The California Board of Accountancy has sanctioned Ernst & Young over the firm's independence in its audit of former client PeopleSoft.

The CBA said that its action was based on an earlier order by the Securities and Exchange Commission, which sanctioned E&Y in April for not being independent in its audits of PeopleSoft's financial statements for fiscal years 1994 through 1999.

SEC Chief Administrative Law Judge Brenda P. Murray barred the Big Four firm from accepting new SEC audit clients for six months, and ordered it to disgorge $1.686 million in audit fees and prejudgment interest, and to hire an independent consultant to review the firm's independence policies and procedures.

The SEC said that E&Y's business relationships with PeopleSoft created a mutuality of interests, violating independence rules. In its order, the SEC said that E&Y was auditing PeopleSoft's books at the same time that the audit firm's international tax group had business relationships with PeopleSoft, including an application software partnership through which E&Y entered a licensing and distribution agreement with PeopleSoft. In addition, the SEC said that Ernst & Young was auditing PeopleSoft's books at the same time that its consulting group had an implementation partnership with PeopleSoft.

Effective Sept. 24, the CBA slapped E&Y with a 30-day stayed suspension and placed the firm's license on probation for three years. Under the CBA sanction, E&Y must comply with the SEC order, "fully communicate with the board or its designees concerning compliance," and hire a third-party reviewer to conduct a practice investigation and report to the board.

"The events that led to the sanction and the SEC sanction itself were violations of California law," said Greg Newington, chief of the CBA's enforcement division. "While the SEC focuses its activities on publicly traded companies, we have a responsibility to regulate the license. When people violate the law, we have a responsibility to discipline that license."

"From our perspective, [probation] means they're on a closer watch and will be monitored more closely than a license that's not on probation," Newington told WebCPA. "The [third-party reviewer] parallels the SEC order, but our intent is to focus that review on California audits and will include entities that go beyond publicly traded companies. That could include government audits, private companies or nonprofits. Our focus is to look at independence standards."

In addition, E&Y has to provide financial and other resources for the board to host an educational program of at least eight hours of continuing education on topics chosen by the board, which all of the firm's attest personnel licensed in California must attend. E&Y will also reimburse the board for up to $100,000 for investigation and prosecution costs.

In a letter to the board, E&Y said, "We wish to emphasize that no one, at the SEC or elsewhere, has ever challenged Ernst & Young's audit work for PeopleSoft or contended that any of the PeopleSoft financial statements upon which Ernst & Young reported were materially misstated."

The letter also noted that the firm sold its consulting practice to Cap Gemini in 2000. "That spin-off serves to eliminate concern over any repetition of the PeopleSoft situation," E&Y said in the letter. The firm also noted that, since 2000, it has instituted "substantive and significant" improvements and changes to its independence standards and system of controls."

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