Auditor Independence - SEC Enforcement Actions Against Audit Committees

Date: January 25, 2016

Publication: Business Law Update Winter 2016

This article is the third of a three-part series intended to help companies understand the basics of auditor independence. This installment discusses the Securities and Exchange Commission’s enforcement actions when auditor independence has been impaired. Read the previous articles: "Auditor Independence – The Framework" and “Auditor Independence – The Role of the Audit Committee.”

This third and final installment of our auditor independence series discusses actions by the U.S. Securities and Exchange Commission (SEC) against directors when auditor independence has been impaired. As previously noted, the SEC is of the view that independence is a shared responsibility between the company and its auditor, and under the Sarbanes-Oxley Act, it is the audit committee that is charged with oversight for the company.

Given the SEC Enforcement Division’s stated position on gatekeepers, including directors, one would expect there to be significant enforcement actions against directors for auditor independence impairment issues. That is not the case, however. Instead, there are a few reported matters, all of which paint a fairly straightforward picture of what, at least to date, the SEC views as violations worth pursuing. Notably, each of these matters was brought against a director who had a personal interest in a venture with the audit firm; none was levied at an audit committee for failure to discharge its auditor independence oversight obligation.

Most recently, the SEC charged a trustee of certain funds, Andrew Boynton, and the funds’ administrator with causing violations related to a Big Four accounting firm’s independence violations. The independence violation was a business relationship between the consulting affiliate of the audit firm and the trustee who served on the boards and audit committees of three funds audited by the Big Four firm. Boynton agreed to pay disgorgement of $30,000 plus prejudgment interest of $5,329 and a penalty of $25,000.

In 2008, the SEC brought a settled action against Mark Thompson, who sat on the boards of three Ernst & Young (E&Y) audit clients and on the audit committee of another. During that time, Thompson and E&Y collaborated to create audio CDs for business development purposes. By participating in the independence-impairing relationship, failing to disclose the resulting conflict of interest, and signing three annual reports and one audit committee report in which each issuer incorrectly claimed that its auditor was independent, Thompson was a cause of each issuer’s resulting reporting violations. Thompson agreed to pay disgorgement and interest of $123,917.

Finally, in 2004, E&Y informed the SEC that one of its nonaudit units had entered into a contract with a company owned by two TIAA-CREF trustees to sell jointly a valuation service for corporate stock options in violation of the auditor independence rules. The two trustees resigned, the SEC’s Office of the Chief Accountant required that TIAA-CREF find another audit firm for the next year’s audit, and TIAA-CREF received a great deal of negative attention, largely focused on the timing of its internal reporting to its Board of Overseers.

Consistent in each of these cases are two facts: first, the directors personally shared an economic interest with the accounting firm. Second, they failed to disclose that interest on their annual questionnaires (in at least two cases because they did not believe the relationships were reportable).

Although directors must carefully discharge their auditor independence oversight obligations, these cases suggest that the greatest risk to an individual director and possibly the company arises from the directors’ own reporting of their relationships. As a result, directors should take care to disclose all relationships that could possibly bear on auditor independence (or clarify that a particular relationship does not) and avoid entering any prohibited relationships while serving on the company’s board. Should an independence issue arise, it should be swiftly addressed at the highest levels.

If you have questions, please contact Tammy Bieber.

This article may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgement of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel.

This document may be considered attorney advertising in some jurisdictions.