Firms Violating Audit Independence by Engaging in Inappropriate Relationships with Clients
I have previously blogged about the increase in commercial activities by the Big-4 CPA firms that jeopardizes independence from audit clients. Many of these relationships create threats to independence that cannot be mitigated by any safeguards.
Independence is impaired when a CPA or CPA firm engages in a close relationship with the client that might influence professional judgment. It doesn’t matter that the CPA can, in fact, maintain independence. The violation occurs because it may appear to a reasonable observer looking at all the facts that the relationship could impair independence.
Independence impairments violate the AICPA Code of Professional Conduct, state board of accountancy regulations, and Rule 3520 of the Public Company Accounting Board. Congress has been concerned about independence problems for about 40 years, during which time consulting services have grown to be a significant a source of revenue for the firms, in some case bypassing the revenue from audit services. With the passage of the Sarbanes-Oxley Act in 2002, firms no longer can provide certain non-audit services for audit clients because it might appear that the firms lack the requisite independence to issue audit reports.
The nature and scope of independence violations leaves no doubt that the firms have reverted to old behaviors. For example, in September 20, 2016, the SEC fined Ernst & Young $9.3 million for inappropriate client relationships that include a former senior partner on an engagement team who “maintained an improperly close friendship” with the company’s chief financial officer, thus violating rules that ensure objectivity and impartiality during audits. The partner reportedly spent close to $100,000 in travel and entertainment expenses between 2012-2015 while socializing with the company’s chief financial officer and his family. Another partner was romantically involved with the chief accounting officer.
A Form 8-K filed by Invesco in May 2016, raises the question whether independence is impaired when a large bank holds more than 10 percent of a company’s equity (Invesco) and provides a line of credit to the auditor, in this case PwC. A loan by a financial institution to an audit client impairs independence because it creates a financial self-interest threat.
On July 1, 2015, Deloitte & Touche agreed to pay more than $1 million to settle charges that the firm violated independence rules when its consulting affiliate kept a business relationship with a trustee serving on the boards and audit committees of three funds audited by the firm. The relationship creates a mutuality of interest that threatens independence because the trustee might attempt to exercise undue influence over the consultants.
In January 2014, KPMG agreed to pay $8.2 million to settle charges by the SEC that the firm violated auditor independence by providing prohibited non-audit services for an audit client including restructuring, corporate finance, and expert services, bookkeeping and payroll services. Around the same time, EY agreed to pay $4 million to settle accusations that the firm violated independence rules by lobbying on behalf of two of its audit clients, an advocacy threat to independence.
Back in May 2013, KPMG had to recall its audit reports on two clients, Herbalife and Skechers, after it was determined that the former partner in charge of the firm’s Southern California regional practice, provided inside information to a close friend about audit clients.
The PCAOB inspects audits by Big-4 firms and issues reports citing deficiencies. Independence violations are oftentimes identified. Still, the firms continue to engage in relationships with clients that threaten audit quality. What can be done about it? Former SEC chief accountant, Lynn Turner, raises an important question: Are the auditors going to serve management, or are they going to serve the best interests of the investing public?
Why are so many independence violations occurring now? I believe the firms have an increased appetite for growth in revenues and market share in the aftermath of Sarbanes-Oxley restrictions. The firms are looking for new sources of revenue and are focusing less on possible independence problems. The protective wall that should exist between non-audit and audit services is crumbling, in part because professionals providing non-audit services are not schooled in what it means to be a CPA. Many are not CPA's and are not committed to the same ethics standards that historically has made the CPA profession one of the most trusted by the public.
It’s time for the SEC to revisit the independence issue and hold discussions with the investing public whether there should be a complete ban on non-audit services for audit clients. The firms would still be able to provide non-audit services, but only for non-audit clients. Such a move would go far to reinvigorate the public interest obligation imposed on the accounting profession by the SEC.