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SEC Receives $9.3 Million Settlement In Auditor Independence Actions
09/26/2016On Monday, September 19, the United States Securities and Exchange Commission (“SEC”) announced that public accounting firm Ernst & Young (“EY”) agreed to pay a total of $9.3 million to settle separate charges that two of the firm’s audit partners, Gregory Bednar and Pamela Hartford, violated auditor independence rules after overseeing allegedly independent audits while allegedly engaging in personal relationships with senior executives of the EY issuer clients that were being audited.
Gregory Bednar was a senior partner at EY, who was the coordinating partner to a longtime EY issuer client’s account. While serving in this role, Bednar maintained a close personal relationship with the client’s CFO. The two men, for example, vacationed together with their families, stayed overnight at each other’s homes, and exchanged hundreds of personal emails and texts. In connection with this relationship, Bednar billed $109,000 in entertainment related expenses related to this client, including for out of town sporting events that he and the CFO’s family attended. According to the SEC, numerous EY partners were aware of these entertainment expenses and Bednar’s travel with the CFO, but failed to confirm that Bednar complied with EY’s independent audit requirements.
The SEC similarly alleged that Pamela Hartford, a former partner at EY, maintained a close romantic relationship with the audit client’s chief accounting officer, Robert Brehl. According to the SEC, several EY partners learned of this romantic relationship, but failed to raise the issue with EY’s U.S. independence group, which is an EY resource that helps partners determine if they are compliant with the independence regulatory requirements. As such, the relationship was not addressed by EY until after one of the client’s vice presidents made an internal whistleblower complaint. Upon receipt of the complaint, the client commenced an internal investigation and reported its findings to EY, which conducted instituted its own internal investigation. Thereafter, EY withdrew its 2012 and 2013 audit reports, after finding that they were improperly certified as independent. The client engaged another accounting firm to reaudit its 2012 and 2013 financial statements. No restatements were made.
The SEC alleged that EY violated Rule 2-01(b)(1) and 2-02(b)(1) of Regulation S-X and caused the issuer clients to violate Section 13(a) of the Exchange Act by certifying that its audits were independent, notwithstanding the above relationships. The SEC further alleged that the two EY partners engaged in improper professional conduct pursuant to Section 4C(a)(3) of the Exchange Act and Rule 102(e)(1)(ii) of the Commission’s Rules of Practice. In addition to imposing fines on EY, the SEC suspended Hartford and Bednar from practicing in front of the Commission for 3 years. The SEC also suspended Robert Brehl and Michael Kamienski, the coordinating partner on the engagement team, who allegedly knew of Hartford and Bednar’s relationship for between 1-3 years.
On Monday, EY issued a statement that the involved partners “violated multiple EY policies, hid their conduct and behaved in a way that was antithetical to EY’s global code of conduct, culture, values, policies and training.” According to the SEC, while EY did require audit engagement teams to follow certain procedures to assess their independence, EY’s procedures did not specifically address non-familial close personal relationships that could impair the firm’s independence. EY has reportedly since adjusted its procedures to require inquiry into any close relationships between EY personnel and client personnel. EY’s procedures also now require audit team members to disclose any such relationships and to certify that they have consulted with an EY independence leader if they enter into such a relationship.
Andrew J. Ceresney, Director of the SEC’s Division of Enforcement highlighted the novelty of these charges, and the SEC’s perceived failure of controls relating to auditor independence: “these are the first SEC enforcement actions for auditor independent failures due to close personal relationships between auditors and client personnel . . . Ernst & Young did not do enough to detect or prevent these partners from getting too close to their clients and compromising their role as independent auditors.” While the SEC did not lay out bright-line rules or guideposts regarding the propriety of personal relationships between auditors and clients, it is clear that the SEC will take a hard look at companies’ internal controls surrounding such issues. Accordingly, it would behoove auditors and issuers to review their policies in this regard, and consider EY’s remedial measures as ones that the SEC eventually may come to expect.
