by Cydney Posner

As discussed in this PubCo post, last week, the SEC announced settled charges against EY and individual EY auditors (and certain officers at the audit clients involved) with regard to alleged violations of the auditor independence rules as a result of “close personal relationships” with officers at audit clients.  As noted in the post, these cases are of interest to issuers as well as auditors because the auditors’ (and the officers’) violations caused the companies involved to violate Section 13(a) of the Exchange Act and Rule 13a-1, which require public companies to file Forms 10-K with financial statements that have been audited by independent accountants.

But what is the impact of the absence of independence on the audit client involved? This article in Compliance Week explores that issue. As noted in the PubCo post, in addition to  the censure of and penalties imposed on EY and the penalties and suspensions imposed on the EY auditors charged, various penalties and suspensions were also imposed on the company officers who were involved in (or who ignored red flags related to) the “personal relationships.” The SEC orders did not, however, identify the audit clients involved.  To that end, the article’s author conducted an investigation with help of Audit Analytics.

In one case, EY had withdrawn its audit reports for two years after determining that the firm was not independent. Subsequently, the company filed a Form 8-K indicating that, as a result of the independence violation, the company was required to have its financial statements for two years re-audited by a new firm.  The company then filed an amended Form 10-K including the newly audited financials that revealed “no accounting anomalies” and included a clean audit opinion.

However, with regard to the other company (the identification of which the author was not able to confirm with the company or the SEC), the the company’s 8-K revealed only disclosure indicating that the company was dismissing EY as its audit firm and engaging another firm, without indicating any “cause for the dismissal, except to say the company completed a ‘competitive process’ to determine which audit firm would serve as its independent auditor, and that EY was invited to participate in the process, and did so.”  In a subsequent article, the author reports that, instead, the company disclosed the independence issue  in its 10-K, indicating that EY informed the company and conducted a review of its independence and audit procedures, re-performing those procedures where appropriate. After the assessment, EY, the company, and the its audit committee “concluded and continue to believe that these matters did not affect EY’s objectivity, skepticism or impartiality”  as auditors of the company’s financial statements. EY did not withdraw its audit report.

If these two results seem a bit difficult to reconcile, Enforcement was apparently not much help, although no objection was raised to the disclosures that were made: “Pressed with questions on whether investors could rely on the financial statements of companies at the center of the SEC’s independence charges, [the director of Enforcement] said … ‘Those determinations and the reliance upon those financial statements are determined separately from this action….I think whatever disclosures were appropriate in those cases have been made.’ The SEC did not respond to a request [as to] why two highly similar cases would result in vastly different disclosure outcomes for investors.”

In any event, some inquiry into the extent of personal relationships in the context of auditor independence is now another menu item on the audit committee’s plate.

Posted by Cydney Posner