A federal judge on February 22, 2024, denied Prager Metis CPAs LLC’s request to stay discovery as it seeks to dismiss the SEC’s independence-related charges, predicting the case “will likely proceed past the motion-to-dismiss stage.”
The SEC in September 2023 charged the firm in US District Court for the Southern District of Florida over alleged violations tied to engagement letter indemnification provisions, arrangements the commission has long identified as incompatible with auditor independence. The commission said Prager Metis, between about December 2017 and October 2020, entered into engagement letters containing the provisions in connection with 62 audits, 11 examinations, and 144 reviews.
The firm in late December sought a “modest” discovery stay until the court resolved its motion to dismiss, arguing the SEC has no basis to claim the firm’s independence was actually impaired and that the commission’s position on a “blanket prohibition against indemnification provisions” is based on nonbinding guidance. Discovery would place a costly and unnecessary burden on the parties and the court, Prager Metis argued, casting the indemnification provisions as boilerplate and never-invoked.
Rule 2-01(b) of the SEC’s Regulation S-X sets out a general standard for independence, under which the commission will not recognize an accountant as independent “if the accountant is not, or a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the accountant is not, capable of exercising objective and impartial judgment on all issues encompassed within the accountant’s engagement.” The SEC, in its complaint, alleged that Prager Metis’ use of the provisions violated Rule 2-01(b), which the firm disputes.
The commission argues that with the inclusion of an indemnification in an engagement letter, an “auditor’s incentive to conduct a thorough audit and question management regarding management’s representations is diminished because the auditor knows that he will be indemnified for management misrepresentations.”
Judge Robert Scola Jr., in the February 22 order, concluded that Prager had not convinced the court of the necessity, appropriateness, and reasonableness of a stay of discovery, and had not demonstrated with enough specificity the “type of extraordinary burden and expense” it would suffer should discovery move forward.
Prager Metis, he wrote, “frames the Commission’s case as turning entirely on the premise that an auditor is never capable of independence where an engagement letter includes any type of indemnification provision, regardless of the provision’s scope.”
“In narrowly focusing its motion on this premise, however, the Court finds Prager neglects to address whether, based on all the facts alleged, the indemnification provisions in this case impaired this defendant’s impartiality,” Scola added. “And while Prager may make a strong case against a per se rule—that an auditor’s impartiality will be deemed to be impaired based on the inclusion of any indemnification provision, no matter its scope or the associated facts and circumstances—it has not convinced the Court (at least upon a cursory review) that the Commission’s allegations here fail to state a claim.”
Also charged alongside Prager Metis was its California-based professional services firm, Prager Metis LLP.
This article originally appeared in the February 27, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
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