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Ernst young auditing firm barred auditing six months { April 17 2004 } Original Source Link: (May no longer be active)
http://www.nytimes.com/2004/04/17/business/17ERNS.htmlhttp://www.nytimes.com/2004/04/17/business/17ERNS.html
April 17, 2004
Big Auditing Firm Gets 6-Month Ban on New Business
By FLOYD NORRIS
Ernst & Young, the big accounting firm, was barred yesterday from accepting any new audit clients in the United States for six months after a judge found that the firm acted improperly by auditing a company with which it had a highly profitable business relationship.
The unusual order, which included a $1.7 million fine, brought to an end a bitter fight in which the Securities and Exchange Commission had contended that Ernst violated rules on auditor independence by jointly marketing consulting and tax services with an audit client, PeopleSoft Inc.
"The overwhelming evidence," wrote Brenda P. Murray, the chief administrative law judge at the S.E.C., is that Ernst's "day-to-day operations were profit-driven and ignored considerations of auditor independence." She said the firm "committed repeated violations of the auditor independence standards by conduct that was reckless, highly unreasonable and negligent."
The rebuke to Ernst, which said it would not appeal the decision, is the latest embarrassment for one of the Big Four accounting firms, which have come under heavy criticism and increased regulation as a result of accounting scandals in recent years. Those scandals led to the demise of Arthur Andersen, which had formerly been among the Big Five.
The judge was harshly critical of the Ernst partner who was in charge of independence issues, saying he kept no written records and had failed to learn enough facts before saying the relationships between Ernst and PeopleSoft were proper. That partner, Edmund Coulson, was chief accountant of the S.E.C. before he joined Ernst in 1991.
Ernst's consulting and tax practices used PeopleSoft software in their business, and the two companies participated in some joint promotion activities. Ernst contended that it should be viewed as a customer of PeopleSoft in the relationship, but the judge said it went far beyond that.
She noted that Ernst had billed itself in marketing materials as an "implementation partner" of PeopleSoft and had earned $500 million over five years from installing PeopleSoft programs at other companies, which use the software to manage payroll, human resources and accounting operations.
She issued a cease-and-desist order against the firm, saying it had refused to admit it had done anything wrong and that there was no reason to believe it would not violate the rules again. She also fined it $1,686,500, the total amount of audit fees the company received from PeopleSoft in the years that were involved, plus interest of $729,302, and ordered that an outside monitor be brought in to assure the firm complied with the rules in the future.
S.E.C. officials said the decision would send a message to other firms. "Auditor independence is one of the centerpieces of ensuring the integrity of the audit process," said Paul Berger, an associate director of the commission's enforcement division, adding that the judge's decision "vindicates our view that Ernst & Young engaged in a business relationship that clearly violated" the rules.
Ernst, based in New York, had previously denounced the commission for seeking a ban on new business, saying any such punishment was completely unwarranted. But last night the firm said it would accept the ruling and would not appeal. It had the right to appeal to the full S.E.C. and then to federal courts if the commission ruled against it.
"Independence is the cornerstone of our practice and our obligation to the public," said Charlie Perkins, a spokesman for Ernst & Young. "We are fully committed to working closely with an outside consultant in the review of our independence policies and procedures."
Mr. Perkins said the firm had decided not to appeal because it wanted to put the matter behind it, and emphasized that it would be able to continue serving its existing clients.
The six-month suspension appears to match the longest suspension on signing new business ever imposed on a leading accounting firm.
In 1975, Peat Marwick, a predecessor of KPMG, agreed to accept a similar six-month suspension as part of a settlement of charges it had failed to properly audit five companies, including Penn Central, the railroad that went bankrupt.
In 1978, an administrative law judge imposed a similar suspension on Ernst & Ernst, a predecessor of Ernst & Young, after finding that it had conducted bad audits. But the full S.E.C. reduced the penalty to a censure, calling the suspension too severe.
In 1976, Seidman & Seidman, a firm that ranks below the top firms in terms of size of business, accepted a six-month bar after the commission found it had failed to properly audit clients that included the Equity Funding Corporation of America, which engaged in a fraud that was then one of the largest ever.
This case, unlike those, did not involve bad audits. There was no accusation that Ernst's audits of PeopleSoft were inaccurate, only that the accounting firm violated rules requiring that it be independent from its audit clients.
In the 1990's, auditing firms greatly expanded their consulting businesses and chafed under independence rules that many considered outmoded. They fought efforts to tighten those rules in 2000 and managed to get the commission to weaken rules it had proposed.
Since then, however, some of the firms, including Ernst, have sold most of their consulting businesses.
The Sarbanes-Oxley Act, passed in 2002, established the Public Company Accounting Oversight Board, which regulates and inspects accounting firms and has issued new rules on auditor independence. Those rules did not play a role in this case because it concerned audits from 1994 through 1999.
Ernst declined to say how many new audit clients it typically added in a six-month period. The exact date the suspension will begin was not clear and could be important. Companies that switch auditors often do so soon after an audit is completed, which is about now for companies that report on a calendar-year basis. The ban will affect companies that file reports with the S.E.C., whether they are based in the United States or other countries.
Arthur W. Bowman, editor of The Accounting Report by Art Bowman, a newsletter, said the firm might add 100 new audit clients a year but that it was unclear how much its revenue would suffer. "It certainly doesn't do well for the firm's public image, but it doesn't do much to the firm's bottom line," he said, noting that some partners of the firm earned annual compensation of more than $1.7 million, the amount of the fine.
Ernst & Young's relationship with PeopleSoft, which is based in Pleasanton, Calif., appears to have been very profitable for the accounting firm, which installed computer software for consulting customers. "In 1998," the judge wrote, Ernst "earned $150 million from implementing PeopleSoft software and $372,000 from auditing PeopleSoft's financials."
PeopleSoft replaced Ernst as its auditor in 2000, after the S.E.C. investigation that led to yesterday's decision had begun. It then hired Arthur Andersen and moved to KPMG in 2002 after Andersen collapsed.
Mr. Perkins, the Ernst spokesman, said most of the relationship with PeopleSoft had been in the consulting division that was sold and that the remainder was in the company's tax practice. He said the tax practice no longer was involved with PeopleSoft.
Most of the arguments over auditor independence have dealt with questions of what services other than auditing could be provided by the accounting firm to its clients. Significant business relationships have long been barred, even to the extent of not allowing auditors to invest in mutual funds that their firms audit.
The current rules on auditor independence bar auditing firms from performing some services for audit clients but allow others if the company's audit committee approves of them. Some institutional investors have mounted campaigns to vote against directors that allow such relationships.
Copyright 2004 The New York Times Company
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