SECTION TWO AUDITS OF High Risk ACCOUNTS staff auditor to count the cash upon Cordova's return. Lukenda also reportedly told the staff auditor that it would not be necessary to place audit seals on the doors of the cabinet or to secure it in any other way given the three key security system used by the branch. Following the telephone conversation with Lakenda, the staff auditor advised bank personnel that Arthur Andersen auditors would count the cash on the date Cordova returned from his trip. CNB's practice of segregating a large amount of cash in the locked cabinet was clearly not a normal banking procedure. In a subsequent investigation, the SEC com- mented on this practice It is an unusual circumstance for a substantial portion of a bank's cash to be inacces sible for an extended period of time. It is also unusual for a substantial portion of a bank's assets not to be invested and earning interest for an extended period of time? In early January 1988, an employee of the 177th Street Branch notified Arthur Andersen that Cordova would return on January 14. On that date, the Arthur Andersen staff auditors arrived at the branch to complete their count of the cash funds. Cordova opened the locked cabinet in the main vault in the presence of the staff auditors. The auditors then proceeded to count the $2.7 million that had not been counted on December 29, 1987. All of the cash was present. None of the other cash funds of the 177th Street Branch or other CNB branches was counted by the Arthur Andersen auditors on January 14, 1988. After counting the segregated cash, the staff auditors asked Cordova why he kept those funds in the locked cabinet. Cordova explained that a customer who had cashed a large certificate of deposit insisted on having the funds available on de- mand at all times. According to Cordova, the customer intended to use the funds to buy foreign currencies when market conditions became favorable. The volatility of the foreign currency market dictated that the customer have immediate access to the funds on a daily basis. Near the completion of the 1987 Capital Banc audit, Lakenda reviewed the work- paper that documented Cordova's explanation for the $2.7 million of segregated cash. Lukenda then discussed that explanation with Curtin. After considering the matter, Curtin instructed Lukenda to have the staff auditors confirm that there was an offsetting liability to the given customer in CNB's accounting records equal to the amount of the segregated funds. The staff auditors obtained the documentation for this liability directly from CNB personnel. This information was not confirmed with the customer or independently verified by the auditors in any other way. The staff auditors also did not obtain documentation confirming that the customer had cashed a large certificate of deposit. Finally, the staff auditors neglected to obtain any evidence to corroborate Cordova's assertion regarding the customer's planned use of the funds. Following the completion of the Capital Banc audit in March 1988, Arthur Andersen issued an unqualified opinion on the firm's 1987 financial statements. Those financial statements reported a net income of $701,000, total cash funds of $14.1 million, and total assets of $143.2 million. Capital Banc included the audited financial statements in its 1987 Form 10-K registration statement filed with the SEC. 2. Securities and Exchange Commission, Accounting and Auditing Enforcement Release No 28 June 1993 SR CASE 2.4 CAPITAL BANC CORPORATION EPILOGUE In July 1990, the Office of the Comptroller of the Currency declared CapitalBanc Corpora tion insolvent and placed it under the control of the Federal Deposit Insurance Corporation (FDIC). The following year, Banco Popular de Puerto Rico purchased the assets of CNB from the FDIC. In late 1991, Carlos Cordova pleaded guilty to three counts of bank fraud and conspiracy to commit bank fraud. Two of Cordova's asso- ciates pleaded guilty to similar charges. Earlier in 1991, Cordova had agreed to an order issued by the SEC that permanently banned him from serving as an officer or director of a public com- pany. A federal Investigation of CNB's financial affairs revealed that Cordova misappropriated at least $100,000 of the $2.7 million allegedly stored in the locked cabinet in the 177th Street Branch's main vault. Cordova, with the help of his subordinates, had intentionally concealed this shortage from the Arthur Andersen audi- tors during the 1987 audit. Cordova secretly returned to the 177th Street Branch on January 9, 1988, and placed cash obtained from other CNB branches in the locked cabinet to replace the funds that he had embezzled. The description of the three-key