Ernst & Young has agreed to pay $8.5 million to the Securities and Exchange Commission after the firm and six of its former and current partners were charged with playing a role in accounting fraud at Bally Total Fitness Holding Corp.
Among the partners charged was Randy Fletchall, a former chairman of the American Institute of CPAs. He and the other partners have also agreed to settle with the SEC, without admitting or denying wrongdoing. The SEC said that E&Y knew or should have known about Ballys fraudulent financial accounting and disclosures.
It is deeply disconcerting that partners, even at the highest levels of E&Y, failed to fulfill their basic obligations to the investing public by not conducting proper audits, said Robert Khuzami, director of the SEC's Division of Enforcement, in a statement. This case is a sharp reminder to outside auditors that they must carry out their duties with due diligence. The $8.5 million settlement, one of the highest ever paid by an accounting firm, reflects the seriousness of their misconduct.
"These settlements allow us and several of our partners to put this matter behind us and resolve issues that arose more than five years ago, said E&Y in a statement.
The firm issued unqualified audit opinions on Ballys 2001 to 2003 financial statements, but the SEC said those opinions were false and misleading. Bally's former CFO John W. Dwyer and former controller Theodore P. Noncek also were charged by the SEC, which had previously charged the company with accounting fraud in February 2008. Dwyer and Noncek agreed to settle the SECs charges.
The firm had identified Bally as a risky audit because its managers were former E&Y audit partners who had historically been aggressive in selecting accounting principles and determining estimates," and whose compensation plans placed undue emphasis on reported earnings. Out of more than 10,000 audit clients in North America, E&Y identified Bally as one of E&Ys riskiest 18 accounts and as the riskiest account in the Lake Michigan Area.
The SEC said when it charged Bally last year that from at least 1997 through 2003, Bally's financial statements were affected by more than two dozen accounting improprieties, which caused Bally to overstate its originally reported year-end 2001 stockholders equity by nearly $1.8 billion, or more than 340 percent. The health club also understated its originally reported 2002 net loss by $92.4 million, or 9341 percent; and understated its originally reported 2003 net loss by $90.8 million, or 845 percent.
Each of the E&Y partners has settled the SEC's charges against them. The three current E&Y partners charged are Randy G. Fletchall, partner-in-charge of E&Y's national office and 2007-2008 AICPA chairman; Mark V. Sever, E&Ys national director of area professional practice; and Kenneth W. Peterson, the professional practice director for the Lake Michigan Area office. The three former E&Y partners charged are Thomas D. Vogelsinger, the area managing partner for E&Ys Lake Michigan Area through October 2003; William J. Carpenter, the E&Y engagement partner for the 2003 audit; and John M. Kiss, the E&Y engagement partner for the 2001 and 2002 audits.
The SEC issued settled cease-and-desist and Rule 102(e) orders finding, among other things, that E&Y partners Sever, Kiss, Peterson and Carpenter knew or should have known that E&Ys unqualified audit opinions regarding certain Bally financial statements were materially false. Under their respective orders, Sever and Kiss may not appear or practice before the SEC as accountants for three years, and Peterson and Carpenter may not appear or practice before the commission as accountants for two years.
In addition, the SEC issued Rule 102(e) orders against Vogelsinger for engaging in repeated instances of unreasonable conduct and Fletchall for engaging in a single instance of highly unreasonable conduct. Under their respective orders, Vogelsinger may not appear or practice before the commission as an accountant for nine months, and Fletchall was censured.
The SEC said that during a 25-minute consultation, Sever, Peterson and Carpenter had requested Fletchall's approval for E&Y to issue a "preferability letter" concerning Bally's change from recognizing revenue from health club membership reactivations on an accrual basis to recognizing the reactivation revenue on a cash basis. His initial reaction had been that going from an accrual basis to a cash basis seemed a little strange, but he approved the issuance of the letter.
The SEC also filed settled civil injunctive actions against former Bally CFO Dwyer and former Bally controller Noncek. Dwyer settled the case against him by consenting to permanent antifraud and related injunctions, payment of $250,000, a permanent officer-and-director bar, and a permanent bar from practice before the SEC in a related Rule 102(e) proceeding. Noncek settled the case against him by consenting to permanent injunctions and a two-year bar from practice before the SEC in a related Rule 102(e) proceeding. The settlements with Dwyer and Noncek are subject to court approval.
In addition to agreeing to pay $8.5 million to settle the SEC's charges, E&Y agreed to undertake measures to correct policies and practices relating to its violations, and agreed to cease and desist from violations of the securities laws. Each of the respondents and defendants agreed to settle with the SEC without admitting or denying the charges against them.
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