Ernst & Young To Pay SEC $11.8 Million To Settle Audit Failure Charges

Chris Gaetano
Published Date:
Oct 18, 2016

Ernst & Young has agreed to pay the Securities and Exchange Commission $11.8 million to settle charges related to accounting fraud undertaken by a client, an oil services company that used deceptive income tax accounting to inflate earnings. The SEC order said that the client, Weatherford International Ltd., made unsupported post-closing adjustments to accounting data in order to lower its effective tax rate and tax expense through reversing the correct data that had been inputted into its system. While Weatherford told analysts and investors that its favorable rate was due to a superior international tax avoidance structure, the SEC said the company was actually just reversing correct accounting data that had previously been entered into the system in order to pay fewer taxes. This allowed the company to appear more successful than it actually was, until the day it announced in 2011 that it would need to restate its financial results for 2007-2010 by $500 million, and that a material weakness existed in its internal control over financial reporting for its income tax accounting. 

The SEC faulted Ernst & Young for failing to detect the fraud, despite the audit team being aware of the post-closing adjustments each year. Had the firm performed its audits according to Public Company Accounting Oversight Board (PCAOB) standards, the fraud would have been detected as early as 2007, according to the SEC. It added that, in 2010, the audit team further failed to perform additional inquiries or perform other appropriate procedures during its quarterly review of Weatherford in order to determine why the company experienced a sudden unexplained increase in income tax receivables. Because of this, the SEC said Ernst & Young violated Section 4C of the Exchange Act, as well as Rule 102(e)(1)(ii) of the SEC Rules of Practice

“Audit and national office professionals must appropriately address known deficiencies in their auditing of high-risk areas, and auditors must have the fortitude to refuse to sign off on an audit if important issues remain unresolved,” said Andrew J. Ceresney, director of the SEC’s Division of Enforcement. “Ernst & Young failed to ensure that material post-closing accounting adjustments were justified by appropriate audit evidence, leading to a significant audit failure.”

Ernst & Young, as well as the audit partner Craig Fronckiewicz and a former tax partner who was part of the audit engagement team named Sarah Adams, consented to the SEC’s order without admitting or denying the findings that they engaged in improper professional conduct during the audits and quarterly reviews and caused Weatherford’s reporting violations. Ernst & Young agreed to pay disgorgement of $9 million, prejudgement interest of $1.8 million, and a penalty of $1 million. The partners Fronckiewicz and Adams agreed to be suspended from appearing or practicing before the SEC as accountants, which includes not participating in the financial reporting or audits of public companies. The SEC’s order permits Fronckiewicz to apply for reinstatement after two years and Adams to apply for reinstatement after one year.

This is the latest piece of bad news that has dogged Ernst & Young over the past few months. In September the SEC faulted the firm for getting too chummy with its clients--in one case the audit partner became very good friends with the client's CFO to the point of taking family vacations together, and in the other an audit partner developed a romantic relationship with an executive in the company she was auditing. Meanwhile in August a federal judge struck down a clause in the firm's employment contract barring workers from taking part in class action lawsuits for work-related claims. 

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