What Are the Consequences of Auditors Subject to Regulatory Enforcement Actions?
Apparently Not Much
US, February 12, 2024
Many public company external auditors who were subject of SEC or PCAOB enforcement actions between 2003 and 2019 did not appear to suffer greatly professionally or financially, an academic study found.
Researchers at Temple University and the University of Michigan looked at what happened to the auditors one year after settled orders were issued by the Securities and Exchange Commission (SEC) or the Public Company Accounting Oversight Board (PCAOB), and they observed three intriguing consequences, or lack thereof.
A significant number of those who were involved in professional misconduct remained gainfully employed by their firms—26% of Big Four firms and 43% of non-Big Four firms.
By contrast for context, another research found that 95% of corporate executives named in the SEC’s accounting and auditing enforcement releases (AAERs) who had enforcement actions against them lost their jobs.
Moreover, auditors who had disciplinary actions against them from the PCAOB suffered less consequences than those who were a subject of the SEC’s AAERs.
In SEC cases, 26% from Big Four firms and 38% from non-Big Four firms remained employed at their firms a year after enforcement. In PCAOB cases, it was 28% for Big Four auditors and 47% for non-Big Four auditors.
If auditors left their jobs at one of the Big Four firms, 79% moved to the corporate sector and landed senior or mid-level executive positions at private companies with an accounting or finance focus. This is partly because regulators often bar auditors from practicing public company accounting for a period of time.
By contrast, 77% of auditors who leave their non-Big Four firm jobs tend to join other non-Big Four accounting firms, often as partners.
Of all culpable auditors that remained in public accounting, 80% held partnerships at the time the data were collected.
“Interestingly, we do not find strong evidence that culpable auditors’ departure is linked to the severity of the misconduct, where severity is measured using either the length of the suspension imposed by regulators or whether only the auditor (rather than both the auditor and audit firm) is subject to enforcement,” the study notes. “This finding suggests that for some culpable auditors, firms are willing to overlook misconduct because the benefits that those individuals provide for the firm outweigh the reputation and operational risk-related costs that they impose on the firm.”
In addition, the researchers also looked at real estate holdings of these auditors as a proxy for wealth effects and found that a large majority do not engage in real estate transactions to come up with cash around the time of enforcement actions.
“The punchline is that many auditors don’t lose their jobs, and the ones that do get other jobs quite easily,” said Mihir Mehta, an accounting professor at the University of Michigan, who is the corresponding author of the working paper dated November 2023.
Others who worked on the research are Jagan Krishnan, Meng Li, and Hyun Jong Park of Temple University.
Analyses indicate that “culpable auditors are more likely to depart their employers when (1) the employer is a Big 4 firm, (2) the enforcement is conducted by the SEC, and (3) when a regulatory suspension is imposed on culpable auditors,” the study states. “We also find that departure is less likely when the individual facing enforcement is a partner.”
Research Might Be of Interest to Regulators
Some might find this troubling since auditors play an important gatekeeper role in the capital markets to make sure that a company’s financial statements are presented fairly and do not contain material misstatements.
“The study is likely to be of interest to the profession and both regulators overseeing auditor misconduct, especially given the recent comments by [PCAOB Chair] Erica Williams about an increased enforcement focus on individual auditors,” Mehta said.
The PCAOB has stepped up its enforcement efforts after Williams became chair in January 2022 and has imposed record fines; thus, the research does not cover the sanctions and fines under her leadership or SEC Chair Gary Genler’s tenure. He became chair of the commission in April 2021, and the agency’s enforcement has also been aggressive overall.
It is important to note that the study’s conclusion does not offer up specific policy recommendations for regulators.
“We tried not to speak to the ‘correct’ penalty because it is such a complex issue. Hopefully, our findings will help regulators and auditors understand what the cumulative penalties are for misconduct, which in turn might help regulators think about the ‘correct’ penalty,” Mehta explained.
Asked by Thomson Reuters about whether a much higher fine would be a better deterrent against auditor misconduct, Mehta concurred.
“I agree with your assessment that if the goal was to deter misconduct, greater fines could be effective—one stream of academic literature makes this very claim,” he said.
Background and Tidbits From Study
They pored through the SEC’s AAERs and PCAOB enforcement orders. And they collected data about the culpable individuals’ employment, relocation, and real estate holdings using LinkedIn, LexisNexis, Facebook, and Google searches.
The research sample was 465 culpable auditors. Of these, 275 were subject to SEC enforcement, and 190 were subject to PCAOB enforcement.
It found that enforcement actions against audit-related misconduct does not result in fines for most auditors.
“When fines are imposed, the amounts are modest in magnitude,” the report states. “By contrast, most individuals face suspensions that limit their ability to engage with publicly listed firms in an accounting or audit capacity.”
Despite suspensions from regulators, 40% to 73% of the culpable individuals depart from their firms, which is lower than the 95% rate for corporate managers.
“Our findings suggest audit firms view many culpable auditors as contributing value that exceeds the reputational or risk related costs of retaining these individuals,” the paper notes.
Most individuals who leave are younger than 55 and are employed within a year following enforcement. The study looked at one year because researchers believe that “if the person was going to be forced out, it would happen within one year after the sanction was levied,” Mehta explained.
About 90% faced a temporary or permanent suspension to practice before the regulators. But how long they were suspended depended on the regulator: 34% of SEC cases and 56% of PCAOB cases result in suspensions of two years or less. But 20% of SEC cases and 18% of PCAOB cases result in permanent suspensions.
The suspensions are longer when the SEC is responsible for the enforcement.
The SEC imposed financial penalties in about one third—the PCAOB one half—of all enforcement cases. The amount ranged from $10,000 to $50,000. Those with Big Four firms typically paid higher fines.
The financial penalties appeared to be “modest.” The amounts represent about 7% to 8% of a partner’s annual income and 2% of the penalty imposed on an audit firm.
“The cumulative findings for the suspensions and fines suggest that the most severe consequences for culpable auditors are via restrictions in their ability to provide professional services or obtain accounting-related employment at a publicly listed company rather than via fines,” the study explains.
Overall, the large majority of departing individuals were employed within one year after the enforcement date—65% of those from Big Four firms and 78% of individuals from smaller firms.
However, “individuals that do not obtain employment are around retirement age on average and primarily appear to retire,” the research found.
[Thomson Reuters]
