EY Settles with the SEC
Ernst and young was fined roughly $9.3 million for violating independence standards.
|Total Penalties for EY|
Ernst and Young repeatedly signed off on financial statements stating that they were independent when in fact they were not. Neither EY nor the wrongdoers admitted violating any standards as part of this settlement.
The Securities and Exchange Commission was the governing body in charge of handing out this punishment to EY. The SEC stated that the audit firm ignored red flags that their was wrongdoing going on which is likely why the firm got penalized.
Let’s review the first case.
Gregory Bednar and the CFO
The first case involves former EY partner Gregory Bednar. He violated independence by becoming to close to the issuer’s CFO.
Who was involved?
According to the SEC report Mr. Bednar is 56, resides in Glenview, Illinois and is a CPA. He worked at EY from August 1982 until June 2015 when EY asked him to leave.
He was the coordinating partner on the engagement until he was let go.
The CFO who was not named in the report, but was 55, a CPA and was licensed in New York in 1987. He was the CFO for 20 years until he retired in 2015. He used to work for an auditing firm before he worked for the issuer.
Whoever the Issuer was terminated EY as the auditor in August of 2015. Before that, EY was their auditor from 1996 until 2015.
When did this start to unravel?
In 2010 the issuer complained about EY, so EY changed the team. A replacement team was put in place which was headed up by Bednar. Gregory Bednar’s primary responsibility on the engagement was to improve the client relationship which means he wasn’t involved in audit work too much.
What was EY’s internal policy about independence?
EY stated in their internal policies that close personal relationships with clients in an accounting or financial reporting oversight role could create independence issues from an appearance perspective.
This essentially means that the public would not view EY as independent if people knew that Bednar and the CFO were really good friends.
Ernst & Young’s policies also forbade partners from taking vacations with and taking leisure time with audit client employees.
This one is a tough one because this guy was tasked with improving the client relationship at this client. How else would he have done this? This is a slippery slope here because all of the big four firms do this pretty regularly.
I think the thing that distinguished this case from others is that Bednar essentially became enmeshed with the CFO’s family.
If the SEC and EY hold all their partners to a standard of no vacations and limited leisure time with clients, then a lot of partners are in violation and will have to leave the firm.
What went wrong?
The EY partner violated independence in multiple years. A table of what he did by year is below.
|Violations by Gregory Bednar|
|January 2012||Bednar gifted tickets to 2 NFL games to the CFO and no EY professionals attended. Bednar also gifted tickets to an NFL playoff game to the CFO which he attended with the CFO|
|March 2012||Bednar stayed with the CFO’s brother-in-law in South Carolina for a golf outing.|
|October 2012||CFO stayed overnight at Bednar’s apartment during a business trip. Bednar also attended a NFL game with the CFO’s son in Nashville.|
|April 2013||Bednar, the CFO and family members attended an NHL game in Nashville and celebrated Bednar’s birthday together.|
|October 2013||The CFO of the issuer traveled to Chicago with his son to visit Bednar and his wife. They attended a golf outing and an NFL game with the Bednars.|
|April 2014||Bednar and family members spent 3 nights at the CFO’s vacation house in South Carolina to attend a golf tournament.|
|December 2014||Bednar, the CFO and their wives flew to Nashville to watch an NHL game with the CFO’s son.|
|February 2015||Bednar and the CFO planned a trip to the Masters golf tournament. They did not end up going because EY received a regulatory inquiry into the relationship between Mr. Bednar and the CFO of the issuer|
Over the course of his time as lead audit partner on the engagement he racked up over $100,000 in expenses related to “mending the client relationship.” The expenses are broken down by year below.
|Bednar Expenses by Year|
These amounts are not shocking for the level of entertainment and travel that Bednar did while on this account. Flying to Nashville, attending NFL games, attending NHL games and going to the Masters is not cheap.
Hopefully this opens EY’s eyes to the fact that they do not have sufficient controls around partners expenses. This does not shock me at all though. When you work at the big 4, you see partners slam codes for all kinds of things and blend it across all their clients so it doesn’t pop on a firm audit. I’ve even heard of one partner who tried to expense a $5,000 luxury baby blanket.
Some of the things these guys try to get through is insane. All in the name of client entertainment.
How did this Pop?
There’s nothing that really shows how this thing popped on the SEC’s radar, but it looks like it might have been a whistleblower because there was a regulatory investigation into this relationship out of nowhere.
Could this have been prevented?
