePlus 2005 and 2006 year-end audits and quarterly reviews. The audit reports issued for hoth years included an explanatory paragraph (ie, emphasis of matter) stating that locatePlus substantial net losses raise substantial dubt about the Company's ability to continue as a going concem. Auditor Resignation On December 10, 2004, LocatePlus former auditor, resigned. In a resignation letter addressed to Locate Plus 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 Locate Plus' 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) dilliculty 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 1.&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 local LocatePlus as a high risk audit client. Audit Difficulties During the 2004 audit. L&H had dilliculties 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. 1.&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 fron. Howley to Fickls. Howley nowed that: (1)L&H was unable to lind records for Omni Dala on the Connecticut Secretary of State's website (ie, the state where Omni Data was purportedly located), (2) that the alleged President of Onini Data was not listed for any of the Omni Data entities that they did find; and (3) that L&II could not locale a website for Omni Dala, despite the fact that Onni Dala 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 Onni Dala, 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, Tields claimed that TOmni 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 rellecling revenue of the sune amount recognized in 2005. No collections had been received as of June 30, 2005 from Omni Data for revenues camed in 2005. Allegations of legal 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 IIowley 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 Dala was a former girlfriend of the omier 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 Ilowley via telephone and e-mail on numerous occasions regarding his concems about fraud at LocatePlus. During the course of multiple e-mail exchanges with Howlcy, 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 10 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 inlomant to LocatePlus's uudit 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 I lowley to address the informant's allegations. The meeting never occurred A major issue in this case is the failure of L&H lo adequately lost the Omni Data revenue and roocivable. The issue involves both inappropriate accounting and the failure of the audit to identify material misstatements in the financial statements 2005 Audit L&H identificd numcrous 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 av erstated 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 Lata transactions as a high risk area and being aware of the allegations that Omni Data was fictitious, L&II, under lowley'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 scrvices for other LocatcPlus'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 compxired 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 Duta. Had L&H reviewed Omni Data's usage logs, they would have discovered that there was no activity or usage in 2005. Instead, L&II relied upon the executed agreement between LocatePlus and Omni Data and confirmation received from Omni Data regarding the monies carned and owed 2006 Audit Questions persisted at L&I throughout the 2006 year-end audit of LocatePlus about the existence and collectibility of the growing Omui 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 auclit 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 Onini Data's payment terms to $45,000 per month for the approximately $4.2 million outstanding balance. Under the original contract terms, payments were duc thirty days from the invoicc 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 Deocmber 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&II, under lowley's direction, failed to adequately plan the 2005 and 2006 year-encl 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." Failure to Competently Evaluate Evidence Obtained by the Confirmation Process In general, it is presumed that audit evidence is more reliable when it is obtained from knowledgeable independent sources outside the entity. During the 2005 ycar-cnd audit. L&H failed to competently evaluate the reliability of the auclit evidence obtained by the confirmation process. Exhibit 1 elaborates on the inadequacies. Failure to Assess the Risk of Material Misstatement Due to the Omni Data Transaction Although L&H became aware of the informant's allegations prior to and during the course of the 2005 year-end audit, it took few steps to investigate the informant's allegations during the auclit. Moreover, to the extent to which L&II developed any evidence regarding the informant's allegations, the evidence corroborated many of the informant's claims. For example, L&H searched Connecticut and Massachusets corporate records, but Cound no evidence that Omni Data was incorporated. Howley attempted to contact the alleged President of Omni Data, but was initially unable to reach her as the first confirmation sent to Omni Data was returned as uncleliverable. L&I discovered additional red flags regarding the Omni Data transaction during the 2005 interim reviews and year-end audit. For example, L&H discovered that: The Omni Data receivable comprised approximately 76 percent of the overall accounts receivable, but LocatePlus had collected only $250.000 in puynients in 2005 Iron Onini Dala out of approximately $3.6 million in revenue recognized. Payments totaling approximately $10,000 from LocatePlus to the alleged I'resident of Omni Dala. Payments totaling approximately $325,000 to the CEO. Although L&II's work papers document the informant's allegations, they do not document the procedures specifically designed to assess these risks. In fact, 1.&H's "Fraud Risk Assessment Form," for the 2005 year-end audit, which lays out procedures intended to facilitate compliance with auditing standards is blank Moreover, an item on L&IT's audit program completed at the conclusion of the audit) specifically instructs "Tilf you believe that fraud or an illegal act may have occurred document the circumstances identified and apply the procedures for potential fraud or illegal acts in additional procedures section of this audit program." The work paper states, "none noted next to the proposed procedure indicaling that L&H never applied the additional procedures in its own audit program Howley testified that he reviewed this work paper. L&It's 2005 year-end work papers do not document that L&H came to any conclusion about the merits of the informant's allegations. L&H's 2006 year-end work papers document that the very existence of Omni Data was still an open question through the 2006 year-end audit and that L&H did not come to a final conclusion about the informant's allegations until, at the earliest, April 2007. Despite the numerous red flags and lingering questions about the existence of the Omni Data receivable, L&T's 2006 year-end work papers also clo not document an assessment of the risks of material misstatement clue to fraud. Despite being aware of the informant's allegations of fraud (and thus the risks of material misstatement). Howley did not undertake adequate audit procedures during the 2005 or 2006 year-end audits to assess these risks. L&H's 2005 year-end audi work papers document that L&H accepted management's explanations for the red Ilags. For example, with regard to the Omni Data receivable, Howley woepled LocatePlus's management's representation that it was collectable despite L&H's difficulties verifying its existence and Omni Data's failure to make payments under the terms of the purported contact. With regard to the CEO payments, Howley accepted the explanation that the payments were "bonuses" approved by the Board even though the bonuses did not go through Locatellus's payroll system. In addition, L&H did not ohtain LocatePlus's Board minutes to attempt to verify the explanation. Finally, with regard to the payments to the alleged President of Omni Data, Howley accepted LocatePlus's explanation that they were "referral fees" despite allegations that the alleged President was a ligurchcad installed by the CEO. Alleged Professional Violations The SEC charged that L&H, Howley und Wood engaged in improper professional conduct that violated Section 4Ca 2) of the Exchange Act and Rule 102(e(1)(ii) of the Commission's Rules of Practice. Under Rule 4C(b)(2) and Rule 102(e)(1)(iv)(B) the term "improper professional conduct" means, in part, "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." In light of the specific allegations that the Omni Data transaction was fictitious, L&H's and Howley's failure to adequately design testing procedures to address that very risk, and Wood's concurrence in the approval of the issuance of L&It's 2005 and 2006 audit reports when he knew that significant matters were unresolved, constituted highly unreasonable conduct that resulted in a violation of applicable professional standards in circumstances in which cach knew, or should have known, that heightened scrutiny was warranted. The Lailure of L&H and Howley to plan the audits properly, test the Omni Duta revenue adequately, obtain sufficient competent evidence to serve as a basis for L&H's audit reports, and assess properly the risks of material misstatement due to fraud, and the failure of Wood to address these deficiencies also constituted highly unreasonable conduct that resulted in a violation of applicable professional standards in circumstances in which each knew, or should have known, that heightened scrutiny was warranted, As a result of the conduct alleged in the SEC filing. L&H, Howley and Wood violated Section 10A(A)(I) of the Exchange Act, which requires cach audit 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