iAs reported by Bloomberg, at a PLI conference in October of 2021 the Acting Chief Accountant of the U.S. Securities and Exchange Commission (“SEC”), Paul Munter, issued a statement concerning the requirements found in SEC rules that, an auditor who is attesting to the accuracy of client financial statements, must be independent of the client. Munter emphasized that the determination of independence is not a “checklist compliance exercise under” the SEC rules. He went on: accountants, audit firms, registrants, and their audit committees should never make the mistake of assuming that just because a particular circumstance is not expressly prohibited in, or captured by, [the SEC rules], their independence analysis is over. The general standard requires an evaluation of auditor independence, including an assessment of independence both in fact and appearance from the perspective of a reasonable investor.
Munter said that the key question is whether the auditor “is capable of exercising the objective and impartial judgment of all issues encompassed within” the auditor’s engagement. He expressed concern about the nature of the relationship between auditor and client, including the issues posed by accounting firms providing non-audit services and the resulting business relationships that can and do develop between the accounting firm and the audit client. He said somewhat harshly: “I have less than zero sympathies for independence violations that resulted from firms having prioritized growing consulting practices, growing non-audit services, prioritizing those over the integrity of its independence to its issuer audit clients”. “Auditor independence” Munter cautioned “is grounded in an understanding of accounting as a profession rather than an industry.”
It is against this backdrop of potential conflicts which would or might undercut the independence of an accounting firm auditing client financial services that one of the so-called “Big Four” accounting firms is seriously considering splitting into two separate companies: one to audit client financial statements; the other to provide consulting and other business services (including, in some instances, legal advice). The accounting firm Ernst & Ernst was founded in 1903 in Cleveland, Ohio by two brothers, Alwin and Theodore Ernst. Arthur Young, a Scottish accountant who emigrated to Chicago, started Arthur Young & Company in 1906. After substantial growth, becoming two of the then so-called Big Eight accounting firms in the U.S., the two firms merged in 1989 to become Ernst & Young, LLP (“EY”). On 31 May 2022 Bloomberg reported that EY was “considering whether to separate its global audit and advisory practices”; noting that a “key reason” for this was “tighter ethics regulations”, which “are holding back the growth of …[EY’s] lucrative consulting business.” The Bloomberg article notes further that “EY’s audit practice…could be a further drag on revenues as the firm faces hefty fines and billion-dollar lawsuits over its work for failed German payment processor Wirecard AG and for London-listed NMC Health Plc.” The piece also observes that EY had previously sold its global consulting arm to Capgemini in 2000 for $11 billion, “only to build up that service line again to the point where it now trumps the audit practice in revenue.” And the conflicts are real; Bloomberg reports that “EY paid $10 million…[in] August [2021] to settle SEC allegations that it violated auditor independence rules in seeking to win business from a competitor.”
The Bloomberg article about the possible separation of practices was corroborated on 20 June 2022 by the Wall Street Journal, which reported that a preliminary draft of the separation plan was being evaluated by the partners of EY. The separation would involve an eventual public offering of stock in the consulting business. The Journal disclosed that the draft plan would involve substantial cash payouts to EY partners: $1.7 million to $3.6 million for those staying with the audit practice; and $5.9 million to $8.1 million for the partners in the new consultancy firm. The plan calls for a partner vote (if EY leadership decides to proceed) in January 2023. Both the Bloomberg and the Journal articles point out that no plan of separation of two practices can occur without regulatory approval, especially on the audit side of the business. Hence, one might expect that EY, its leaders, and its employees would wish to take extra care to comply with the best practices in accounting, including auditing and related attest services. Consistent with the statements of Paul Munter, accountants are to always remember that theirs is a profession, and not just “an industry”.
One of the critical and continuing areas of professionalism for accountants is taking regular courses in professional education, including ethics. As the SEC’s 28 June 2022 Order Instituting Administrative and Cease-and-Desist Proceedings against EY says:
State accountancy boards require CPAs [Certified Public Accountants] to complete continuing professional education (CPE) courses to ensure that they remain knowledgeable about them ethical obligations and current accounting standards. CPAs must pass examinations designed to test their understanding of these materials to get credit for these courses and maintain their licenses.
The Order goes on to note that “over multiple years, a significant number of EY audit professionals cheated on these exams by using answer keys and sharing them with colleagues.” According to the Order from 2017 to 2021, 49 professionals sent or received answer keys, and “hundreds of other audit professionals cheated on CPE courses.” An additional “significant number of EY professionals’ who did not themselves cheat, violated the EY Code of Conduct “by failing to report” the cheating by others. The Order also reports that this was not a first-time offense, as between 2012 and 2015 over 200 EY professionals used a software flaw on the EY CPE testing platform to pass exams despite having only “a low number of correct answers”. Each time this type of misbehavior occurred EY took “disciplinary actions and repeatedly warned its professionals not to cheat.”
On 17 June 2019, the Commission issued an order finding that another one of the Big Four accounting firms “had engaged in misconduct, that included, among other things, cheating on internal training exams”. In fact, that other firm had, according to the SEC’s 17 June 2019 Press Release, altered past audit work after receiving stolen information about inspections of that firm by the Public Company Accounting Oversight Board (“PCAOB”), and numerous audit professionals cheated on internal exams by “improperly sharing answers and manipulating test results.” The PCAOB was created as a non-profit Federal corporation to oversee the accounting profession by Congressional passage of the Sarbanes-Oxley Act of 2002 in the wake of the Enron and WorldCom accounting scandals. As the then Co-Director of the SEC’s Enforcement Division observed, “Investors and other market professionals rely on these gatekeepers to fulfill a critical role in our capital markets.” That other Big Four accounting firm paid a civil penalty of $50 million as part of its settlement with the Commission.
