Big audit firms remain difficult targets for SEC

WASHINGTON — The last fiscal year was a busy one for enforcement at the Securities and Exchange Commission. As departing Chairman Harvey Pitt noted, the agency took a record 598 enforcement actions, up 24 percent from the year before.

But a closer look at the numbers reveals one of the agency's persistent weaknesses — an Achilles' heel that will pose a challenge for Pitt's successor as it has for him and his predecessors.

Amid an epidemic of accounting fraud and error that has been several years in the making, the thin spot in SEC enforcement involves major audit firms and their personnel. The big accounting firms that audit the vast majority of companies listed on the stock markets remain difficult targets for the agency, past and current SEC officials say.

During the fiscal year that ended Sept. 30, the SEC took action against only two auditors it identified as working for Big Five accounting firms, a Washington Post examination of the enforcement record found. One of them received a censure, a verbal reprimand.

The SEC was far more likely to discipline auditors employed by smaller accounting firms than it was to take action against those employed by the big firms. The agency took action against 15 auditors from smaller firms.

In several cases, the SEC acted against big accounting firms, but it did so without identifying or punishing the individual accountants responsible for the firms' alleged wrongdoing.

"In most circumstances, where wrongdoing is involved, you will not get the accountability and deterrence that is necessary unless you name individuals," SEC Commissioner Harvey Goldschmid said.

Former SEC Commissioner Bevis Longstreth said, "It isn't easy to take on those big boys, but one has to do it because otherwise I think the big boys are encouraged to feel that they can push the SEC around."

SEC outnumbered?

Though Arthur Andersen was convicted of a felony involving its client Enron last year and has all but gone out of business, it was the Justice Department that prosecuted Andersen, and the charge was obstructing justice — not the sort of accounting violations that are at the core of SEC policing efforts.

During the past fiscal year, the SEC barred Kevin Andersen, an accountant for a small Utah firm who is unrelated to the Andersen firm, from auditing public companies. But the SEC brought no new cases against Arthur Andersen or any of its individual auditors.

The cash-strapped agency has been slower to take actions involving big accounting firms partly because the big firms can deploy overwhelming resources in their defense, SEC insiders and private securities lawyers say.

In contrast, small accounting firms and their employees are more likely to settle cases with the SEC because they are ill-equipped to battle the government, lawyers say. Accounting cases are among the most complex the agency tackles.

Congress and President Bush have promised but have not yet delivered a big boost in the agency's funding.

Charles Niemeier, acting chairman of the new accounting-oversight board and former chief accountant in the SEC's enforcement division, cited another difference between small and large accounting firms. The small firms were more likely to commit errors of incompetence, such as failing to detect accounting problems, he said. The big firms were more likely to show lapses of integrity — finding the problems but allowing them to go uncorrected, Niemeier said.

A senior official at a major accounting firm said SEC officials have approached cases with sensitivity to the likelihood that any enforcement action against an auditor would end the auditor's career.

The SEC's investigations of accounting scandals are continuing, and the agency's response can't be judged until they are concluded, SEC spokesman John Nester said.

Since the last fiscal year ended, the SEC has initiated enforcement action against three Andersen auditors. For example, in November, without admitting or denying wrongdoing, an Andersen auditor of Golden Bear Golf agreed to be barred from practicing before the SEC, with the right to seek reinstatement after a year. Golden Bear publicly corrected the accounting at issue more than four years ago.

Overall, the SEC brought 163 cases during the past fiscal year involving allegations of improper accounting, flawed disclosures and financial fraud. From 1997 to early 2002, almost 10 percent of companies listed on the major U.S. stock markets corrected financial statements because of material error or fraud, according to a recent study by the General Accounting Office. Fraud or error in a company's financial statements does not necessarily involve misconduct by the auditors.

In a speech late last year, SEC Enforcement Director Stephen Cutler cited the laxity of auditors as one of the foremost causes of the rise in accounting fraud. Cutler said auditors who let their clients issue inaccurate financial statements apparently believed "they stood a good chance of getting away with it."

Cutler said the SEC has a strong record of enforcement against individual auditors. "I don't think there is any question that the commission has pursued such individual misconduct aggressively," he said, citing actions against 10 auditors at Big Five firms over the past few years. He predicted "more of the same in the near future."

Cutler faulted the agency for erring in a different way. He said the SEC has failed to hold accounting firms accountable for the conduct of individuals: "In short, absent egregious conduct in which senior firm managers participated or acquiesced, the commission typically has elected not to pursue a case against the firm itself."

"It is time to adopt a new enforcement model — a new paradigm: one that holds an accounting firm responsible for the actions of its partners; one that reverses the current presumption against suing firms for an audit failure," Cutler said.

No individual sanctions

As far as major firms are concerned, however, that analysis seemed at odds with the record for the past fiscal year. During that period, the SEC took four enforcement actions against big accounting firms for alleged auditing misconduct. But none of those actions sought to discipline any of the accounting-firm personnel responsible for the misconduct the SEC was alleging.

In July, the SEC alleged that PricewaterhouseCoopers violated auditor-independence rules in its relationships with 16 clients from 1996 to 2001. In some cases, the firm allegedly allowed companies to improperly account for its own consulting fees. In other cases, PricewaterhouseCoopers allegedly doubled as investment banker to companies it was auditing, and its audit fees were improperly tied to the success of the transactions the companies were pursuing.

PricewaterhouseCoopers agreed to cease and desist from violating auditor-independence rules and to be censured. It also agreed to pay $5 million. That amounted to six hundredths of a percent of the firm's fiscal 2001 revenue of more than $8.8 billion.

No PricewaterhouseCoopers personnel were named or disciplined by the SEC.

"We believe the SEC concluded that sanctions against individuals were not warranted in this case," one of its executives said, adding that the firm disciplined three partners in the matter.

It was hardly the first time the firm got in trouble with the SEC for violating rules meant to keep auditors independent from the companies they audit. In January 2000, a study commissioned by the SEC found thousands of violations at the firm. In January 1999, the SEC charged PricewaterhouseCoopers with dozens of independence violations. The firm settled the 1999 case by agreeing to devote $2.5 million to auditor education and improve its compliance.

Similarly, the SEC filed administrative charges last year against Ernst & Young, alleging the firm violated independence rules by jointly marketing software with PeopleSoft while auditing the company's books from 1994 through 2000. The SEC staff alleged that Ernst earned hundreds of millions of dollars of consulting fees from helping clients implement PeopleSoft's software.

But the SEC did not charge any Ernst employee.

Ernst says its conduct was "entirely appropriate." It is fighting the action.