Don’t Get Too Close: Auditor Independence Failures Result in SEC Enforcement Actions

Recently, the London-based public accounting firm Ernst & Young, along with a senior partner and an auditor agreed to pay approximately $9.3 million in settlement charges after SEC investigations determined that there had been violations of auditor independence rules.  According to the news release and orders issued by the SEC, there were two incidences of violations of auditor independence rules.  The first was by a senior partner of Ernst & Young, Gregory S. Bednar, due to the fact that he had developed a close friendship with the chief financial officer of a company that Mr. Bednar had been assigned to work with.

The second incident happened, according to the SEC, when Pamela Hartford, an auditor with Ernst & Young, developed a romantic relationship with a financial executive while serving as an audit member on the team that was auditing his company.  Apparently, the violations were further compounded because certain partners and a supervisor became aware of the activities and did not take appropriate actions to confirm independence or correct the potential violations.

According to the SEC release, Ernst & Young requires audit engagement teams to follow procedures that assess their independence.  Although these procedures address employees’ familial, employment or financial relationships with audit clients, they fail to factor in close personal relationships that are non-familial.

Andrew J. Ceresney, the Director of SEC’s Division of Enforcement was quoted in the news release as saying: “These are the first SEC enforcement actions for auditor independence failures due to close personal relationships between auditors and client personnel,” and further, “Ernst & Young did not do enough to detect or prevent these partners from getting too close to their clients and compromising their roles as independent auditors.”

These SEC enforcement cases should be considered as a call to action for financial industry firms, such as broker-dealers and investment advisers that are required to obtain “independent” financial audits.  When is the last time you performed due diligence on your accounting firm?   A review of the steps they take to ensure compliance with independence regulations should be part of the due diligence process.

Performing due diligence on service providers is a daunting, but required task.  Core Compliance & Legal Services, Inc. consultants are well versed in due diligence requirements and can assist firms with this process.  For further information or if you have questions, please call us at (619) 278-0020.

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