Office of the Chief Accountant:
Regarding the Initial Decision
In the Matter of Ernst & Young LLP, April 16, 2004
April 27, 2004
Mr. James Turley
Chief Executive Officer
Ernst & Young LLP
5 Times Square
New York, New York 10036
Re: In the Matter of Ernst & Young LLP, File No. 3-10933
Dear Mr. Turley:
On April 16, 2004, Chief Administrative Law Judge Brenda P. Murray issued the Initial Decision in the above-referenced matter. Among other relief, the Initial Decision suspended Ernst & Young LLP ("E&Y") from accepting "new Commission registrant audit clients for a period of six months." This Initial Decision was made final by Order of the Commission entered on April 26, 2004.
We have received a number of inquires from registrants and from E&Y seeking further guidance on the definition of "new Commission registrant audit clients" and on the timing of the suspension. In order to respond to these inquires and provide guidance and clarity to the marketplace, the staff has developed a set of "guiding principles." It is clear from the language of the Initial Order that it is intended to discipline E&Y, not to punish registrants or E&Y's pre-existing audit clients. The staff believes that the guiding principles set forth below are consistent with the intent of the suspension. Situations that do not fit squarely within the guiding principles should be brought to the attention of Mike Husich, Office of the Chief Accountant.
1. These principles are based on the overriding premise that the purpose of the Suspension Order's limitation on accepting "new Commission registrant audit" clients is to obtain the remedial effect of the suspension as to E&Y, without unduly burdening registrants from a financial or operational standpoint.
2. During the six-month period that the Suspension Order is effective (a period that commenced on April 26, 2004, the date the Initial Decision was adopted as a final decision of the Commission), E&Y should neither accept, nor solicit, nor negotiate to accept, audit engagements for new Commission registrant audit clients.
3. For the purpose of determining who is a "new Commission registrant audit client," the applicable date is the date of the Chief ALJ's Initial Decision, i.e., April 16, 2004.
4. The guidance as to what constitutes a "new Commission registrant audit client" will reside within the Office of the Chief Accountant ("OCA"). OCA, in consultation with other Divisions or Offices where necessary, will be guided by the following principles, giving primary consideration to the impact of its guidance on the registrant:
a. OCA would not deem the following scenarios as involving "new Commission registrant audit clients" for purposes of the Suspension Order:
i. E&Y had a continuing audit relationship with the entity as of April 16, 2004, as evidenced by a signed engagement letter, significant audit work having been done, a registration statement having been filed by a private audit client, or a Form 8-K having been filed with the Commission announcing E&Y's appointment as auditor (except that the addition of an incremental entity is addressed in paragraph ii, below);
ii. E&Y had a continuing audit relationship with a registrant or an investment company complex as of April 16, 2004 and, thereafter, an incremental entity is added (e.g., a new mutual fund is added to an existing investment company complex), and requiring an auditor other than E&Y for the incremental entity would impose a significant burden on the registrant;
iii. E&Y had a continuing audit relationship with a registrant as of April 16, 2004, and, thereafter, the E&Y client registrant enters into a merger or other business combination and the E&Y client registrant is the surviving entity for accounting purposes (i.e., the E&Y client is the accounting acquirer or predecessor).
b. Reissuance of an audit report and consenting to the use of a previously issued audit report would be considered acceptable activities under the Suspension Order.
c. The restrictions in the Suspension Order apply to E&Y and not to international affiliates of E&Y.
5. In those circumstances where application of these Guiding Principles may cause undue hardship or a significant burden on a client, or in cases of doubt concerning the application of the Suspension Order and above guidance to the situation, E&Y or the registrant should consult with OCA, which, in consultation with other Divisions or Offices where necessary, may provide guidance.
The guiding principles set forth above balance the need to discipline E&Y with not unfairly punishing registrants or E&Y's pre-existing audit clients. The Order provides for significant remedies and sanctions against E&Y including:
- A cease and desist order from violating or causing violation of the Commission's rules;
- A finding that E&Y engaged in improper professional conduct;
- Disgorgement of $1,686,500 and prejudgment interest;
- Retention of an independent consultant to assure the Commission that E&Y's leadership is committed to, and has implemented policies and procedures that reasonably can be expected to remedy the violations found in the Initial Decision and result in compliance with the Commission's rules on auditor independence related to business relationships with clients and with GASS. Furthermore, E&Y must cooperate with the independent consultant in all respects, including staff support, and must compensate the independent consultant; and
- Suspension from accepting audit engagements for new Commission registrant audit clients for a period of six months.
Maintaining independence in fact and appearance is of critical importance to ensure the integrity of the audit process and maintain confidence in our capital markets. I recognize that the Order may have a significant adverse effect on E&Y. It is my hope that E&Y does take these sanctions seriously and is committed to reforming its independence policies and procedures to ensure its independence and protect the investing public.
Donald T. Nicolaisen