J. E. Boritz and D. J. Cockburn
School of Accountancy
University of Waterloo
Waterloo ON N2L 3G1
June 2001
Philip Services Corporation (Philip) is a Canadian company with its head office in Hamilton, Ontario. Its common shares are listed on the Toronto Stock Exchange (TSE), the Montreal Exchange and from April 30, 1996 the New York Stock Exchange. In 1997 the company filed with the Securities and Exchange Commission (SEC) a registration statement and a prospectus to sell 20 million common shares.
The company is engaged in the business of providing metal recovery and processing services including environmental waste management services throughout the U.S. and Canada. Philip’s business was organized into two divisions – the Metals Group and the Industrial Services Group. The Metals Group accounted for more than 60% of the company’s revenue (US$ 1.1 billion out of US$ 1.75 billion) and was in turn comprised of three divisions – copper, ferrous and aluminum processing, and recycling.
The company’s primary base of operations is in the U.S. with approximately 70% of its revenue generated in the U.S. as at September 30, 1997 and over 60% of its common stock held by U.S. investors.
The company is subject to a number of US shareholder class action suits and is subject to disciplinary proceedings by the Ontario Securities Commission (OSC). The class action period runs from May 21, 1997 (the date the 1996 annual report was filed with the SEC) through January 26, 1998 (the date the company announced that it would be recording two charges to income totaling between $US250 to $US275 million; $60-80 million relating to inventory and the balance relating to the company’s restructuring and acquisition program including a write down of goodwill relating to acquisitions made from 1993-1996).
The principal complaint in the class action suits is that the company overstated its inventory and the value of the acquisitions made during 1993-1996. The class action suits are pleading for damages as a result of the overstatement of the company’s results for the class period.
The defendants in the class action suits appear to be Allen Fracassi, the President, Chief Executive Officer and a Director of the company; Philip Fracassi, the Executive Vice President, Chief Operating Officer and a Director; Howard I Beck, Chairman of the Board; Robert Waxman, the President of the Metals Group and a Director; Marvin D. Boughton, the Executive Vice President and Chief Financial Officer (who prior to joining the company had been a partner in the company’s audit firm) and the company.
The defendants in the OSC proceedings, in addition to the above, also include Graham Hoey, the Senior Vice President, Finance (who also had been a partner in the company’s audit firm); Colin Soule, the General Counsel, Executive Vice president and Corporate Secretary; and John Woodcroft, Executive Vice President, Operations; but exclude Beck.
The attached OSC Statement of Allegations contains a number of allegations by OSC staff against the company and its officers. The OSC alleges that the 1997 prospectus filed by the company on November 6, 1997 was materially misstated because it failed to make full, true and plain disclosure of material facts. The prospectus included audited 1995 and 1996 annual financial statements and unaudited financial statements for the six months ended June 30, 1997 and 1996. In addition unaudited financial statements for the nine months and three months ended September 30, 1997 and 1996 were included. The audit firm consented to the inclusion of their unqualified audit opinions on the 1996 and 1995 annual statements and provided a comfort letter (negative assurance) regarding the June 30 financial statements.
In the view of the OSC, the defendants knew that the 1997 prospectus was materially misstated and the allegations are discussed under the following three headings:
- the Waxman allegations, paragraphs 34-66
- the restructuring charge allegations, paragraphs 67-116, and
- the material financial transactions (special charge) allegations, paragraphs 117-176.
No allegations have been made to date against the audit firm by the OSC although a number of US shareholder class action suits have been filed naming the audit firm, among others, as a defendant.
Required:
Was the audit firm deficient in the work it performed or was it the victim of deceit on the part of senior management, including senior accounting officers? Were there “red flags” which should have alerted the audit firm that there were financial reporting problems within the company? Whilst no allegations have been made against the audit firm by the OSC, assume that you have been engaged to develop a defense for the auditor based solely on the information contained in the OSC Statement of Allegations.
Glossary - Ontario Securities Act
- Securities Act - the Act that regulates distribution and trading of securities in Ontario.
- Ontario Securities Commission (OSC) - the securities regulator in Ontario.
- Part XV of the Securities Act - the part of the Act that deals with the distribution of securities by prospectus.
- Section 56 - describes, in general terms, the purpose and content of a prospectus.
- Section 58 - prescribes certification of a prospectus on behalf of the issuer by the CEO and CFO and, on behalf of the Board, two directors.
- Section 122 - discusses offences, defenses and penalties under the Act.
- Section 127 - discusses orders that may be made in the public interest by the Ontario Securities Commission including cease-trading orders.
- Section 128 - permits the OSC to apply to the Ontario Court (General Division) for a declaration that a person or company has not or is not complying with the Act and remedial orders.