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Audit Firms’ Tone at the Top Sounds Like a Brown Note, Says SEC Chief Accountant

Public accounting firm partners but make them LEGO

In a statement released today (“Fostering a Healthy ‘Tone at the Top’ at Audit Firms“), SEC Chief Accountant Paul Munter has some strong words for accounting firm leadership: Early-career staff are watching what their leaders do and your elastic ethics have been noted by both the SEC and your impressionable youngsters.

TLDR: Independence and ethics should come before profits. Firms shouldn’t be sweeping incidents under the rug. THE SEC IS WATCHING YOU.

To illustrate his point, he offers this oddly specific scenario:

Picture the following scenario: An issuer’s audit committee solicits competitive bids from audit firms for the company’s independent audit work. In an effort to secure the lucrative engagement, a senior partner at an audit firm secretly promises the issuer’s CFO that if his firm is chosen as the company’s auditor, his firm would provide tax and other permissible non-audit services to the company at reduced rates. The audit firm wins the audit engagement.

Following an investigation by the SEC’s Division of Enforcement, the Commission institutes an administrative proceeding and finds that because of the mutual conflict of interest created by the audit firm’s provision of non-audit services at reduced rates in exchange for being chosen as the company’s auditor, the audit firm and audit partner were not independent within the meaning of Rule 2-01(b) of Regulation S-X. The Commission orders a censure, monetary penalties, and a suspension from appearing or practicing before the SEC for the audit partner.

In the aftermath of such an enforcement action, how might the audit firm respond?

We already know how most of them respond but let’s entertain Mr. Munter anyway, he obviously spent a lot of time and energy on this.

The firm may opt to sweep the incident under the rug. It may treat the independence violation as an isolated incident—an efficient breach or just the “cost of doing business”—and wait things out by allowing the partner to focus on non-audit business development until being reinstated.

Alternatively, the firm may opt to address the incident head-on. Firm leadership may openly discuss among its personnel what went wrong; use the underlying violations as an opportunity to teach and instill in all staff the critical importance of professional integrity, ethics, and serving the public trust; and possibly internally sanction, terminate, or suspend the audit partner.

Firms’ version of the second option: The firm develops a new module of independence training that’s mandatory for all staff and partners to complete. Then everyone shares answers so they can get back to real work and firm leadership feels the issue has been adequately addressed.

Although he doesn’t speak to any specific matter (darn, this would be so much better with names), he does say the SEC has observed firms choose option one. “[A]ccountants, including high-profile audit partners, remain in positions of firm leadership following an enforcement action that results in discipline against the accountant with seemingly no professional repercussions while waiting for a prescribed reinstatement period to pass.” Well yeah. What do you want firms to do, ship them off to Naughty Partner Island? These partners have been building their networks for decades, you can’t just throw that away because they got sued and fined by the SEC.

“But what sort of tone does that response set at the firm?” he asks. “What message does it send to the accounting profession and firm staff, particularly less-experienced staff and staff in service lines other than audit? Does it teach them that skirting the rules is acceptable, as long as you don’t get caught? And if you do get caught, is it simply the cost of doing business and the firm will take care of you until your ‘time out’ from appearing and practicing before the Commission as an accountant is over?”

And then the cycle repeats itself when those less-experienced staff start rising through the ranks themselves. Hey, I remember this from a PSA.

This guy is smoking some strong shit if he thinks any of this will be internalized by growth-at-any-cost audit firms. Bless him for trying though.

Less-experienced staff watch what their managers do. If they see their managers bend the rules or make exceptions for profitable partners who engage in inappropriate conduct, less-experienced staff may assume that this behavior is the path to rise through the ranks. This is why firm leadership must make ethics and character a fundamental part of the firm’s hiring, retention, and promotion criteria for all professionals, regardless of service line within the firm—even at the expense of a more profitable bottom line in the short-term. Professionals trained to conduct themselves, and to expect others on their team to conduct themselves, with integrity in an ethical and professional manner reinforce one another with the support of firm leadership. By contrast, leadership that encourages corner cutting to save time on audit engagements, promotes individuals that do not exhibit key indicia of professional ethical conduct, and fails to support and defend professionals that make difficult decisions in favor of high audit quality will, in the end, fail in their role as public watchdogs.

