Former Ernst & Young Audit Partner Arrested for Obstruction Charges and Criminal Violations of Sarbanes-Oxley Act
FOR IMMEDIATE RELEASE
|U.S. Securities and Exchange Commission|
San Francisco District Office
44 Montgomery St., 11th Floor
San Francisco, California 94104
|U.S. Department of Justice United States Attorney|
Northern District of California
11th Floor, Federal Building
450 Golden Gate Avenue, Box 36055
San Francisco, California 94102
US Attorney's Office and FBI Announce Guilty Plea of Former Ernst & Young Auditor to Obstruction Charges
SEC Charges Former Ernst & Young Employees for Alleged Role in Destruction of Audit Working Papers
Thomas C. Trauger, a former Ernst & Young partner who allegedly altered and destroyed audit working papers, was arrested this morning by FBI agents on criminal charges for obstructing investigations by both the Office of the Comptroller of the Currency and the Securities and Exchange Commission. The arrest and charges were announced today by the U.S. Attorney's Office for the Northern District of California, the Federal Bureau of Investigation, and the Securities and Exchange Commission. This is one of the first cases of document destruction brought under the newly enacted Sarbanes-Oxley Act.
In addition, the Securities and Exchange Commission instituted two administrative proceedings, an unsettled proceeding against Mr. Trauger and Michael Mullen, former audit manager at E&Y, and a separate settled proceeding against Oliver Flanagan, former senior manager at E&Y.
Mr. Trauger, age 40, is a resident of Berkeley, California, and a former partner in the San Francisco offices of Ernst & Young. Mr. Trauger, a certified public accountant licensed in the State of California, was charged in a criminal complaint that was unsealed after his arrest this morning. The complaint contains two counts: one count charging Mr. Trauger with obstructing the examination of a financial institution and one count charging falsification of records in a federal investigation in violation of the Sarbanes-Oxley Act of 2002. The complaint was filed in San Francisco federal court yesterday and was under seal until Mr. Trauger's arrest.
The charges follow a guilty plea by Mr. Flanagan, also announced today by the U.S. Attorney's Office and the FBI. Mr. Flanagan pled guilty to a one-count information charging him with obstructing the examination of a financial institution.
In a separate administrative proceeding, the Division of Enforcement alleged that Trauger and Mullen, a 33-year old Seattle resident, engaged in unethical and improper professional conduct as a result of their alleged alteration and destruction of documents. Also this morning, the SEC instituted a settled administrative proceeding against Oliver Flanagan, age 34 and a citizen of Ireland, for his role in the alleged document destruction.
According to the allegations in the criminal action, and the Division of Enforcement's allegations in the administrative actions, in approximately October 2001, Mr. Trauger, assisted by Mr. Flanagan and Mr. Mullen, began to alter and destroy copies of working papers related to E&Y's audit work for its client NextCard, Inc., a publicly- traded, San Francisco-based issuer of credit cards over the Internet. The document destruction allegedly occurred after the working papers had been completed and during an OCC examination of NextCard's banking subsidiary, NextBank. The bulk of the destruction of documents allegedly followed an October 31, 2001 announcement by NextCard that the OCC and the Federal Deposit Insurance Corporation would require NextBank to revise certain accounting assumptions which would in turn cause the bank to be severely undercapitalized under federal banking regulations.
According to an affidavit filed by an FBI agent in support of the criminal complaint, Mr. Trauger destroyed, altered, and falsified both hard and electronic copies of working papers related to E&Y's audit of NextCard's financial statements for its fiscal year ended December 31, 2000, and E&Y's review of NextCard's financial statements for its quarterly reporting periods ending March 31, 2001, and June 30, 2001. The complaint also alleges that, between approximately March 2002 and April 2002, Mr. Trauger assisted in the collection and production of altered workpapers to the OCC, pursuant to a subpoena addressed to Mr. Trauger. Finally, the complaint alleges that in April 2003, Mr. Trauger gave sworn testimony to the SEC related to NextCard where he allegedly concealed his alteration and destruction of documents when questioned about his role in the production of E&Y's audit working papers to the OCC.
"This is a bellwether day for the Corporate Fraud Task Force," said Robert McCallum, chairman of the President's Corporate Fraud Task Force and Acting Deputy Attorney General. "Today's actions mark one of the first instances in which prosecutors have been able to use an important weapon in the fight against corporate fraud given to us by Congress under the Sarbanes-Oxley Act of 2002 — the ability to prosecute those who would seek to destroy, alter or falsify financial information and records. Today's plea and arrest should remind accountants and lawyers not only of their commitment to represent their clients professionally, but also of our strong commitment to enforcing the law."
In announcing the charges, U.S. Attorney Kevin V. Ryan said, "This is one of the first cases in the country in which an auditor has been accused of destroying key documents in an effort to obstruct an investigation. Our financial markets depend on the integrity of auditors, lawyers and professionals to do their jobs ethically and fairly. Where they fail to do so because of negligence, markets are compromised. Where they fail to do so because of criminal intent, all of us are at risk. The U.S. Attorney's Office will bring those professionals to justice who join in the criminal acts they are supposed to uncover and expose."
Stephen Cutler, Director of Enforcement for the SEC, said, "Complete and accurate work papers are critical to the integrity of the audit process and to the efficacy of our investigative work. We will aggressively pursue auditors who alter or destroy work papers or otherwise undermine the financial reporting process, and will work closely with criminal authorities to ensure that those who engage in such conduct are held accountable."
