SEC Discusses Auditor Independence, Cooperation Credit, and Crypto
On June 9-10, 2022, Arnold & Porter co-sponsored and co-chaired the American Law Institute’s Accountants’ Liability Conference in Washington, DC. The event kicked off with Arnold & Porter Partner Paul Fishman sitting down for a “fireside” chat with SEC Enforcement Director Gurbir Grewal and Acting Chief Accountant Paul Munter to discuss emerging issues related to accountants’ liability. The conference also featured discussions with PCAOB Director of the Division of Registration and Inspections, George Botic, and a faculty of high-ranking government officials, general counsel from international firms, and seasoned outside counsel and forensic experts. The following are several high-level takeaways from the conference.
Comments by SEC Enforcement Director Grewal and Acting Chief Accountant Munter. Echoing a statement issued one day prior to the conference, Acting Chief Accountant Munter and Director Grewal emphasized the importance of auditor independence under Rule 2-01(b) of Regulation S-X. According to Rule 2-01(b), auditors must be independent in fact and in appearance, as measured by “a reasonable investor with knowledge of all relevant facts and circumstances.” The rule also includes a non-exclusive list of circumstances—paragraphs (c)(1) through (c)(5) —that the Commission finds inconsistent with independence requirements. Acting Chief Accountant Munter cautioned auditing firms and issuers, however, against viewing Rule 2-01 and auditor independence with a checklist mentality. The circumstances listed under Rule 2-01(c) are necessary but not sufficient to achieve auditor independence under Rule 2-01(b).
Director Grewal and Chief Accountant Munter also reaffirmed the Commission’s intent to pursue auditing firms and issuers for accounting improprieties. In a recent settlement, the Commission charged an auditing firm and three of the firm’s partners with improper professional conduct related to two clients, imposed a $1.9 million penalty against the firm, and imposed bars against two partners while censuring the national office partner. The SEC cited the firm’s deficient quality control system and repeated failures to exercise due professional care at all levels, from the engagement team up through the firm’s national office, not only allowed but were a cause of the clients’ disclosure violations. Director Grewal and Chief Accountant Munter echoed the comments from Melissa Hodgman, Associate Director in the Division of Enforcement, at the time the settlement was announced: “Auditors are critical gatekeepers that must employ a robust system of quality control to ensure faithful adherence to professional standards.” In another recent settlement, this time with Synchronoss, the SEC used all available sanctions and remedies to claw back $1.3 million in stock sale profits and bonuses from the company’s founder and former CEO, despite bringing no misconduct charges against him. In a press release discussing the matter, Director Grewal stated that the Synchronoss case should “put public company executives on notice that even when they are not charged with having a role in the misconduct at issue, we will still pursue clawbacks of compensation.”
Finally, Director Grewal and Chief Accountant Munter expressed concern over the technology and regulatory risks presented by digital assets. The Commission has issued guidance, Staff Accounting Bulletin No. 121, on accounting for obligations to safeguard crypto-assets an entity holds for its platform users. The Commission issued SAB No. 121 because digital assets present unique legal questions that do not exist in other custodial relationships. And for Acting Chief Accountant Munter, these kinds of risks manifest as an accounting liability that should be on the balance sheet and measured at fair value of the digital asset safeguarded. Given the difficulty with identifying a digital asset, the SEC’s Division of Corporation Finance and Strategic Hub for Innovation and Financial Technology are offering consultations to identify whether assets held by trading platforms qualify as digital assets. The Commission intends to ensure that all digital offerings, products, and platforms fall within the SEC’s remit and follow the agency’s rules.
SEC Enforcement Priorities and Trends According to SEC Staff. When responding to an SEC request or subpoena, the SEC staff recommend responding quickly and completely so that a determination may be made efficiently. It is an animating principle of the Commission to enhance public trust in financial institutions, regulators, and markets by moving cases forward quickly. The SEC may tailor remedies, such as imposing a lesser penalty or no penalty at all, as a result of a firm’s cooperation or remediation throughout the investigative process. The staff clarified, however, that cooperation does not mean merely complying with a subpoena. Instead, cooperation may include self-reporting workpapers that may be otherwise difficult for the SEC to detect, providing an analysis to the SEC that would be otherwise time consuming for the agency to conduct, or providing documents outside the scope or date range of a subpoena relevant to an investigation.
The staff also recommend conducting remediation throughout the SEC’s investigative process. A firm’s ability to isolate and address a problem may lower an SEC sanction. Moreover, updating or revising a firm’s policies, procedures, or controls is not a form of admission, according to the staff. However, slowing or preventing an SEC investigation will deter the staff from maintaining an open mind or applying a cooperation or remediation credit to an audit firm’s sanction. According to Director Grewal, the staff has seen defense counsel slow the investigative process by coaching witnesses, threatening SEC attorneys, slow rolling document production, and inappropriately asserting privilege.
The PCAOB Inspection Program. In 2022, the PCAOB’s inspection focus remains COVID-19. The PCAOB is examining how auditing firms navigate a hybrid workforce, increased costs and inflation, the Great Resignation, and SPAC and De-SPAC transactions. In addition, the PCAOB has deployed a team of ten individuals to perform “targeted inspections” of emerging issues, such as C-suite commitments to carbon neutrality and delivery centers for excellence. Targeted inspections are random and follow a risk-based selection approach. In May, the Office of the Chief Auditor published an updated standard-setting agenda, including near and mid-term projects related to quality control, attestation standards, and fraud.
The SEC and PCAOB’s enforcement priorities are rapidly shifting in response to emerging issues within the US audit profession. These priorities reveal a period of increased compliance enforcement against issuers and firms. Market participants should take notice of the shift in approach, including external messaging related to auditor independence, cooperation and remediation credits, and crypto-assets, and take proactive steps to ensure compliance with the federal securities laws.
Arnold & Porter is continuing to monitor and report on key enforcement and regulatory developments at the SEC and PCAOB. In the meantime, please reach out to any author of this Advisory or your regular Arnold & Porter contact with any questions.
© Arnold & Porter Kaye Scholer LLP 2022 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.