“Leadership should reward individuals or engagement teams that took difficult stands and sacrificed short-term profitability in order to preserve independence and other professional responsibilities of the firm,” he said completely unironically. “Technical excellence and integrity should be rewarded at least as much as billing, profitability, and business development.” Imagine bonuses being tied to how often you flag potential independence violations and ethical dilemmas.

Another item from his statement stood out like a glaring klaxon (this thing: 🚨). It reads like a big hint that the SEC (and, by extension, the PCAOB because they have nothing better to do) will be keeping a close eye on the private equity arrangements popping up and how firms taking these deals are sectioning off their audit practices.

He said:

Audit firms have also sought investments from third parties, such as private equity firms, that have not been subject to the same independence and ethical responsibilities as auditors. Depending on how those investments are structured, they could lead the firm’s professionals to question the firm’s commitment to both independence and high-quality audits. Firm leaders need to be sensitive to the message such arrangements could send and stand ready to correct any such misimpressions.

And later in the statement, using “cost of doing business” for the third time:

So when firm leadership fails to set a strong tone at the top­—for example, by sweeping mistakes and bad behavior under the rug, treating violations of law as isolated incidents or the “cost of doing business,” not holding wrongdoers throughout the firm and across service lines accountable, or changing their firm structures in ways that could pose future independence challenges for the firm with respect to its audit engagements—they risk eroding the firm’s culture, professional skepticism, quality control systems, and public responsibility as gatekeepers of our capital markets.

[insert Ain’t Nobody Got Time Fo’ Dat gif here]

In conclusion:

Accountants serve a trusted public role in promoting the integrity of our markets and the protection of investors. The value of an audit and auditors depends on their credibility and trustworthiness. Audit professionals in particular have a difficult job—they sometimes must make difficult determinations that pit the public interest against self- or firm-interest. But that is precisely how public accountants fulfill their gatekeeping function to help protect investors: by ensuring that issues are promptly identified and addressed. To maintain that function, and in training the next generations of public accountants, it is critical that leaders of public accounting firms lead by example and foster a healthy tone at the top by prioritizing integrity and professionalism over profit and growth.

It’s a good thing the next generation of public accountants will be algorithms. It’s easier to program in than to demonstrate ethics.

Fostering a Healthy “Tone at the Top” at Audit Firms [SEC]

3 thoughts on “Audit Firms’ Tone at the Top Sounds Like a Brown Note, Says SEC Chief Accountant

  1. So why doesn’t the SEC ever require that the company’s financials be “re-audited” for the years where independence was violated? How does monetary penalties of an audit partner in any way “correct” this independence deficiency? The SEC is weak.

    >>Following an investigation by the SEC’s Division of Enforcement, the Commission institutes an administrative proceeding and finds that because of the mutual conflict of interest created by the audit firm’s provision of non-audit services at reduced rates in exchange for being chosen as the company’s auditor, the audit firm and audit partner were not independent within the meaning of Rule 2-01(b) of Regulation S-X. The Commission orders a censure, monetary penalties, and a suspension from appearing or practicing before the SEC for the audit partner.<<

  2. Sigh…are they just now noticing this? How do they think people become partners at the large firms in the first place? Has anyone ever become partner at a large firm by taking a hard stance against a client? “Yeah Jim, you did a terrific job in standing up to that CFO putting him in his place with that material weakness. Even though we lost the engagement now, welcome to the partnership.” LOL

  3. This is nonsense. In 1976, the “Metcalf Report” was released about problems in the accounting business. It accomplished as much as the PCAOB has. Nothing. By now it should be obvious: the Big Four are doing what Congress really wants and all Munter is doing is making random noise.
    Does Congress want any large bank holding company audited? Or the Fed itself?

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