EY agrees to $11.8 million settlement with SEC on failed audits

In another enforcement blow to Big 4 firm EY, the Securities and Exchange Commission has settled charges at a price tag of $11.8 million that the firm and two partners repeatedly ignored red flags in tax accounting at Weatherford International, enabling concealment of earnings-inflating fraud for several years.

Weatherford and two employees settled earlier with the SEC and agreed to pay $140 million that will be combined with the EY penalty and returned to investors. The SEC says Weatherford tax officials James Hudgins and Darryl Kitay made numerous post-closing adjustments to fill gaps and meet the company’s previously disclosed effective tax rate, or the average rate a company pays on its pre-tax profits. The activity continued over at least four years, leading to three separate restatements beginning in 2011.

The latest settlement with EY follows by only a few weeks an earlier action involving auditor independence charges. There EY parted with $9.3 million to settle a pair of allegations that audit partners grew too close personally to their audit clients.

EY said in a prepared statement that the firm is pleased to settle the Weatherford matter. “Audit quality is central to EY and all of our stakeholders,” the firm said. “Since the time of the Weatherford audits, and as referenced in the SEC order, EY has taken significant steps in improving audit quality. Our commitment to audit quality is ongoing, and we are continually reviewing and enhancing our audit procedures, policies and training of our people.”

Weatherford is an Irish multinational energy company, based in Switzerland with offices in Houston, listed on the New York Stock Exchange. According to the SEC, EY identified it as a high-risk audit client with an aggressive acquisition-based growth strategy, a history of completing significant unusual transactions at the end of reporting periods, and a pattern of putting pressure on management to meet earnings targets.

The SEC says EY coordinating partner Craig Fronckiewicz, along with Sarah Adams, a former tax partner who was part of the Weatherford audit engagement team, have agreed to suspensions to settle the charges against them. The enforcement order says the two failed to comply with auditing standards and sniff out more audit evidence when faced with post-closing adjustments that lowered income tax provisions. Instead, the two partners relied on “unsubstantiated explanations” from the Weatherford team, enabling the fraud to continue for more than four years, the SEC says.

In addition to monetary penalties and the suspensions for the two partners, the SEC enforcement order prescribes a detailed remedial plan to improve the firm’s system of quality controls, including the appointment of an internal team leader “not unacceptable” to the SEC.

“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,” said Andrew Ceresney, SEC director of enforcement, in a statement. “Ernst & Young failed to ensure that material post-closing accounting adjustments were justified by appropriate audit evidence, leading to a significant audit failure.”