WASHINGTON (AP) – Federal regulators, after an initial failure, alleged for a second time Wednesday that Ernst & Young violated rules designed to keep accountants independent from the companies they audit when it engaged in business with a software company client.
The Securities and Exchange Commission took the action again against the big accounting firm now that there are enough SEC commissioners without a conflict of interest in the case. An administrative law judge at the SEC dismissed it several months ago because only one commissioner had voted to authorize the action.
New York-based Ernst & Young disputed the SEC's allegations, as it did when they were first raised in May. “Our position has remained the same throughout: Our conduct was entirely appropriate and permissible under the profession's rules,” firm spokesman Les Zuke said in a statement.
“It did not affect our client, its shareholders or the investing public, nor has the SEC claimed any error in our audits or our client's financial statements as a result of them. The commission's proceedings are focused on consulting, which, because we sold our consulting business in May 2000, is now a moot point,” the statement said.
The issue of auditor independence was among those at the heart of the Enron affair, which raised questions about Enron's longtime accountant, Arthur Andersen, having done both auditing and consulting work for the energy-trading company.
Andersen was convicted in June of obstruction of justice for destroying Enron audit documents.
In its administrative proceeding, the SEC said that Ernst & Young was auditing the books of business software maker PeopleSoft Inc. at the same time it was developing and marketing a software product in tandem with the company. Ernst & Young engaged in the dual activities from 1993 through 2000, according to the SEC.
The SEC said the product, named EY/GEMS, incorporated some components of PeopleSoft's proprietary source code into software previously developed and marketed by Ernst & Young's tax department. The SEC alleged that Ernst & Young tried to gain a competitive advantage by putting the source code into its product and agreed to pay PeopleSoft royalties of 15 percent to 30 percent from each sale of the product.
When the case arose in May, there were only three commissioners on the five-member SEC: Chairman Harvey Pitt, Cynthia Glassman and Isaac Hunt. Pitt and Glassman removed themselves from voting on whether to take the action against Ernst & Young because Pitt had represented the firm as a private securities lawyer and Glassman had been an Ernst & Young executive.
That left only Hunt to authorize the SEC attorneys to proceed, prompting the administrative law judge's dismissal.
A new hearing will be scheduled before a law judge to determine whether any sanctions should be imposed on Ernst & Young, the SEC said.
It was the second time the SEC had brought an auditor independence action against Ernst & Young. The firm settled a 1995 action by agreeing to comply with independence guidelines.
Robert Herdman, who resigned as the SEC's chief accountant last Friday in the controversy over the selection of former FBI director William Webster to head a special accounting oversight board, also had been an executive of Ernst & Young before coming to the SEC.
In a similar case, the SEC in January censured another Big Five accounting firm, KPMG, for allegedly violating the auditor independence rules. The agency said KPMG invested $25 million in a mutual fund at the same time it was auditing the fund's books.
KPMG, which was not fined, agreed to the SEC's censure without admitting or denying the allegations and agreed to take measures to prevent future violations.
The SEC adopted the independence rules in November 2000 after a bitter fight between the accounting industry and Arthur Levitt, then the SEC chairman. He and others worried that accountants in some cases had become too cozy with the companies they audited, threatening the integrity of financial reports and undermining investor confidence.
The rules identified several services as inconsistent with auditor independence, including bookkeeping, financial systems design and implementation, human resources and legal services.