When you can’t trust the watchdogs

Corrupt Watchdogs

By Phil Mattera for the Dirt Diggers Digest

At first glance it seemed to be a satirical piece from The Onion. The Securities and Exchange Commission issued a press release announcing that Big Four accounting firm Ernst & Young was being fined $100 million for failing to prevent its audit professionals from cheating on ethics exams required to obtain and maintain their CPA licenses.

Not only did EY exercise poor oversight over its employees—it also tried to withhold evidence of the misconduct from agency investigators. This prompted the SEC to impose the largest fine ever against an audit firm.

The SEC’s release quoted Enforcement Division Director Gurbir Grewal as saying “it’s simply outrageous that the very professionals responsible for catching cheating by clients cheated on ethics exams, of all things,” adding: “And it’s equally shocking that Ernst & Young hindered our investigation of this misconduct.”

Yes, it’s shocking, shocking in a Casablanca sort of way to learn that EY management is apparently as corrupt as its auditors. The SEC failed to mention that EY has a long track record of misconduct. Even before this latest case, it has racked up more than $350 million in fines and settlements since 2000, as documented in Violation Tracker.

In 2013, for instance, EY paid $123 million to resolve allegations that it promoted a tax shelter scheme to clients that was so dodgy that the IRS asked the Justice Department to bring criminal charges against the firm. In 2009 EY paid $109 million to the Michigan Attorney General to settle allegations that it failed to expose accounting fraud in its audits of HealthSouth Corporation.

The SEC itself fined EY eight previous times in the past two decades, including a case last year in which the firm paid $10 million to settle allegations it violated auditor independence rules.

EY is not the only member of the Big Four with a checkered record—they are all tainted. As shown in Violation Tracker, PricewaterhouseCoopers has accumulated $114 million in penalties, Deloitte has $260 million and KPMG a whopping $560 million.

A big portion of the KPMG total came from a 2005 case in which it paid $456 million to resolve criminal charges that it designed and marketed fraudulent tax shelters. It has paid penalties to the SEC nine times since 2000—including a $50 million fine involving the same kind of cheating found at EY.

Given the ineffective deterrent effects of monetary penalties and criminal charges resolved through non-prosecution and deferred prosecution agreements, one might ask whether there is any way to eliminate corruption among the big auditing firms.

The 2002 Sarbanes-Oxley Act created a federal entity called the Public Company Accounting Oversight Board, which is supposed to keep auditing firms on the straight and narrow. It has brought more than 100 cases against the Big Four and smaller firms, yet auditing scandals continue to happen.

There is a need to find ways to end the stranglehold the Big Four have on providing auditing services for large corporations. This could include reforms such as stricter requirements for companies to rotate the firms they use. New reforms adopted in the UK will require large corporations to use smaller firms for at least a portion of their auditing.

A bolder approach could involve the creation of non-profit auditing agencies with more rigorous independence rules to prevent them from being influenced by unscrupulous clients. These and other reforms are urgently needed to end a system in which auditors who are supposed to ferret out corruption instead end up facilitating it.

Note: Just before the EY case was announced, Violation Tracker posted its latest quarterly update with about 10,000 new federal, state and local regulatory enforcement actions and class action lawsuits. This brought the total number of entries to 522,000 and total penalties to $804 billion. The EY case will be added soon.