By Bill Carlino

New York — Ernst & Young won’t appeal a six-month suspension from accepting new public clients and a $1.7 million fine after a Securities and Exchange Commission judge ruled that the Big Four firm violated independence rules with former audit client PeopleSoft.

On April 16, administrative law judge Brenda Murray barred the global firm from signing on new SEC clients for half a year and ordered that an outside consultant monitor the firm’s compliance progress.

“While we are surprised and disappointed by the harsh sanctions, we accept them,” the firm said in a statement. “The foundation of our profession depends on our independence and the objectivity of our auditors and advisors. We are committed to delivering quality in everything we do and this requires that our people never compromise their independence or objectivity, in perception or reality.”

The ban officially began on April 26.

The ruling, which centered on E&Y’s relationship with Pleasanton, Calif.-based software provider PeopleSoft, charged that the auditor engaged in a software licensing joint venture with the client, while at the same time serving as the company’s outside auditor from 1995 to 1999.

Ernst’s consulting division — which has since been sold to European consulting giant CapGemini — reaped about $500 million from PeopleSoft product installations to other companies during that four-year period.

In a 69-page ruling, Murray stated that “the evidence shows EY has an utter disdain for the commission’s rules and regulations on auditors’ independence.”

She went on to note that “the persuasive evidence in this record is that EY is neither implementing, nor does it have in place, policies and procedures that can reasonably be expected to ensure compliance with independence rules in business dealings with audit clients.”

“You don’t get a decision like that unless you clearly did something wrong,” said Lynn Turner, former chief accountant at the SEC and now a managing director at proxy researcher Glass Lewis & Co. “But I give them kudos for the fact they won’t appeal it — they’ll take their medicine and move on.”
The SEC prohibits auditors from engaging in business partnerships with their clients. Ernst, however, argued that it was, in essence, a customer of PeopleSoft, an argument that the judge rejected.

The E&Y-PeopleSoft independence issue occurred back when accounting firms did not reveal revenues generated from non-audit services, and consulting had become the true profit center for what was then the Big Six.

That new business model prompted the SEC, under former Chairman Arthur Levitt, to draft stricter auditor independence rules, a bitterly fought campaign that found the commission outgunned by a powerful accounting lobby that included a host of politicians and many of the larger accounting firms.

Eventually, a more diluted set of rules — prior to the 2002 passage of Sarbanes-Oxley — was adopted in November 2000.

Judge Murray’s opinion included a model that highlighted the exponential growth of E&Y’s consulting revenues, which rose from $775 million in 1994 to $2.5 billion by 1999.

Currently, Deloitte & Touche remains the lone Big Four firm to retain its consulting arm.

The six-month suspension of Ernst & Young equals one meted out nearly 30 years ago to Peat Marwick — which eventually became KPMG — for its failure to properly audit several companies, including the Penn Central railroad.

The judge also ordered that the independent consultant report in writing to the SEC the findings of its review six months after it begins work.

The ruling, however, doesn’t prevent the firm from accepting new private audit clients or accepting re-appointments via shareholder proxies. It also doesn’t mandate that the firm pay back the $500 million in fees that it earned from the PeopleSoft installations.

“This proxy season should be interesting,” said Turner. “My gut feeling tells me that the level of non-audit fees is going to come down. I think you’ll see a drop in the number of audit committees buying non-audit services.”

The public client ban was the latest in a roster of recent setbacks for the Big Four firm.

Last year, E&Y paid $15 million to the Internal Revenue Service to settle a dispute over the marketing of tax shelters. It also remains the focus of both SEC and Justice Department probes over a profit-sharing agreement with American Express Co., and a controversial rebate program with two major air carriers is currently in litigation.

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