EY denies audit firm split tied to $100M SEC penalty

Ernst & Young said a proposal to spin off its audit firm as a separate entity from its consulting practice is unrelated to the record $100 million penalty levied Tuesday by the Securities and Exchange Commission accusing the firm of cheating on CPA ethics exams and misleading investigators.

The SEC charged the firm Tuesday with the largest penalty ever imposed by the commission against an audit firm, saying EY’s audit professionals had cheated on exams required to obtain and maintain their CPA licenses, and for withholding evidence of the misconduct from the SEC’s Enforcement Division during an investigation (see story). The Big Four firm admitted that over several years, a number of its auditors cheated on the ethics component of the CPA exam and various continuing professional education courses, including ones designed to ensure accountants can properly evaluate whether clients’ financial statements comply with U.S. GAAP.

EY also admitted that during the SEC Enforcement Division’s investigation of potential cheating at the firm, the firm told the SEC in a submission it did not have current issues with cheating when, in fact, it had been informed of potential cheating on a CPA ethics exam. 

EY also admitted it didn’t correct its submission after it launched an internal investigation into cheating on CPA ethics and other exams and confirmed there had been cheating, even after its senior lawyers discussed the matter with members of the firm’s senior management. The SEC order found that EY didn’t cooperate in the commission's investigation regarding its materially misleading submission.

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Reports have circulated since last month that EY has been considering spinning off its audit firm from its consulting firm on a global basis, as major accounting firms come under pressure from regulators in Europe, the U.K. and the U.S. to deal with potential conflicts of interest and independence issues (see story), but EY insisted the breakup plan is unrelated to the SEC action. 

“The SEC investigation is more than two years old, and this resolution has been in the works for some time,” said EY spokesperson Brendan Mullin. “It is unrelated to any analysis of the EY structure and our competitive landscape. As the most globally integrated professional services organization, we regularly conduct scenario planning and review EY businesses on a global basis to determine that we have the optimal strategy, structure and footprint to focus on delivering high-quality audits and exceptional service to all clients across EY.” 

The proposal to split the audit and consulting firms would require approval from the majority of EY’s member firms and partners, however, and EY global chairman and CEO Carmine Di Sibio sent a memo last month to the firm’s partners pointing out that stakeholders “are increasingly asking for greater independence and choice in a number of markets around the world,” according to The Wall Street Journal. 

However, questions have emerged from partners about how their pay and compensation would be affected by a breakup, especially as the capital markets face the prospect of a potential recession in the year ahead. Di Sibio spoke during a webcast last week to reassure the partners that they would continue to receive the same multiple of pay, according to The Wall Street Journal, even if an IPO of the consulting practice was facing a bear market. However, the firm has been tweaking its compensation terms in response to concerns raised by the 13,000 partners in recent weeks, offering a payout to partners who want to retire ahead of a potential split, but acknowledging that pay at a new consulting company would be based more on equity, while cash compensation would be lower. 

Partners who stayed at the audit firm could also see less pay in some countries. “Some countries, the profitability is very good,” said Di Sibio, according to the WSJ. “In other countries, that’s less so, so they might make some less money going forward.” 

Even if the possible split is unrelated to the SEC penalties announced Tuesday, it will no doubt affect the partners’ decision on the future of the firm. 

“At EY, nothing is more important than our integrity and our ethics,” the firm said in a statement forwarded to Accounting Today by Mullin. “These core values are at the forefront of everything we do. EY acknowledges the findings determined by the SEC and is complying with the requirements of the order. We have repeatedly and consistently taken steps to reinforce our culture of compliance, ethics and integrity in the past. We will continue to take extensive actions, including disciplinary steps, training, monitoring and communications that will further strengthen our commitment in the future. We are confident that the outcomes of the undertakings will reinforce steps we have already taken in the years since these situations occurred. Sharing answers on any assessment or exam is a violation of our code of conduct and is not tolerated at EY. Our response to this unacceptable past behavior has been thorough, extensive and effective.”

SEC officials blasted the firm’s actions. “This action involves breaches of trust by gatekeepers within the gatekeeper entrusted to audit many of our nation’s public companies,” said Gurbir Grewal, director of the SEC’s Enforcement Division, in a statement. “It’s simply outrageous that the very professionals responsible for catching cheating by clients cheated on ethics exams of all things. And it’s equally shocking that Ernst & Young hindered our investigation of this misconduct. This action should serve as a clear message that the SEC will not tolerate integrity failures by independent auditors who choose the easier wrong over the harder right.”

In addition to paying a $100 million penalty, EY is required by the SEC’s order to retain two separate independent consultants to help address the problems uncovered by the investigation. One consultant will review EY’s policies and procedures relating to ethics and integrity. The other will review EY’s conduct regarding its disclosure failures, including whether any EY employees contributed to the Big Four firm’s failure to correct its misleading submission.

“The SEC will not permit the submission of misleading information or any action that delays or frustrates our mandate to protect investors and our markets,” said Melissa Hodgman, associate director of the SEC’s Enforcement Division, in a statement. “Ernst & Young faces significant sanctions and extensive remediation to ensure that its culture and conduct meet the ethical standards required of those responsible for the integrity of our capital markets.”

The SEC order found that EY violated a Public Company Accounting Oversight Board rule requiring the firm to maintain integrity in the performance of a professional service, committed acts discreditable to the accounting profession, and failed to maintain an appropriate system of quality control. EY acknowledged that its conduct violated the PCAOB integrity standard and provided a basis for the SEC to impose remedies against the firm. The PCAOB assisted the SEC in the matter.