Yes it could have been prevented multiple times throughout the process and that is why the SEC is nailing EY here.
There were several times throughout the 2012 – 2014 period that the client and EY looked at Bednar’s excessive spending. Spending of Bednar’s nature often pops in overall partner meetings because that is allocated across the partnership. One partner can’t benefit by slamming a whole bunch of expenses through.
Bednar slammed these expenses to the client though. That is most likely why the EY senior partners weren’t too concerned with what was going on.
The client did care and raised the question multiple times. Some invoices would have amounts of $32,000 and $18,000 that they investigated. EY would provide high level summaries that had the client and EY going back and forth chasing numbers with no conclusion.
What really came out of this investigation was that EY has no control over partners that try to slam through a ton of expenses to a client code.
The SEC settlement penalties for Ernst & Young are detailed below.
|Penalty for EY – Gregory Bednar Case|
|Audit Fee Disgorgment||$3,562,400|
Mr Bednar had to pay the SEC $45,000 as part of the settlement as well. He is also suspended from practicing before the SEC
Pamela Hartford and Ventas
Who was involved?
The EY partner involved in the next case was Pamela Hartford who is 41 and a CPA in Illinois.
Robert Brehl was the accountant on the client side and is 54. He was the chief accounting officer from 2006 to 2014. He is a CPA in Kentucky. Mr. Brehl is now a managing principal at RDB properties LLC. The client in this case was Ventas.
What went wrong?
In July of 2011, Pamela Hartford was promoted to partner and became the second highest ranking partner on the client. From March of 2012 until July 2014 she was romantically involved with Robert Brehl.
They tried to keep the relationship private to avoid scrutiny from coworkers. Despite this romantic relationship Hartford signed off on EY being independent from the client.
Hartford eventually became coordinating partner on the account. Brehl helped her get that position by giving her a heads up on the questions that the client would ask Hartford for her interview for coordinating partner. Brehl told Hartford but didn’t tell any other candidates, so he obviously did this to help her.
They obviously were not independent.
Could this have been prevented?
Michael Kamienski was the coordinating partner before Pamela Hartford. He knew about this because he told several colleagues that Pamela Hartford and Rob Brehl were in a romantic relationship. He even told several vice presidents of the client that Brehl and Hartford were in a relationship. He even went so far as to say that he thought Pamela received her position in the firm because of her close relationship with Brehl.
The SEC believes that Kamienski should have stepped in to prevent independence issues and to report the independence violations. He knew what was going on and let the financials go out stating that EY was independent of Ventas.
How it was resolved?
The issue was only resolved after a vice president made an internal whistleblower claim stating that the relationship between Brehl and Hartford was inappropriate. This got Hartford kicked off the engagement. Then EY investigated the matter and found that EY had not been independent of Ventas because of the relationship. They subsequently fired Pamela Hartford.
SEC Settlement Penalties
The following were the SEC penalties for EY related to the Hartford Case.
|Penalty for EY – Pamela Hartford Case|
|Audit Fee Disgorgment||$3,168,500|
The penalties for the individuals involved are disclosed below.
|Penalty for individuals involved|
|Total Individual penalties||$50,000|
An Ernst and Young spokesperson said that EY hid this conduct from EY and that it violated their Global code of conduct. Therefore, there were limited things that EY could have done to discover what was going on.
Every year any big 4 accountant has to sign off on this global code of conduct. The big 4 companies make you do this in case you do something wrong, and then they can say that you read their code of conduct, were aware of it and still violated it. Most fortune 500 companies have a similar process where they make employees sign off on a global code of conduct to reduce their risk.
I agree that the partners were likely aware of the code of conduct and violated it willingly, but I do not think that leaves EY off the hook. If other people within the firm knew something was wrong, it is up to them to say something. Especially if they are CPA’s. Because they knew it and did nothing, EY as a firm is responsible for what occurred.
Unfortunately, both of these cases look like they were identified by the client initially. What that means is that a lot of independence violations occur without employees in the big four CPA firms raising their hand. These are firms filled with CPAs that are held to high ethical standards. There were even senior partners well aware of what was going on in both of these cases, but it took the clients raising their hands in order for partners at EY to get reprimanded.
I hope this SEC settlement with EY encourages people within the Big 4 accounting firms to start acting and reporting “rotten” partners. With all the whistleblowing cases and fraud cases hitting the headlines, CPA’s need to step up and maintain independence. Partners becoming best buds with their clients is how little ethical issues grow into big ethical issues without anyone reporting it.