Auditor Independence Violations and SEC Enforcement.

How Can This Lead to Parallel Proceedings?

What Other Additional Exposure Could There Be?

How Can an Independence Conflict Create Additional Liability?

What Types of Relationships and Services Are Generally Regarded as Impairments to Auditor Independence?

Under Rule 2-01 of Regulation S-X (17 C.F.R. § 210.1-02(c)), auditor-client independence may be impaired under a variety of circumstances. Rule 2-01(b) sets out the general standard, providing that the Commission “will not recognize an accountant as independent, with respect to an audit client, if the accountant is not, or a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the accountant is not, capable of exercising objective and impartial judgment on all issues encompassed within the accountant’s engagement.” Under Rule 2-01(c)(4), this includes the performance of any of the following services for a client:

• Broker-dealer services;
• Investment-adviser services;
• Investment-banking services;
• Legal services;
• Unrelated expert services; and,
• Any other service that generally cannot be provided to a client of the auditor in addition to performing its audit or review.

In addition, while Section 10A(i) of the Exchange Act generally requires audit committees to preapprove any and all audit and non-audit services that auditors provide to public companies, auditor independence is a concerns in all cases involving non-audit services; and Section 10A(g) of the Exchange Act has specific restrictions on the type of non-audit services that auditors can perform for their clients.

Which Individuals are Required to Rotate off of Audit Engagements, and When?

What Happens if an Auditor Has a Former Career as a Public Company Auditor?

Which Types of Financial Interests are Generally Prohibited Under Rule 2-01?

When Can Auditors Provide Bookkeeping and Financial-Information-System Services to their Audit Clients?

Who Investigates Auditor Independence Violations and Related Criminal Conduct?

The SEC’s Division of Enforcement is responsible for investigating suspected violations of the federal securities laws. While the SEC may investigate suspected civil (and sometimes administrative) liability in parallel with criminal conduct, the Department of Justice (DOJ) is responsible for investigating suspected criminal conduct, including conduct that also may be the basis for civil liability, and the DOJ is the only authority that can bring criminal charges against individuals or entities. In parallel proceedings involving both the SEC and the DOJ, prosecutors and federal securities enforcers frequently work together to build their respective cases. The Public Company Accounting Oversight Board (PCAOB) is also empowered to investigate alleged professional misconduct involving audit firms and audit professionals. In these cases, the PCAOB often works closely with the SEC. If the PCAOB uncovers evidence of suspected criminal conduct during an audit-related investigation, the PCAOB may refer the matter to the SEC, the Attorney General, or other appropriate authorities for potential criminal prosecution. A licensed CPA may also be subject to discipline from his or her state’s accountancy board for various reasons. In many cases, this includes disciplinary action resulting from investigations by federal regulators. This can be the case regardless of whether the state’s accountancy board’s disciplinary action could also result in fines, or whether it could result in a loss of professional licensing for the CPA involved. The Financial Industry Regulatory Authority (FINRA) has the authority to investigate broker-dealers for violations of the self-regulatory organization’s securities-industry rules and reporting requirements. While state and federal regulators have the authority to investigate and discipline broker-dealers in many cases as well, FINRA remains an essential body that oversees these firms and helps to protect investors from fraud and other forms of unethical conduct. The Commodity Futures Trading Commission (CFTC) may also investigate conduct that falls within its jurisdiction. Like the PCAOB, the CFTC can refer criminal matters to the DOJ when appropriate, and the CFTC also conducts investigations in parallel with the SEC in many cases. For executives and professionals, facing government inquiries from any of these agencies can trigger consequences beyond the penalties that the agencies themselves have the authority to pursue. Federal inquiries can lead to losses of licensure, disqualification from receiving government contracts, other forms of debarment, loss of professional liability insurance coverage, and substantial reputational harm.

How does an SEC auditor investigation progress toward charges?

Are Examinations or Inspections Different from Enforcement Proceedings?