Given EY’s checkered history of cheating on CPA exams, it is not surprising that almost immediately after the $50 million settlement with the other firm, the SEC’s Division of Enforcement sent EY a formal request on 19 June 2019 asking if EY had “received any ethics or whistleblower complaints regarding testing associated with any EY training program or continuing professional education course” and requesting the response by 20 June 2019. It should be noted, that although this was a formal request, it was not a subpoena so the response might possibly be viewed as “voluntary”. Also, on 19 June 2019 (in response to the $50 million settlement by the other Big Four firm) EY’s U.S. Chair and Managing Partner sent a message to ALL U.S. personnel that “[s]haring answers on internal or external tests or evaluations is highly unethical behavior and will not be tolerated at EY.” She further noted that the SEC enforcement action “serves as an important reminder of our responsibility to serve the public interest and the need to always act with integrity and honesty.”
EY responded to the Commission on the 20th of July as requested, detailing five matters related to the SEC’s question; none of those matters “involved potentially ongoing misconduct” by current EY employees or which EY had not addressed. However, also on 19 June an EY employee “reported to a manager that a professional” in EY’s audit group had e-mailed that employee answers to a CPA ethics exam. The manager informed an EY human resources employee that afternoon, and that information was relayed that day to others in the EY human resource group.
After a series of meetings among EY leadership and EY’s General Counsel Office after June culminating in October 2019, EY determined to conduct a firm-wide investigation to determine the scope of cheating problems and the best corrective steps to take. That investigation, which the Order characterizes as “robust”, determined that many EY audit professionals continued to cheat, including 91 who cheated after the 19 June 2019 message from the U.S. Chair and Managing Partner. EY decided after four more months (i.e., by the end of February 2020) to provide a full report to the PCAOB, because by then EY knew “the extent of the misconduct” and “had a credible plan in place to address the problem.” However, it was only in March 2020 that the PCAOB informed the SEC of the scope of the EY problems, which the Order rather angrily notes were “almost nine months after the June 19, 2019, request.” EY itself NEVER corrected or withdrew its 20 June 2019 response to the Commission.
The Order charged EY with two separate failures: first, the continuing cheating on CPE exams, especially those related to ethics; and second, withholding evidence of the exam misconduct from the SEC’s Enforcement Division during the period that the Commission was looking into exam cheating by EY professionals. The settlement which EY agreed to on 28 June 2022, is quite constrictive on EY. In addition to a cease-and-desist order and a censure, EY was required to pay $100 million as a civil penalty. More significant, perhaps, is that the Order requires EY to retain two independent consultants: i) the first to review and propose improvements to EY’s quality controls, policies, and procedures relevant to ethics and integrity, including how EY responds to information requests; and ii) the second to review the bases for and the personnel involved in EY’s “disclosure failures”. This second consultant, termed the Remedial IC in the Order, is to be selected by a three-member committee of “EY senior personnel who had no involvement in EY’s conduct relating to the June 2019 Enforcement Division Request, including its failure to correct its submission, and who will have authority to direct and oversee employment and other remedial actions on behalf of the firm.” The Remedial IC is specifically to be tasked to make recommendations to the three-member committee “as to employment actions or other remedial steps.” Obviously, this second consultant structure is designed to impose widespread sanctions against EY personnel, including its leadership and in-house counsel, for the investigation and disclosure steps taken AND NOT TAKEN.
The imposition of the Remedial IC in the context of an incomplete response to the SEC 19 June 2019 Request, where the Request, even though made formally by EY’s regulator with a one-day turnaround, might be seen as technically a “voluntary” response, was seen by at least one Commissioner (Hester Peirce), as an example of regulatory overreach, as laid out in her Statement of 28 June 2022. She also raised concerns about the size of the civil penalty, $100 million, in contrast to the $50 million penalty imposed on the other firm that had engaged in criminal theft of PCAOB materials. Hence, Commissioner Peirce dissented from the SEC Order, although she confirms that she would have supported it if the charge had focused on the continuing cheating on exams and if the remedies had not been so severe.
At the proverbial “End of the Day”, one may wonder how much cooperation and regulatory flexibility the Commission may show if EY does decide to go forward with its attempt to separate the audit practice from the consulting business. As the Commission’s Director of Enforcement states in the SEC’s 28 June 2022 Press Release about the EY proceeding:
This action involves breaches of trust by gatekeepers within the gatekeeper entrusted to audit many of our Nation’s public companies. It’s simply outrageous that the very professionals responsible for catching cheating clients cheated on ethics exams of all things. The SEC will not tolerate integrity failures by independent auditors who choose the easier wrong over the harder right.
In fact, the SEC proceeding and resulting settlement made the front page of the Wednesday, 29 June 2022 Wall Street Journal with the three-column headline “EY to Pay $100 Million Fine in Ethic-Cheating Scandal”. The Journal article notes that the $100 million is “the largest fine ever imposed by the Securities and Exchange Commission on an audit firm.” The Journal goes on to observe that “[t]he case is the latest reputational setback for a profession entrusted with overseeing the reliability of public company financial statements.” It appears for all the history of the accounting profession in the 21st century, and particularly that of EY, the personnel of EY have yet to fully confront the question of The Who, which serves as the title for these meanderings.