security system relayed to the Arthur Andersen audi- fors by employees of the 177th Street Branch was a subterfuge. The fast-thinking employees conceived that hoax to deter the auditors from gaining access to the locked cabinet on the day of the surprise cash count. Cordova's explana- tion regarding why he kept the large amount of cash segregated in the locked cabinet was also a fabrication in 1993, the SEC reported the results of its investigation of Arthur Andersen's 1987 Capital Banc audit, an investigation that focused on the audit of the 177th Street Branch's cash funds. In that report, the SEC disclosed the follow- ing sanctions imposed on Thomas Curtin and James Lakenda: Ris hereby ordered, that Respondents Curtin and Lukendal are censured and must be daily registered and in good standing as certified public accountants in the states in thich they each reside or their principal office is located and they must each become a member of or be associated with a member firm of the SEC Practice Section of the AICPA's Dision for CPA Firms as long as they practice before the Commission Questions 1. When auditing cash, which of the management assertions discussed in SAS Na 106 "Audit Evidence," are of primary concern to an auditor? Why? . Identify audit procedures that should be applied to cash funds maintained by a client on its business premises. 3. Identify mistakes or oversights made by Arthur Andersen personnel while auditing the cash funds at the 177th Street Branch. 3. lbid CapitalBanc Corporation In 1975, Carlos Cordova and several other investors founded Capital National Bank (CNB) in Bronx, New York. Cordova was appointed the bank's chief executive offi- cer (CEO) and chairman of the board. Over the next several years, the bank opened five branch offices in the New York City metropolitan area, CNB catered primarily to the banking needs of Hispanic American and immigrant communities in New York City, In 1986, Cordova and the other owners of CNB formed Capital Banc Corpora- tion, a publicly owned bank holding company registered with the Securities and Ex- change Commission (SEC). Throughout its entire existence, the principal operating entity controlled by CapitalBanc was CNB. Cordova assumed the titles of president, CEO and chairman of the board of the new bank holding company. In the falrol 1987, CapitalBanc retained Arthur Andersen & Co, as its independent audit firm. Andersen's first engagement for CapitalBane was to audit the bank hold ing company's consolidated financial statements for the fiscal year ending December 31, 1987 Thomas Curtin, an Arthur Andersen partner since 1979, served as the en gagement partner for the 1987 CapitalBanc audit. Curtin delegated the responsibility for much of the audit planning to James Lukenda, an audit manager with Arthur Andersen since 1983. Lakenda also supervised the staff auditors assigned to the Capital Banc engagement On December 29, 1987 several Arthur Andersen stall auditors accompanied members of CNB's internal audit staff to the bank's 177th Street Branch. The Arthur Andersen auditors intended to observe and participate in a surprise count of the branch's cash funds by the internal auditors. Related audit objectives included testing CNB's compliance with certain control procedures and evaluating the competence of the bank's internal audit staff. The accounting personnel at each CNB branch maintained a "vault general ledger proof sheet" that reconciled the cash on band to the balance of the branch's general ledger cash account. Dur ing the surprise cash count at the 177th Street Branch, the Arthur Andersen audi Tors discovered a $2.7 million reconciling Item listed on the branch's proof sheet. That amount equaled 61 percent of the branch's general ledger cash balance and 45 percent of the branch's total cash funds that were supposed to be available on the date of the surprise count. When the staff auditors asked to count the $2.7 million of cash represented by the reconciling Item, bank employees told them that Cordova had segregated those funds in a locked cabinet within the bank's main vault, Three keys were required to unlock the cabinet. Cordova, who was out of the country at the time, maintained custody of one of those keys. Stymied temporarily, one of the staff auditors telephoned Lukenda. The staff audi: for relayed to Wikenda the information regarding the $2.7 million ol segregated cash. After considering the matter and discussing it with Curtin, Lakenda instructed the T. The facts of this case were drawn from the 1987 annual report of Capital Banc Corporation and the following source Securities and Exchange Commission, Accounting and Auditing Enforcement Release No. 458, 28 June 