The Securities and Exchange Commission (SEC) will not hesitate to file charges against accountants and auditors in district courts instead of using in-house administrative proceedings, said the agency’s Enforcement Director Gurbir Grewal at a conference on Oct. 25, 2023.
This comes as the commission is locked in a battle in a Supreme Court case—SEC v. Jarkesy—about the constitutionality of the SEC’s use of in-house judges. Arguments are set for Nov. 29. Critics of the SEC believe that the administrative enforcement program is unfair. By contrast, federal courts afford greater protections to defendants.
“We are not going to just stop holding auditors and other gatekeepers responsible when they fall short of their professional obligations just because there is some uncertainty in the court,” said Grewal at Securities Enforcement Forum hosted by Securities Docket in Washington. He spoke via a livestream.
Bringing enforcement actions in-house gives the SEC the authority to suspend accountants when they are found to have violated relevant securities laws and regulations. But in late September, the commission filed charges against accounting firm Prager Metis CPAs for allegedly violating auditor independence rules with the U.S. District Court for the Southern District of Florida. And a moderator asked whether there could be more charges filed in federal courts and forego unique remedies that the SEC can impose on accountants.
“Just because we are awaiting a ruling from the Supreme Court, [we should pause]; we need to hold folks accountable now,” Grewal said. “And so filing in federal court is an option that’s available to us, and we are committed to using every possible tool that we can to hold bad actors in this case, gatekeepers accountable.”
Grewal has also emphasized the importance of auditor independence. This has been a message that the SEC, mainly through Chief Accountant Paul Munter, has been sending to auditors in the past couple of years under Chair Gary Gensler’s leadership.
On the Prager Metis case, Grewal said that auditor independence is a bedrock principle that underpins the credibility of financial reporting.
“We take it seriously, and I know that there are so many people who work in this profession who do the right things every day, who put a tremendous amount of effort in to make sure they are getting independence right,” he said, “which is why it’s so important that we hold those auditors responsible when there are wholesale failures in this space.”
The SEC is seeking a permanent injunction, disgorgement plus prejudgment interest and a civil penalty against Prager Metis, which made headlines late last year as it was one of the two auditors of failed cryptocurrency exchange FTX founded by Sam Bankman-Fried.
In particular, Prager allegedly failed to comply with auditor independence rules in 62 audits, 11 examinations and 144 reviews under 87 engagement letters, according to the SEC’s complaint. Prager Metis has denied the SEC’s allegations, saying the firm “always acted in a way that was independent of our clients” and “intends to vigorously defend itself in this litigation.”
SEC Enforcement Scrutinizing Quality Control of Audit Firms
At the forum, Grewal sent another message to auditors: firms should have an effective system of quality control.
“Anytime we are looking at an auditor’s conduct when it comes to a particular engagement, we are also focused on the overall quality control environment at that firm and the effect that that environment has on the overall audit practice,” Grewal said.
He said that his remarks may prompt some law firms and accounting firms to write risk alerts or client memos. But he assured that the enforcement division is not going to start adding quality control violations to every enforcement matter that it brings.
“What it’s saying is that there’s going to be situations where there’s a strong system of quality controls, and that may … limit the scope of an enforcement action, counsel against action,” Grewal explained. “But there may be a system where there’s poor quality controls, and so that may expand our inquiry. But it will be a point of inquiry for us when we look at the quality control environment.”
Financial Reporting Cases
In the meantime, the SEC’s enforcement chief said that financial reporting frauds are an evergreen priority for the division.
He said the securities bar does a good job of analyzing every SEC enforcement cases and focusing on when the division is looking at, for example, non-GAAP measures or whether something is material qualitatively or quantitatively.
“The takeaway here should be all those considerations are valid, but sometimes we lose the forest from the trees that what we are really talking about is communications with investors. And whatever those communications that management is making are to investors, they need to be correct and complete,” Grewal said. “So that could be non-GAAP metrics; it could be KPIs [key performance indicators]; it could be the MD&A [management’s discussion and analysis]; it could be financial statements…. You shouldn’t have to really spend time distinguishing between whether something’s quantitatively material or qualitatively material…. So, it will be a continuing focus for us.”
This article originally appeared in the October 26, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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