Yes, examinations and inspections are different from enforcement proceedings. SEC, FINRA, and PCAOB examinations and inspections are routine regulatory oversight activities, while enforcement proceedings seek to address specific allegations of misconduct. While an examination or inspection may yield evidence of alleged misconduct, and in this regard, it may trigger an enforcement proceeding; and while the SEC, FINRA, and PCAOB (along with other regulators) can impose sanctions, fines, and other penalties at the conclusion of an examination or inspection, they do so under different rules than they do at the conclusion of an enforcement proceeding.

Do All SEC Inquiries and Investigations Qualify as Enforcement Proceedings?

The Division of Enforcement often opens “informal inquiries” before formal investigations, and many of these inquiries may ultimately not result in enforcement proceedings. A Commission-issued formal investigation order is the mechanism that formally transforms an inquiry into an enforcement proceeding. It is also the mechanism that empowers Enforcement staff to use subpoenas and other other compulsory process in SEC investigations.

What Is a “Wells Submission”?

A “Wells submission” is a response to a “Wells notice,” a notice issued by the Division of Enforcement to the potential defendant in the case informing them of the Division’s intent to recommend enforcement action to the SEC Commission. A Wells submission provides potential defendants the opportunity to explain why the SEC should not recommend charges or to argue that the proposed charges should be narrowed in scope.

Does the Division of Enforcement Initiate SEC Enforcement Actions?

The Division of Enforcement recommends SEC enforcement actions (including civil actions in U.S. District Court and administrative enforcement actions) to the Commission. If the SEC Commission authorizes the Division’s recommended enforcement action, and the matter does not conclude in a settlement negotiation or pre-filing compromise, the Division of Enforcement will then initiate the action against the defendant.

Does the SEC Process Always Result in Prosecution or Sanctions?

No. Many SEC investigations conclude without recommendations of Commission action. Some investigations lead the SEC staff to conclude that no charges should be brought against a defendant or that any action taken should be within the agency’s administrative authority to pursue sanctions.

Can I Communicate with the SEC Division of Enforcement if I am the Target of an Investigation?

Yes. It is common for the SEC’s Enforcement staff to interview the target of an investigation, and it is also common for the target to appear before the Division of Enforcement to provide testimony during an investigation. If you are the target of an SEC inquiry or investigation, however, it is extremely important that you protect yourself by not making unnecessary mistakes during your communications with federal regulators. At Spodek Law Group, we handle matters handling these matters for clients facing these government inquiries and investigations, and we encourage you to speak with an experienced attorney if you believe that the SEC (or any other agency) is interested in your accounting firm’s or your individual professional’s records, audits, or testimony.

What is the most common SEC action against auditors?

Does the SEC Have the Authority to Revoke a Licensed Professional’s State License to Practice as a CPA in the United States?

No. While the SEC has broad authority under Rule 102(e) of the Commission’s Rules of Practice (17 C.F.R. § 201.102(e)) to assess penalties against CPAs, the SEC does not have the authority to revoke a CPA’s state license. Rather, Rule 102(e) governs professionals’ privileges to practice before the Commission.

What are “Commission Practice Privileges” and What are the Consequences of Violating Rule 102(e)?

The SEC grants auditors, as well as other professionals, the privilege to practice before the Commission. The consequences of violating the privilege to practice before the Commission are serious, particularly when a professional’s entire career is dependent upon the ability to assist clients with SEC-related matters. Under Rule 102(e), the SEC is empowered to censure any professional or entity in violation of Rule 102(e), or to temporarily or permanently deny such professionals’ and entities’ privileges to practice before the Commission.

Although Rule 102(e) is referred to as the Rule governing professionals’ privileges to practice before the SEC, the Rule extends to “any person” who has (i) displayed a lack of qualifications, character, integrity, or ethical conduct, (ii) willfully violated the federal securities laws, or (iii) willfully aided and abetted a violation of the federal securities laws. These rules provide the SEC with incredibly broad authority to deny professionals (and entities) the privilege to practice before the SEC.

How are Rule 102(e) Matters Enforced?