1993. SECTION TWO AUDITS OF High Risk ACCOUNTS staff auditor to count the cash upon Cordova's return. Lukenda also reportedly told the staff auditor that it would not be necessary to place audit seals on the doors of the cabinet or to secure it in any other way given the three key security system used by the branch. Following the telephone conversation with Lakenda, the staff auditor advised bank personnel that Arthur Andersen auditors would count the cash on the date Cordova returned from his trip. CNB's practice of segregating a large amount of cash in the locked cabinet was clearly not a normal banking procedure. In a subsequent investigation, the SEC com- mented on this practice It is an unusual circumstance for a substantial portion of a bank's cash to be inacces sible for an extended period of time. It is also unusual for a substantial portion of a bank's assets not to be invested and earning interest for an extended period of time? In early January 1988, an employee of the 177th Street Branch notified Arthur Andersen that Cordova would return on January 14. On that date, the Arthur Andersen staff auditors arrived at the branch to complete their count of the cash funds. Cordova opened the locked cabinet in the main vault in the presence of the staff auditors. The auditors then proceeded to count the $2.7 million that had not been counted on December 29, 1987. All of the cash was present. None of the other cash funds of the 177th Street Branch or other CNB branches was counted by the Arthur Andersen auditors on January 14, 1988. After counting the segregated cash, the staff auditors asked Cordova why he kept those funds in the locked cabinet. Cordova explained that a customer who had cashed a large certificate of deposit insisted on having the funds available on de- mand at all times. According to Cordova, the customer intended to use the funds to buy foreign currencies when market conditions became favorable. The volatility of the foreign currency market dictated that the customer have immediate access to the funds on a daily basis. Near the completion of the 1987 Capital Banc audit, Lakenda reviewed the work- paper that documented Cordova's explanation for the $2.7 million of segregated cash. Lukenda then discussed that explanation with Curtin. After considering the matter, Curtin instructed Lukenda to have the staff auditors confirm that there was an offsetting liability to the given customer in CNB's accounting records equal to the amount of the segregated funds. The staff auditors obtained the documentation for this liability directly from CNB personnel. This information was not confirmed with the customer or independently verified by the auditors in any other way. The staff auditors also did not obtain documentation confirming that the customer had cashed a large certificate of deposit. Finally, the staff auditors neglected to obtain any evidence to corroborate Cordova's assertion regarding the customer's planned use of the funds. Following the completion of the Capital Banc audit in March 1988, Arthur Andersen issued an unqualified opinion on the firm's 1987 financial statements. Those financial statements reported a net income of $701,000, total cash funds of $14.1 million, and total assets of $143.2 million. Capital Banc included the audited financial statements in its 1987 Form 10-K registration statement filed with the SEC. 2. Securities and Exchange Commission, Accounting and Auditing Enforcement Release No 28 June 1993 SR CASE 2.4 CAPITAL BANC CORPORATION EPILOGUE In July 1990, the Office of the Comptroller of the Currency declared CapitalBanc Corpora tion insolvent and placed it under the control of the Federal Deposit Insurance Corporation (FDIC). The following year, Banco Popular de Puerto Rico purchased the assets of CNB from the FDIC. In late 1991, Carlos Cordova pleaded guilty to three counts of bank fraud and conspiracy to commit bank fraud. Two of Cordova's asso- ciates pleaded guilty to similar charges. Earlier in 1991, Cordova had agreed to an order issued by the SEC that permanently banned him from serving as an officer or director of a public com- pany. A federal Investigation of CNB's financial affairs revealed that Cordova misappropriated at least $100,000 of the $2.7 million allegedly stored in the locked cabinet in the 177th Street Branch's main vault. Cordova, with the help of his subordinates, had intentionally concealed this shortage from the Arthur Andersen audi- tors during the 1987 audit. Cordova secretly returned to the 177th Street Branch on January 9, 1988, and placed cash obtained from other CNB branches in the locked cabinet to replace the funds that he had embezzled. The description of the three-key