Prosecutors and regulators investigating allegations of corporate fraud say they are ramping up their probes of auditors but trying to do so in a way that will not put accounting firms out of business.
Some prosecutors said the first line of attack against accounting firms will probably be civil rather than criminal because they do not want another Arthur Andersen LLP — the one-time accounting giant that collapsed after it was found guilty of obstructing justice.
The effort is based on the idea that with limited resources, it is sometimes more effective for regulators and prosecutors to go after the gatekeepers of the capital markets such as accountants, lawyers and investment bankers than to just pursue the corporations that committed the financial or securities fraud.
The strategy is reflected in the Securities and Exchange Commission’s plans to soon file a civil fraud complaint against KPMG for its failed audit of Xerox Corp. The SEC also is looking at PricewaterhouseCoopers in connection with allegations of massive fraud at Tyco International Ltd., sources said, although no charges have been brought against the accounting firm.
Yesterday the SEC settled a civil case against Phillip E. Harlow, a former senior Arthur Andersen accountant under fire for his work on behalf of Sunbeam Corp., which resulted in Harlow being barred for three years from practicing before the agency. The SEC said Harlow failed to follow accounting rules. Harlow’s attorney, Peter E. Fleming Jr., said his client did not admit wrongdoing as part of the settlement.
Accounting firms say privately they are concerned that they may be unfairly singled out because government officials are under pressure to get tough. They warn that an overreaction could damage the accounting firms, the profession and further depress U.S. stock prices.
When KPMG officials learned last week that the SEC was preparing to file civil fraud charges against the firm and its partners for their Xerox audits, chairman and chief executive Eugene D. O’Kelly issued a sharply worded statement.
“Unfortunately, today’s charged regulatory environment has resulted in inappropriate actions being taken,” Kelly said. “In this case, the result is a great injustice to KPMG and the four partners involved.”
PricewaterhouseCoopers spokesman Steven Silber declined to comment, except to say that the firm is cooperating with investigators.
Prosecutors and regulators say they aim to hold auditors more accountable for cooked books but will try to do so in a way that protects the firm from ruin. The SEC’s goal is not to run errant audit firms out of business, said one agency attorney, but instead to hold them to the fire when they misuse their reputation on behalf of a client.
Manhattan District Attorney Robert M. Morgenthau, whose office has brought charges against Tyco executives, said prosecutors cannot ignore accounting firms, especially in cases where it looks like “everybody is in on the act, the lawyers, the accountants, the board and the chief executive” and “there are no checks and balances.”
But he said that any criminal investigations would “be directed to the people who did the misdeed and not the whole firm except in extraordinary circumstances.” Morgenthau said that the nation’s biggest accounting firms have thousands of employees, most of whom have nothing to do with the scandals and could lose their livelihood if their employer were criminally prosecuted.
“We don’t want to swing at a bad auditing team and knock down 20,000 employees,” said James B. Comey, the U.S. attorney for Manhattan, whose office is handling numerous corporate fraud cases. But he added that federal prosecutors can’t absolutely rule out going after entire accounting firms. “It simply wouldn’t do if people running an entity were able to hold their employees hostage whenever prosecutors came near. . . . Sometimes we have to say, ‘this corporate culture is sick.’ ”
The Justice Department was bitterly criticized by Andersen employees last spring for bringing obstruction charges against the entire firm. The employees argued that if criminal charges were to be brought, they should have been directed against specific auditors who did work for Enron Corp. Arthur Andersen was ruined after the guilty verdict against the firm caused massive numbers of clients to flee.
Attorneys close to the Justice Department group that brought the case against Andersen defended the decisions to go after the entire firm, saying the criminal trial could have been avoided if Andersen had agreed to a settlement that would have satisfied the Justice Department. And in a speech last week, Justice Department criminal division chief Michael Chertoff said if firms do not cooperate with prosecutors and accept responsibility for failed audits, they still could face criminal charges.
In many cases, prosecutors say they are more comfortable having accounting firms face civil, instead of criminal, enforcement.
By seeking monetary penalties and court-mandated behavior changes, the SEC “can sometimes accomplish what we hope is accomplished by criminal prosecution without the collateral damage,” Comey said.
In the Sunbeam case, the SEC said it found that Harlow in some cases failed to root out improper accounting and other times backed down when Sunbeam’s management disagreed with his findings. Private securities attorneys said that the SEC often is more aggressive in pursuing auditors who find problems but don’t force companies to correct their financial records.
The SEC also yesterday announced that Robert J. Gluck, former Sunbeam controller, and former Sunbeam vice president Donald R. Uzzi, each agreed to pay fines of $100,000 to settle fraud charges. The settlement also bars Gluck from serving as an officer or director of any public company for five years and bars him from appearing before the SEC as an accountant for five years. Under the settlement, neither Gluck nor Uzzi admitted wrongdoing.
In a speech last month, Stephen M. Cutler, the SEC’s enforcement director, signaled that the agency would move more aggressively against auditors. “It is time to adopt a new enforcement model: one that holds an accounting firm responsible for the actions of its partners,” Cutler said.
SEC sources said that Cutler and others are revisiting a strategy fashioned by retired federal judge Stanley Sporkin when he headed the SEC enforcement division for seven years, until 1981. Because of the agency’s limited resources and heavy case load back then, Sporkin used a controversial enforcement strategy known as “access theory.”
It was based on the idea that large-scale securities fraud cannot happen without access to financial markets, which is controlled by investment bankers, accountants, lawyers and other professionals. By vigorously enforcing securities laws against these gatekeepers, the SEC could prevent more violations than by trying to attack every corporation engaged in fraud, according to this theory.
Sporkin said in an interview that he went after major accounting firms 18 times, sometimes barring the companies from taking on new clients for a month or more until they had brought in outside consultants to help clean up the business.
Under Sporkin, the SEC also brought action against numerous law firms, sparking complaints from lawyers that the agency had exceeded its authority. Accounting firms complained that the SEC was bullying them with scare tactics. Sporkin said the “access strategy” fell out of favor after he left the SEC until now.
Accounting industry executives say they understand regulators must investigate auditing, but that investigators have to understand that legitimate disputes do occur during audits.
“We hope every time the SEC reviews a matter that it won’t necessarily jump to the conclusion that the firm’s at fault or that there are systemic problems,” said Joel Allegretti, a spokesman for the American Institute of Certified Public Accountants, a professional lobby.
Allegretti added that the industry is now pushing to have those kinds of accounting probes done by a newly created accounting oversight board, not the SEC.
In a speech last month to the AICPA, Cutler said a “significant contributing factor” in the widespread corporate scandals “was the laxity” of many gatekeepers accountants, lawyers, research analysts and board members. He noted that accountants are legally required for a company to sell securities.
“Rather than lending their expertise to ensuring that a company’s financial statements accurately depicted its financial situation, auditors too often have been tools for achieving better or, more accurately, the appearance of better financial results,” he said.