Unlike the other enforcement actions described above, Rule 102(e) matters are administrative proceedings. While typical SEC enforcement actions typically begin with a complaint filed in a United States District Court, Rule 102(e) enforcement actions proceed administratively.

Can Auditing Firms Face Significant SEC Penalties, or Are These Actions Limited to Individual Audit Professionals?

Auditing firms can face significant SEC penalties, and accounting professionals who work in these firms can also be at risk of facing sanctions. For example, the accounting firm Marcum paid a $10 million SEC penalty in 2023 for deficiencies in its SPAC audits and other related independence violations. Separate from that SEC penalty, the PCAOB also imposed a $3 million penalty against Marcum.

Can Auditors be Held Liable for Violating PCAOB Standards?

Yes. Auditors can be held liable for violations of the professional standards adopted by the PCAOB, and violations of the PCAOB’s professional standards (including standards concerning auditor independence) fall within the SEC’s authority to pursue enforcement action. The PCAOB can assess fines and other penalties as well, and violations of PCAOB standards can lead to various other state, federal, and private enforcement consequences.

What should auditors do after discovering an independence problem?

Should I Destroy or Dispose of Audit Documentation to Help My Accounting Firm Avoid Enforcement Action for an Auditor Independence Violation?

No. While it may be tempting to dispose of incriminating documentation, this is usually a bad idea. Rule 2-06 of Regulation S-X (17 C.F.R. § 210.2-06) requires auditing firms to retain their audit workpapers and other documents that constitute their audit documentation for seven years after the accountant concludes the audit or review. With these rules in place, the government may scrutinize records from past audits and reviews as part of current or future inquiries.

Furthermore, Federal law contains criminal penalties for those who knowingly destroy, alter, falsify, or conceal records in order to obstruct an investigation by federal authorities. This is true regardless of whether an individual or firm is under investigation. Generally speaking, federal preservation duties apply when litigation is pending or reasonably foreseeable, and they are critical to protecting against allegations of spoliation and other criminal charges.

If I Have Discovered an Auditor Independence Problem, Is Self-Reporting to the SEC a Good Idea?

Under the SEC’s “Seaboard” framework (Securities Exchange Act Release No. 44,969 (Oct. 23, 2001)), there are four broad factors that the SEC takes into consideration when deciding whether to target a company for enforcement action. These factors include: (i) the self-reporting and self-remediation of any wrongdoing; (ii) whether the company has adequately self-policed in the past; (iii) the seriousness of the underlying misconduct; (iv) the identity and rank of those involved; and (v) the extent of the company’s cooperation with federal regulators during the SEC’s investigation.

While self-reporting is one important factor under the Seaboard framework, it is not an absolute defense against SEC enforcement action. Along with other factors, self-reporting must be viewed in the context of the company’s ability and willingness to cooperate during the SEC’s investigation and federal regulators’ other inquiries.

How Long Does an Auditing Firm Have to Correct Deficiencies Following a PCAOB Inspection or Audit?

Under Section 104(g)(2) of the Sarbanes-Oxley Act, a firm may have up to twelve months from the date of a PCAOB inspection report to address certain criticisms or potential defects in its quality-control systems. During this time, auditors must address any issues that are subject to remediation, including remediating auditing deficiencies, updating internal control procedures, or addressing audit independence violations.

What Else is Required of Public Companies if Their Auditors Are at Risk of a Professional Conduct Enforcement Action?

Public companies must also investigate potential auditor independence violations, and other auditing related problems, that may cause potential problems for their auditing firm’s ability to practice before the SEC. For example, audit committees may need to commission independent investigations when they have reason to believe that an accounting error, fraud, or other irregularities have led to inaccurate financial reporting. Along with investigating whistleblower allegations and other concerns, companies and audit committees must ensure they are providing shareholders and federal regulators with accurate information.

Contact a Federal Criminal Defense Attorney

Nothing here is legal advice, and the details of your case matter. Todd Spodek and Spodek Law Group take federal criminal and white collar cases nationwide, from offices in New York, Brooklyn, Queens and Los Angeles. You can reach the firm at 212-300-5196.