SEC Charges Ernst & Young for Audit Failures

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The U.S. Securities and Exchange Commission (SEC) recently announced that Ernst & Young has agreed to pay over $11.8 million to settle charges related to failed audits of an oil services company that used deceptive income tax accounting to inflate earnings.

Ernst & Young’s payment will be combined with the $140 million penalty agreed to last month by the audit client, Weatherford International PLC (NYSE: WFT), and money collected from two charged Weatherford employees for a total of more than $152 million that will be returned to investors who were harmed by the accounting fraud.

The agency also charged the Ernst & Young partner who coordinated the audits, Craig Fronckiewicz, and a former tax partner who was part of the audit engagement team, Sarah Adams. Both agreed to suspensions to settle charges that they disregarded significant red flags during the audits and reviews.

Despite placing the Weatherford audits in a high-risk category, Ernst & Young’s audit team repeatedly failed to detect the company’s fraud until it was more than four years ongoing, according to the SEC. Also the audit team was aware of post-closing adjustments that Weatherford was making to significantly lower its year-end provision for income taxes each year, but it relied on Weatherford’s unsubstantiated explanations instead of performing the required audit procedures to scrutinize the company’s accounting.

Andrew J. Ceresney, Director of the SEC’s Division of Enforcement, commented:

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. 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 Fronckiewicz, and Adams consented to the SEC’s order without admitting or denying the findings. Ernst & Young agreed to pay disgorgement of $9 million, prejudgment interest of more than $1.8 million, and a penalty of $1 million.

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 is permitting Fronckiewicz to apply for reinstatement after two years and Adams to apply for reinstatement after one year.

Shares of Weatherford were last trading up about 5.8% at $6.26, with a consensus analyst price target of $7.93 and a 52-week trading range of 4.71 to $11.49.