Has Ernst & Young Struck a Blow for Ethics?
11/04/2024
When Should an Audit Firm Walk Away from a Client?
I worked for Arthur Young longer ago than I choose to remember. I always felt the firm was committed to ethical behavior, and for the most part it was. I can remember a training session where a video was shown (hypothetical case) of a first-year junior being grilled on the stand in a lawsuit claiming the firm did not exercise due care in conducting its audit. I could see the sweat on the brow of staff person. The video was a reminder not to compromise our values in performing professional services for clients.
Fast forward to the present day and there is no denying that EY has been getting into trouble for a variety of ethical lapses. The firm's 37% audit deficiency rate led the Big Four in 2023, according to the PCAOB audit inspection report, but it’s at least better than the 46% it had in 2022.
According to a report in the Wall Street Journal, 84 audit clients have left EY since January 2023, based on data from Ideagen Audit Analytics. EY told the Journal that it thinned its roster to improve the quality of its audits. Those audits had the distinction of leading the Big Four in deficiencies last year, according to the PCAOB. EY has also added fewer new clients: just 21 since 2023. That’s reported to be intentional. This is a good sign assuming EY is committed to freeing itself of troubled clients and management that can't (shouldn't) be trusted.
The problems caused by a lack of ethics has run deep at EY. It's not just in their audits, as reflected by the 84 deficiency rate. I believe it has been ingrained in their culture, but I am hopeful that has changed for the better. Here are two examples that stand out in my mind.
Cheating on Internal Training Exams
Over multiple years, a sizable number of EY audit professionals cheated on the ethics component of the CPA Exam, as well as on a variety of other examinations required to maintain their CPA licenses. As this was ongoing, EY withheld this misconduct from SEC staff investigating potential cheating at the firm. EY audit professionals’ repeated cheating on exams and the firm’s misrepresentations to the SEC violated PCAOB standards. The firm violated PCAOB Rule 3500T, which requires EY and associated persons to comply with ethics standards, including integrity, and not commit an act discreditable to the profession. The SEC imposed a $100 million fine on the firm.
Over multiple years, a sizable number of EY audit professionals cheated on these exams by using answer keys and sharing them with their colleagues. From 2017 to 2021, 49 EY audit professionals sent and/or received answer keys to CPA ethics exams. In addition, hundreds of other audit professionals cheated on CPE courses, including those addressing CPAs’ ethical obligations. And a significant number of EY professionals who did not cheat themselves, but knew their colleagues were cheating and facilitating cheating, violated the firm’s Code of Conduct by failing to report this misconduct.
Sealed Air: A Lack of Independence
The SEC charged EY and EY partner James Herring, and former EY partners, James Young, and Curt Fochtmann with improperly interfering with Sealed Air’s selection of an independent auditor by soliciting and receiving confidential competitive intelligence and confidential audit committee information from the issuer’s then-Chief Accounting Officer, William Stiehl, during the request for proposals (RFP) process. The SEC concluded that EY’s misconduct in connection with the audit pursuit would cause a reasonable investor to conclude that EY and its partners were incapable of exercising objectivity and impartiality once the audit engagement began. The SEC’s separate order against Stiehl states that, through his misconduct during the RFP process, including withholding key information from the issuer’s audit committee, Stiehl caused the issuer’s reporting violations.
The SEC’s order found that the aforementioned parties violated the auditor independence provisions of the federal securities laws, and that EY, Herring, and Young caused Sealed Air to violate its obligation to have its financial statements audited by independent public accountants. The order also found that all respondents engaged in improper professional conduct within the meaning of Rule 102(e) of the SEC’s Rules of Practice.
EY Quits Its Audit of Super Micro
A few days ago, it was announced that EY has resigned as the auditor of Super Micro Computer, saying it can no longer rely on management’s and audit committee representations. In an October 24, 2024, letter to the company, EY said it was resigning due to information that has recently surfaced which led the firm to decide it can no longer be associated with any financial statements that Super Micro management prepares and the firm expressed its concern that board of directors’ independence from CEO Charles Liang and other management had been compromised.
EY had told Super Micro back in July that it had concerns about the company’s internal controls over financial reporting, as well as transparency and completeness of its communications with the firm. EY delayed the filing of audited financial statements on time, needing more time to assess financial reporting controls. The delay occurred one day after short seller Hindenburg Research said it found glaring accounting red flags at Super Micro, accusing the company of allegedly engaging in undisclosed related party transactions, sanctions and export control failures.
Super Micro paid $17.5 million in 2020 to settle SEC allegations of widespread accounting violations. Since then, a former employee accused Super Micro the company of violations and filed a whistleblower lawsuit.
Conclusion
Having taught accounting ethics for over 30 years, it is nice to read a positive story of a firm walking away from a lucrative client over ethics concerns. While it may be true that EY’s actions come after the SEC settlement, in past years the firm might have stood firm, supported the client, and didn’t withdraw from the engagement. Kudos to EY for doing the right thing. I hope they continue to build on this positive ethics story.
Posted by Steven Mintz, aka Ethics Sage, on November 4, 2024. You can sign up for his newsletter and learn more about his activities at: https://www.stevenmintzethics.com/.