Independence Breach Costs E&Y $2.9 Million

A series of audio CDs intended to depict audit partners as "thought leaders" ends up costing the firm a hefty fine instead.
Tim Reason and Stephen TaubAugust 7, 2008

Ernst & Young LLP agreed to pay more than $2.9 million to the Securities and Exchange Commission to settle charges that it violated auditor independence rules by co-producing a series of audio CDs with a man who was also a director at three of E&Y’s audit clients.

According to the SEC, Ernst & Young collaborated with Mark C. Thompson between 2002 and 2004 to produce a series of audio CDs called The Ernst & Young Thought Leaders Series. The CDs featured E&Y partners interviewing CEOs and CFOs in various different industry sectors, which the SEC says was part of an effort by E&Y to promote its partners as experts in specific industries.

That relationship, said the SEC, violated independence rules because Thompson was serving on the boards at several of E&Y’s clients during the period when the CDs were produced. The SEC censured Ernst & Young and fined the firm $2,918,987. It also censured partner John F. Ferraro for setting up the relationship, and partner Michael G. Lutze for failing to alert one of his audit clients — apparently Best Buy — after learning of the relationship. Lutze was also suspended from practicing before the commission for one year. The SEC also issued a cease and desist order against Thompson. E&Y, Thompson, Ferraro, and Lutze settled with the SEC without admitting or denying its findings in the case.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

Thompson is chairman of his own private business, Executive Powertools, a training firm dealing with executive leadership. Although the SEC did not name the audit clients on whose board Thompson served, SEC filings and Thompson’s biography on his own website show that he served as a director for E&Y clients Best Buy, Korn/Ferry, and Teletech Holdings during the period detailed by the SEC, and served on Best Buy’s audit committee from March 2000 to August 2003.

Best Buy announced in a May 14, 2004 8-K filing that Thompson had resigned as the result of a conflict of interest. In December 2002, Thompson, the company reported, “entered into a personal service agreement with Ernst & Young LLP, the registrant’s independent auditor (E&Y), that was not disclosed to the registrant by either Mr. Thompson or E&Y until May 4, 2004.” Best Buy said at the time that it “does not currently believe that E&Y’s independence was impaired as a result of its personal service agreement with Mr. Thompson.”

On June 7, 2004 Korn/Ferry also announced in an 8-K that it had heard from the SEC that the regulator was conducting an informal inquiry into independence issues arising from Thompson’s relationship with E&Y. Thompson was no longer a director at Korn/Ferry at that point, and the company said it believed E&Y had delivered “a written confirmation of its independence, and its belief that the payments made to the company affiliated with Mr. Thompson did not impair E&Y’s independence.”

That written confirmation may have made things worse for E&Y, which the SEC said caused both Company A (apparently Best Buy) and Company B (apparently Korn/Ferry) to unknowingly submit inaccurate filings attesting to the independence of their auditor, both during and after Thompson’s work with E&Y became known. E&Y, the SEC says, erroneously concluded that Thompson’s relationship with the firm did not impair the firm’s independence because it fit within the “consumer in the ordinary course of business” exception to the independence rules’ prohibition on such relationships.

Among the several reasons the SEC said the relationship did violate independence rules was that fact that “unbeknownst to E&Y,” the $377,500 that Thompson was paid for his work amounted to approximately half of his net income at the time.

The SEC also noted in its findings that “Since the conduct discussed in this Order, E&Y has significantly improved its independence policies and procedures,” adding that it had, among other steps, established a new evaluation process for review and evaluation of existing and new business relationships.

In a statement sent to, E&Y spokesman Charles Perkins said “We have revised our independence policies and procedures since this issue arose, which the SEC noted in its order. This settlement puts this matter behind us, and we remain committed to taking every possible step to maintain our independence, which is the foundation of our audit work and our obligation to investors.”