SEC Charges EY in First Auditor Independence Actions Based on Personal Relationships
The SEC has long stressed auditor independence. The agency has brought a series of cases over the years to reinforce the point. Two settled actions involving accounting giant Ernst & Young LLP and others are the first, however, based on close personal relationships between the firm’s auditors and client financial personnel.
In the Matter of Ernst & Young LLP, Adm. Proc. File No. 3-17552 (Sept. 19, 2016) names as Respondents the audit firm and Gregory S. Bednar, CPA. Mr. Bednar served as the coordinating partner for a new EY engagement team for Client I after the firm had been terminated. The engagement team reported to him. While the engagement partner was responsible for the day-to-day engagement, Mr. Bednar had overall responsibility for the engagement and focused on the “relationship piece” with Client I.
E&Y had independence related policies in effect at the time. Those polices provided that all activities with clients have a valid business purpose requiring an expectation of meaningful business discussions or activity. The policy also stipulated that close personal relationships between engagement team members and audit client employees could create independence issues.
During 2012 – 2014 Mr. Bednar developed and maintained a close personal relationship with the CFO and members of his family. He spent extensive leisure time with the executive and his family. There were frequent out of town and overnight trips with the CFO and his family; overnight stays at his home; repeated social events and gifts; tickets to professional sports events for the CFO and his family; and other social contacts throughout the period. While other EY partners became aware of the close personal relationship, they failed to act.
Firm policies at the time required audit engagement teams for public companies to comply with certain annual and quarterly procedures to assess the firm’s independence. They also required engagement team members to certify their independence. While the firm recognized that a close personal relationship could cause an independence issue, it never asked about such relationships. The individual certifications focused on possible employment relationships but not close personal relationships.
Here Mr. Bednar lacked independence from Client I under Rule 2-01(b) of Regulation SX. EY also lacked independence and Mr. Bednar aided and abetted and caused the firm’s violations.
In resolving the action EY undertook to improve its policies and procedures. The firm and Mr. Bednar also consented to the entry of cease and desist orders based on Rule 2-02(b) and Exchange Act Section 13(a). EY was censured and Mr. Bednar denied the privilege of appearing or practicing before the Commission as an accountant with the right to request reinstatement after three years. EY will also pay disgorgement of $3,562,400, prejudgment interst and a penalty of $1.2 million.
In the Matter of Ernst & Young LLC, Adm. Proc. File No. 3-17553 (Sept. 19, 2016) is similar. In addition to the audit firm, the proceeding names as Respondents Robert J. Brehl, CPA, Pamela J. Hartford, CPA and Michael T. Kamienski. Mr. Brehl served as chief accounting officer of public Client 2 while Ms. Hartford acted as the EY engagement partner and later the coordinating partner for Client 2 and Mr. Kamienski served as the coordinating partner on the engagement from 2009 through 2013.
EY served as outside auditor to Client 2 from 2004 through 2014. From March 2012 through June 2014, while Ms. Hartford served first as the engagement partner and later the coordinating partner, she and Mr. Brehl maintained a romantic relationship. That relationship was marked by a “high degree of personal intimacy, affection and friendship, near daily communications that were personal as well as work related and occasional exchanges of small gifts. While the two tried to secrete their relationship, they were unsuccessful. During the time he served as coordinating partner Mr. Kamienski became aware of certain red flags but failed to properly follow-up.
In June 2014 a firm vice president at Client 2 made an internal whistleblower complaint regarding a possible inappropriate relationship between Mr. Brehl and Ms. Hartford. The company conducted an internal investigation and reported its findings to EY. The audit firm removed Ms. Hartford from the engagement team, conducted its own investigation and eventually withdrew its audit reports issued on the 2012 and 2013 financial statements of the firm and other reports.
To resolve the matter each Respondent consented to the entry of a cease and desist order based on Rule 2-02(b)(1) of Regulation S-X and Exchange Act Section 13(a) and Rule 13a-1. EY was censured while Respondents Hartford, Kamienski and Brehl were denied the privilege of appearing before the Commission as accountants. Respondents Hartford and Kamienski may apply for reinstatement after three years; Mr. Brehl may apply after one year. EY will also pay disgorgement of $3,168,500, prejudgment interest and a civil penalty of $1 million. Respondents Hartford and Brehil will each pay a civil penalty of $25,000.
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