The SEC Sends A Message To Auditors

And the message is: Our patience has been tested enough.

Yesterday, the SEC Enforcement Division announced an $11.8 million settlement with Ernst & Young over flawed audits of Weatherford International over a four-year period. Two partners have been suspended from public practice.

What’s unsettling: according to the Accounting and Auditing Enforcement Release, Ernst & Young had always considered Weatherford to be a risky client. From the Release:

“From at least 2004, Ernst & Young concluded that Weatherford posed a “significant risk to the firm; that is, there is a significant chance the firm will suffer damage to its reputation, monetarily, or both.”  Accordingly, Ernst & Young designated “close monitoring” status upon Weatherford, the highest-risk category that the firm recognized.  Risk factors the firm specifically identified in reaching this assessment included factors that were among the causes of the audit failure in this matter, including:

  • a history of completing significant or unusual transactions shortly before or at year-end or quarter end;
  • an ability to book journal entries without multiple levels of review;
  • difficulties in auditing Weatherford’s complex tax structure in a timely manner;
  • pressure on management to meet earnings and EPS requirements; and
  • significant pressure for “marginal GAAP.””

Yet, warning signs appeared in the audits of the tax provision - where all the mischief took place - and they were ignored for years, despite the high-risk classification.

According to the Wall Street Journal, this is the first enforcement action by the SEC against a Big Four firm for audit failures since 2009. With the exception of several independence cases, the SEC has remained patient with audit firms’ quality efforts. This might be a signal of a change in attitude.

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