Big 4 Conflicts of Interest Are in Regulators’ Crosshairs, EY Tops the Independence Naughty List

a man with binoculars

There’s a story in the New York Times today about how EY “devised an elaborate arrangement” for nonprescription drugmaker Perrigo to avoid more than $100 million in taxes, an arrangement that was questioned by Perrigo’s then-auditor BDO. Perrigo did what any reasonable tax-avoiding nonprescription drugmaker would do and dropped BDO for EY, hence totally resolving the issue. Cue Obama awarding Obama a medal meme here.

At least one EY official, too, expressed concern that the tax shelter his colleagues had designed was overly aggressive. Even so, auditors at EY, also known as Ernst & Young, eventually blessed the transactions, which federal authorities now claim were shams, according to previously unreported documents made public in a court case last year.

The potential — nay, obvious? — conflict of interest is now wide open for everyone to see. And question:

Internal EY emails and memos — made public last year in a court case in which the I.R.S. is challenging Perrigo’s tax arrangements and accusing EY of constructing “an abusive tax dodge” — provide a rare inside look at the potential conflicts of interest that arise as a single firm constructs tax shelters and simultaneously audits its own work.

“When you are a consultant, you are partnering with management. You are trying to make management look really good,” said Lynn Turner, a former chief accountant at the Securities and Exchange Commission. “That’s not the role of an independent auditor.”

Quick aside: LYNN TURNER 🥰🥰

Independence? Never heard of her.

The Big 4 accounting firms — EY, KPMG, PwC and Deloitte — have emerged as perhaps the most powerful private-sector force in U.S. tax policy. They lobby federal officials to tweak tax rules to help their clients. A steady stream of lawyers from the firms rotate in and out of senior tax positions in the Treasury Department, where they write rules favorable to their former clients.

At the same time, the Big 4 firms help companies move profits out of the reach of the U.S. government. Then the companies’ auditors — often a different group of employees from the same firm that created the structures in the first place — have to sign off on the setups. In assessing their legitimacy and the effect on the client’s financial results, the auditors frequently consult with the colleagues who devised the tax strategies.

The I.R.S. is taking a dim view of these transactions.

DealBook has some specifics on the Perrigo scheme, er, shelter mentioned above:

How Perrigo’s tax shelter worked: In 2005, EY devised a plan to help Perrigo, then based in Allegan, Mich., avoid U.S. taxes on its popular anti-heartburn medication, omeprazole. If Perrigo had bought omeprazole from a manufacturer and then sold the pills to customers in the U.S., its profits would have been taxed there. Instead, EY advised Perrigo to set up a subsidiary in Israel, with no employees and no offices, to buy the omeprazole. The shell company then sold the pills to Perrigo in the U.S. at a profit. That meant that Perrigo’s income on the pills largely remained in Israel rather than in the U.S., out of reach of the I.R.S. And because of the vagaries of Israeli tax law, the profits weren’t taxed in Israel, either.

The I.R.S. eventually questioned the transactions and required Perrigo to pay $163 million in back taxes. In a related case, Justice Department lawyers representing the I.R.S. accused EY of enabling a “shell game” and a “flagrant tax scheme gone awry.” The fight went to a federal trial last year. The judge hasn’t announced a verdict yet.

The SEC has been on the case of Big 4 firm independence for some time with at least one SEC office “seeking information about client work that could cause auditors to violate rules requiring they be independent of clients whose finances they inspect,” reported WSJ last March.

In the current investigation, the SEC has asked audit firms to disclose instances to regulators in which the firms provided services such as consulting, tax advice, and lobbying to audit clients, according to the people familiar with the matter. The SEC also asked for information on any cases in which audit firms obtained contracts that reimburse them for losses caused by lawsuits over their work, or made fees contingent on a particular result or outcome, they say.

Much like Perrigo swapping auditors to resolve the issue of outside auditors questioning EY’s tax work surely cutting audit off from the firm like a gangrenous limb will fix any conflict of interest issues, right?

According to a May Bloomberg Tax article about EY’s plan to split consulting and audit, that’s exactly the plan:

Tighter ethics regulations are holding back the growth of Ernst & Young’s lucrative consulting business, a key reason firm leaders are considering whether to separate its global audit and advisory practices.

“There’s work we can’t do,” a source with knowledge of the matter said. Conflict-of-interest rules limit the type of advisory work the firm can provide, including fast-growth technology as long-term outsourcing contracts are barred for audit clients.

Keep an eye on this, it’s feeling like there might be way more than a couple wrist-slaps given out when all is said and done. Clearly no one is learning anything from all the wrist-slapping.

Related:
The SEC Only Gives Out Wrist-Slaps to the Big 4 When They Break Independence Rules On Providing Non-Audit Services to Audit Clients

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2 Comments

  1. Are you aware of the $3.3 billion tax fiasco at Coca-Cola?
    Another E&Y “special”.
    Where is the PCAOB on this?
    Too busy harassing insignificant CPA firms with miniscule clients.

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