PriceWaterhouseCoopers LLP Auditors? Independence Issues & Violations
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The SEC and the former Chairman Arthur Levitt Jr. were extremely concerned that the public accounting firms were violating the auditors independence rules addressed through the Securities Exchange Acts. Auditing firms now had dual citizenship in public companies: (1) they issued opinions on audited financial statements and (2) they participated in various consulting engagements for those same companies. Levitt's solution was to split auditing and consulting. The former Chairman was concerned that the public would lose confidence in the financial markets …… and the whole system would be jeopardized.
Public Accounting Revenues vs. Consulting Revenues by 1999
By 1976, audit fees accounted for approximately 70% of total revenue earned by any accounting firm in general. According to the Public Accounting Report, an Atlanta newsletter, the auditing and assurance services revenues dropped to 30% and tax services business accounted for 19% of the total revenues earned in 1999. Mathematically speaking, this means management consulting services accounted for approximately 51% of the total revenue being earned in 1999 by public accounting firms.
Fact: According to The Business Journal's Book of Lists, PwC had $75 million in South Florida billings in 1998 to place third among accounting firms.
SEC Auditors’ Independence Rule
The independence rules require that auditors refrain from investing in companies that they audit, to ensure objective, truthful reporting and opinion. The rule applies to all auditors, their relatives, spouses, dependents, non-dependents, and, in some cases, associates must disclose all holdings.
On the September 25, 2002 issue of BusinessWeekOnline.com, the Accounting Wars Powerful auditor-consultants are the target of Arthur Levitt’s crusade articles defined “Independence to mean, CPAs cannot audit their own or their partners' work….…..clear and honest information is dependent on the CPAs independence……an auditor must not have any financial stake in the health, or even survival, of a client company.”
There are those in the profession that believe this rule is archaic and does not hold any value in today’s financial world. Barry Melancon, President and CEO of the American Institute of Certified Public Accountants stated, “The SEC has a right to expect the profession to adhere to the rules; however, the profession has a right to expect the regulatory environment to remain modern.”
Fact: In 1933, when Congress first required public financial reports, lawmakers debated whether audit fees would taint auditors' independence.
PriceWaterhouseCoopers LLP is a public accounting firm formed through a merger between Coopers & Lybrand LLP and Price Waterhouse LLP, which was consummated on or about July 1, 1998.
Fact: The merger resulted in making PwC the largest accounting firm in the world.
The SEC Targets the C&L Tampa Office for possible violations
During 1997, the SEC received an anonymous letter from a whistle blower at the Southeast Regional Office in Miami. The letter alleged that audit staff in the Tampa office of C&L owned stock in the companies they were auditing, which clearly violated the SEC’s independence rule. In 1998, the SEC ordered an investigation into the allegations of auditor conflicts of interest at Coopers & Lybrand's Tampa office, now known as PwC.
Fact: Upon merging, both accounting firms (partners and staff) were required by the independence rule to divest all shares owned in companies audited by each other. The independent study revealed that this never took place and in fact PwC had committed an independence violation at that location.
SEC Charges PwC with Auditors’ Independence Rules
The "auditor independence" issue came to the forefront on January 14, 1999. The SEC issued an Opinion and Order Pursuant to Rule 102(e) of the Commission's Rules of Practice In the Matter of PricewaterhouseCoopers LLP (Securities Exchange Act of 1934 Release No. 40945) ("Order"), which censured PwC for violating auditor independence rules and improper professional conduct. PwC agreed to a complete internal review supervised by an independent person or firm to be appointed by the SEC and to report any additional violations.
Fact: Although no violations compromised or impaired any of the PwC audits it did trigger an investigation of the remaining Big Five by the Public Oversight Board.
PwC had taken the position that the independence issue was a result of the merger and a one-time breakdown in the internal system.
Fact: The independent report concludes……the numbers of violations alone, as PwC acknowledges, reflect serious structural and cultural problems that were rooted in both its legacy firms (PW and C&L); although a large percentage of the reported and unreported violations is attributable solely to the Merger, an even larger portion is not; thus, the situation revealed by the internal investigation is not a one-time breakdown explained solely by the merger.
Independent Consultant Review Regarding PwC’s Violations
On March 1999, the SEC appointed independent consultant Mr. Jess Fardella of Lankler Siffert & Wohl LLP to supervise PwC's internal review of potential independence violations by the firm.
The SEC issued the independent consultant’s report citing PwC with 8,064 violations and that a substantial number of PwC professionals (mostly partners) had attributed to the independence violations.
Facts uncovered from the independent consultant’s report:
1. Of 8,064 reported violations, 81.3% were reported by partners and 17.4% by managers; 45.2% of the violations were reported by partners who performed services related to audits of financial statements.
2. Approximately half of the PwC partners had self-reported at least one independence violation. The average number of violations was approximately five; 153 partners reported more than 10 violations each.
