Auditor Draws Six-Month New-Client Ban

Judge finds that Ernst & Young violated rules on auditor independence.
Stephen TaubApril 20, 2004

A judge ruled that Ernst & Young cannot accept new audit clients in the United States for six months because it violated Securities and Exchange Commission rules on auditor independence, according to published reports.

According to the commission, the accounting firm marketed consulting and tax services to audit client PeopleSoft Inc. “The overwhelming evidence,” wrote Brenda P. Murray, the chief administrative law judge at the SEC, is that Ernst’s “day-to-day operations were profit-driven and ignored considerations of auditor independence,” according to The New York Times. Murray added that the firm “committed repeated violations of the auditor independence standards by conduct that was reckless, highly unreasonable, and negligent.”

The judge was especially critical of Edmund Coulson, the Ernst partner who was in charge of independence issues, saying he kept no written records and had failed to learn enough facts before saying the relationships between Ernst and PeopleSoft were proper, according to the paper. Coulson was chief accountant of the SEC before he joined Ernst in 1991.

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The dispute centered on PeopleSoft software that Ernst & Young used for its consulting and tax practices, and on joint promotion activities of the two companies, the report noted.

Ernst & Young had argued that it was merely a PeopleSoft customer, but, the judge reportedly noted that the firm had billed itself in marketing materials as an “implementation partner” of PeopleSoft, and that it had earned $500 million over five years from installing PeopleSoft programs at other companies.

Judge Murray issued a cease-and-desist order against the accounting firm, which did not admit wrongdoing, she added. Ernst & Young’s nearly $1.7 million fine equals the total amount of audit fees it received from PeopleSoft in the years in question, plus interest of $729,302. The judge also ordered an outside monitor to ensure that the firm complied with the rules in the future.

Ernst & Young might have fared far worse had this case been decided under the auditor independence rules established by the Sarbanes-Oxley Act of 2002 — but Ernst & Young’s audits took place between 1994 and 1999.

“Auditor independence is one of the centerpieces of ensuring the integrity of the audit process,” said Paul Berger, an associate director of the commission’s enforcement division. Berger added that the judge’s decision “vindicates our view that Ernst & Young engaged in a business relationship that clearly violated” the rules, according to the Times.

“Independence is the cornerstone of our practice and our obligation to the public,” Charlie Perkins, a spokesman for Ernst & Young, told the paper. “We are fully committed to working closely with an outside consultant in the review of our independence policies and procedures.”

The Times also observed that in 1978, an administrative law judge imposed a similar suspension on Ernst & Ernst, a predecessor of Ernst & Young, after finding that the firm had conducted bad audits. However, the full SEC reduced the penalty to a censure, added the paper, calling the suspension too severe.