security system relayed to the Arthur Andersen audi- fors by employees of the 177th Street Branch was a subterfuge. The fast-thinking employees conceived that hoax to deter the auditors from gaining access to the locked cabinet on the day of the surprise cash count. Cordova's explana- tion regarding why he kept the large amount of cash segregated in the locked cabinet was also a fabrication in 1993, the SEC reported the results of its investigation of Arthur Andersen's 1987 Capital Banc audit, an investigation that focused on the audit of the 177th Street Branch's cash funds. In that report, the SEC disclosed the follow- ing sanctions imposed on Thomas Curtin and James Lakenda: Ris hereby ordered, that Respondents Curtin and Lukendal are censured and must be daily registered and in good standing as certified public accountants in the states in thich they each reside or their principal office is located and they must each become a member of or be associated with a member firm of the SEC Practice Section of the AICPA's Dision for CPA Firms as long as they practice before the Commission Questions 1. When auditing cash, which of the management assertions discussed in SAS Na 106 "Audit Evidence," are of primary concern to an auditor? Why? . Identify audit procedures that should be applied to cash funds maintained by a client on its business premises. 3. Identify mistakes or oversights made by Arthur Andersen personnel while auditing the cash funds at the 177th Street Branch. 3. lbid CapitalBanc Corporation In 1975, Carlos Cordova and several other investors founded Capital National Bank (CNB) in Bronx, New York. Cordova was appointed the bank's chief executive offi- cer (CEO) and chairman of the board. Over the next several years, the bank opened five branch offices in the New York City metropolitan area, CNB catered primarily to the banking needs of Hispanic American and immigrant communities in New York City, In 1986, Cordova and the other owners of CNB formed Capital Banc Corpora- tion, a publicly owned bank holding company registered with the Securities and Ex- change Commission (SEC). Throughout its entire existence, the principal operating entity controlled by CapitalBanc was CNB. Cordova assumed the titles of president, CEO and chairman of the board of the new bank holding company. In the falrol 1987, CapitalBanc retained Arthur Andersen & Co, as its independent audit firm. Andersen's first engagement for CapitalBane was to audit the bank hold ing company's consolidated financial statements for the fiscal year ending December 31, 1987 Thomas Curtin, an Arthur Andersen partner since 1979, served as the en gagement partner for the 1987 CapitalBanc audit. Curtin delegated the responsibility for much of the audit planning to James Lukenda, an audit manager with Arthur Andersen since 1983. Lakenda also supervised the staff auditors assigned to the Capital Banc engagement On December 29, 1987 several Arthur Andersen stall auditors accompanied members of CNB's internal audit staff to the bank's 177th Street Branch. The Arthur Andersen auditors intended to observe and participate in a surprise count of the branch's cash funds by the internal auditors. Related audit objectives included testing CNB's compliance with certain control procedures and evaluating the competence of the bank's internal audit staff. The accounting personnel at each CNB branch maintained a "vault general ledger proof sheet" that reconciled the cash on band to the balance of the branch's general ledger cash account. Dur ing the surprise cash count at the 177th Street Branch, the Arthur Andersen audi Tors discovered a $2.7 million reconciling Item listed on the branch's proof sheet. That amount equaled 61 percent of the branch's general ledger cash balance and 45 percent of the branch's total cash funds that were supposed to be available on the date of the surprise count. When the staff auditors asked to count the $2.7 million of cash represented by the reconciling Item, bank employees told them that Cordova had segregated those funds in a locked cabinet within the bank's main vault, Three keys were required to unlock the cabinet. Cordova, who was out of the country at the time, maintained custody of one of those keys. Stymied temporarily, one of the staff auditors telephoned Lukenda. The staff audi: for relayed to Wikenda the information regarding the $2.7 million ol segregated cash. After considering the matter and discussing it with Curtin, Lakenda instructed the T. The facts of this case were drawn from the 1987 annual report of Capital Banc Corporation and the following source Securities and Exchange Commission, Accounting and Auditing Enforcement Release No. 458, 28 June 1993