3. Approximately half of the reported violations were based on direct investments in securities, mutual funds, bank accounts, or insurance products associated with a client. Approximately 32% of reported violations involved holdings of a client's stock or stock options.
4. Six out of eleven partners at the senior management level who oversee PwC's independence program self-reported violations.
5. Each of the 12 regional partners who help administer PwC's independence program reported at least one violation; one reported 38 violations and another reported 34 violations.
6. PwC’s Board of Partners is comprised of 43 partners of whom 31 self-reported at least one violation. Four of these had more than 20 violations; one of these partners had 41 violations and another had
The SEC’s Regional Director of the Miami office Randall Fons made the following statement after the publication, "frankly, it was a shock to me to see that they had such a large number of violations."
Fact: The SEC now had irrefutable evidence of independence violations by the largest Big Five accounting firm, which included heads of major PwC divisions and top managers in charge of enforcing the conflict-of-interest rules in audit clients; astonishing enough even its Chief Executive James Schiro owned forbidden stock….. PwC client filings could be rightfully rejected by the SEC.
Weakness in system uncovered per the independent consultant’s report:
1. Reporting systems relied on the individuals themselves to sort through their own investments and interests for violations;
2. Efforts to educate professionals about the independence rules and their responsibilities to the client to comply with the rules were insufficient;
3. Resolution of reported violations were not adequately documented; and
4. Reporting systems did not focus on the reporting of violations that were deemed to be resolved before annual confirmations were submitted.
PwC Settlement with the SEC:
• Needs to maintain a database of all clients and other publicly traded entities in which investments by employees are to be restricted; plus, it needs to maintain a separate database to track securities held by partners and managers.
• All partners, principals and managers are required to review database prior to buying any security and disclosure any purchase or sale of securities within five days so that administrators can check them against the restricted list.
• PwC was to pay $2.5 million toward educating the accounting profession about independence.
Fact: PwC agreed to the settlement; however, it never admitted to any wrong doing for any of the violations on its behalf.
A spokesman for PwC Steve Silber, was quoted on the April 7, 2000 issue of the South Florida Business Journal that “PwC spent more than $25 million since early 1999 designing and implementing a "state-of-the-art" systems and was training all employees about potential independence violations ……and that PwC will conduct random audits to avoid future violations and punish offenders."
Fact: The Tampa Bay Business Journal was quoted stating that, “Ironically, those auditors worked for C&L, and the violations occurred before Price Waterhouse's buyout of the firm last July.” However, the independent consultant reported that a large number of violations could be attributed to systems changes related to the merger but added that "an even larger portion" could not be tied to the merger.
Fact: With the failure of Enron, Congress implemented the rest of Former SEC Chairman Arthur Levitt Jr. agenda into the Sarbanes-Oxley Act of 2002.
1. Tampa Bay Business Journal – February 15, 1999: SEC issues auditors new independence guidelines by Carol Cronan: http://tampabay.bizjournals.com/tampabay/stories/1999/02/15/newscolumn2.html
2. CFO Magazine – March Issue 2000 – CFO.com: Policing the Auditors There are rumbles in the industry that more than one Big Five accounting firm will be found in violation of independence regulations by Leslie Schultz: http://www.cfo.com/article.cfm/2988508/c_3046533?f=insidecfo
3. Accounting Education.com: Independent Consultants Finds Widespread Independence Violations at PriceWaterhouseCoopers – January 10, 2000 by Andrew Priest: http://www.accountingeducation.com/news/news779.html
4. South Florida The Business Journal – April 7, 2000: SEC keeping close eye on accountants’ independence by Jim Freer: http://www.bizjournals.com/southflorida/stories/2000/04/10/focus3.html?t=printable
5. The CPA Journal: The SEC’s New Auditors Independence Standard by Dan L. Goldwasser Esq. http://nysscpa.org/cpajournal/2001/0400/features/f041801.htm
6. Business Week Online.com – September 30, 2002 – Arthur Levitt’s Crusade http:businessweek.com/print/magazine/content/02_39/b3801097.htm/
7. The Auditor’s Report Volume 23, No. 2, Winter 2002 – An Update on Auditor Independence by Douglas F. Prawitt, Brigham Young University http://www.accounting.rutgers.edu/raw/aaa/audit/Pubs/Audrep/00winter/item04.htm
8. Business Week Online.com – September 25, 2002 – Accounting Wars Powerful auditor-consultants are the target of Arthur Levitt’s crusade http://businessweek.com/2000/00_39/b3700001.htm?scriptFramed
9. TheStreet.com: Report on PriceWaterhouseCoopers Violations Has Some Critics by Robert Kowaiski and Tracy Byrnes Staff Reporters http://thestreet.com/pf/funds/taxes/856161.html
10. The Motley Fool – Fool.com: Who’s Auditing the Auditors? by Yi-Hsin Chang http://www.fool.com/news/2000/foth000110.htm