Mark Mershon, Special Agent In Charge of the San Francisco office of the FBI, said, "We look to certified public accountants to maintain the integrity of publicly traded companies. The criminal acts of auditors who abuse their authority, act in their own self-interest, and violate the sacred trust of the shareholders will not be tolerated. This investigation illustrates the high level of commitment and collaboration among the FBI, SEC, and U.S. Attorney's Office in the vigorous prosecution of those individuals who engage in unethical and improper professional conduct."
In the SEC's orders instituting administrative proceedings against Mssrs. Trauger, Mullen and Flanagan, the Division of Enforcement alleges:
- In the first few days of November 2001, Mr. Trauger became concerned that E&Y's audit work for NextCard would be examined by regulatory agencies or others. Mr. Trauger, assisted by Mr. Flanagan, met in E&Y's offices in San Francisco and altered portions of the E&Y electronic working papers for the NextCard 2000 audit. Mr. Trauger, assisted by Mr. Mullen, had already investigated how to access and alter electronically stored working papers. In order to ensure that the revised documents appeared to have been created as part of the original working papers, Mr. Trauger instructed Mr. Flanagan to reset the date on his computer to ensure that any documents bearing computer-generated dates would reflect a date in early 2001.
- Later in November 2001, Mr. Trauger asked Mssrs. Flanagan and Mullen to assist him in making additional alterations to the working papers for the NextCard 2000 audit and Mr. Flanagan showed Mr. Mullen how to change the date on his laptop computer, again to make it appear as though the altered working papers were created earlier in the year at the time the original audit work had been performed.
- Mr. Trauger's purpose in altering E&Y's working papers was to make it appear that there was a more satisfactory basis for E&Y's audit conclusions. After making the changes, Mr. Trauger instructed Mr. Flanagan to scour his hard drive and delete documents or emails inconsistent with the altered versions of the working papers, and Mr. Flanagan erased some documents in response.
- After E&Y received a subpoena for documents from the OCC in February 2002, Mr. Trauger also instructed Mr. Flanagan to destroy a computer diskette containing a copy of a portion of the hard drive of an accountant who had worked on the NextCard 2000 audit. Unbeknownst to Mr. Trauger, Mr. Flanagan did not comply with this request.
The SEC's orders instituting administrative proceedings against Mssrs. Trauger, Mullen and Flanagan allege that the three engaged in unethical and improper professional conduct when they altered the working papers for NextCard and that their conduct violated the applicable professional standards, including professional auditing standards governing the creation and retention of working papers and those establishing the standards for ethical conduct by auditors. The Division of Enforcement seeks an order denying Mr. Trauger and Mr. Mullen the privilege of appearing or practicing before the SEC.
Simultaneously with the institution of the proceedings against him, Mr. Flanagan agreed to settle the charges. Without admitting or denying the findings of the SEC order, Mr. Flanagan consented to an order denying him the privilege of appearing or practicing before the Commission, but may request that the SEC consider his reinstatement after three years. Mr. Flanagan cooperated with the SEC's investigation.
A hearing will be scheduled before an administrative law judge in the action against Mr. Trauger and Mr. Mullen to determine whether the allegations contained in the order are true, to provide Mr. Trauger and Mr. Mullen an opportunity to respond to them, and to determine whether any remedial action should be ordered, or penalties imposed, by the Commission. The SEC's investigation is continuing.
Robert Mitchell, head of the enforcement program in the SEC's San Francisco District Office, said, "Auditors play an important role in safegaurding the reliability of public company financial information. By altering workpapers in such a way as to obscure what actually occurred during the audit process, the auditor violates his or her professional and ethical obligations."
In the criminal complaint, Mr. Trauger is charged with one count of obstructing the examination of a financial institution, in violation of 18 U.S.C. 1517, with carries a maximum penalty of 5 years in imprisonment and fine of $250,000. He is also charged under the Sarbanes-Oxley Act of 2002 with one count of falsification of records in a federal investigation, in violation of 18 U.S.C. 1519, which carries a maximum penalty of 20 years in prison and a fine of $250,000.
Any criminal sentence following conviction would be dictated by the Federal Sentencing Guidelines, which take into account a number of factors, and would be imposed at the discretion of the Court. A criminal complaint simply contains allegations against an individual and, as with all defendants, Mr. Trauger must be presumed innocent unless and until convicted. The criminal case is being prosecuted by Assistant U.S. Attorneys William Kimball and Anne-Christine Massullo. E&Y cooperated in the criminal investigation.
A copy of this press release may be found on the U.S. Attorney's Office's website at www.usdoj.gov/usao/can. Related court documents and information may be found on the District Court website at www.cand.uscourts.gov or on http://pacer.cand.uscourts.gov.
All press inquiries to the San Francisco District Office of the SEC should be directed to Assistant District Administrator Robert L. Mitchell at (415) 705-2351. A copy of the Orders referenced in this release may be found on the SEC's website at www.sec.gov.
All press inquiries to the U.S. Attorney's Office should be directed to Assistant U.S. Attorney Matthew J. Jacobs at (415) 436-7181.See Also: Administrative Proceeding Release No. 34-48542; Administrative Proceeding Release No. 34-48543