SEC Sanctions Auditor, Should Make Small Issuers Think Twice

by Brooks Pierce

The SEC brought a settled administrative action against an auditor on October 24th.  Often I’ll take a case like this and write something about it to warn other auditors (or investment advisers or broker-dealers, or whomever) from similar behavior.  But you know what?  No.  It’s too dumb.


Here’s the relevant law:  Section 10A(j) of the Exchange Act says: “It shall be unlawful for a registered public accounting firm to provide audit services to an issuer if the lead . . . audit partner . . . has performed audit services for that issuer in each of the 5 previous fiscal years of that issuer.”  And Rule 2-01(c)(6) of Regulation S-X says: . . . an accountant is not independent of an audit client when: (A) Any audit partner … performs: (1) The services of a lead partner …. or concurring partner . . . for more than five consecutive years.”


According to the SEC’s administrative order, Elliot Berman and his audit firm Berman & Company did not pay close attention to these five-year rotation rules.  Instead, Elliot served as the lead partner for the mysteriously identified “Issuer A” for five years, from 2006 through 2010, and came up with a neat trick for 2011.  When he should have rotated off, he appointed a Berman & Co. employee as the nominal lead partner for Issuer A’s 2011 audit.  Unfortunately, this employee:

  • was not a certified public accountant;
  • had never been a CPA;
  • had no experience auditing public companies;
  • had very little experience auditing private companies;
  • did not have the requisite understanding of PCAOB audit standards to perform a public company audit; and
  • was not otherwise qualified to be the lead partner of a public company audit.

Meanwhile, according to the order, Elliot continued to serve as the primary contact with Issuer A’s management, board of directors, and the board’s audit committee.  Elliot presented certain matters related to the audit to Issuer A’s audit committee, and communicated with management on substantive audit issues.  He was the sole contact with the engagement quality review partner for the 2011 Issuer A audit.  Elliot also reviewed and commented on the company’s 2011 Form 10-K, reviewed the audit work papers for some of the 2011 quarterly reviews and left comments for the audit team, made staffing decisions concerning the engagement, directed staff regarding audit documentation, and performed the audit work regarding the company’s discontinued operations.

Anyway, that was the alleged plan – turn over the nominal reins to this employee while Elliot retained control over the audit, and the business relationship with Issuer A.  I think it’s safe to say that no amount of continuing education or professional reading (maybe not even erudite blog posts!) will fix the will to engage in this sort of jiggery-pokery.  Maybe a one-year suspension from practicing before the Commission and a $15,000 civil penalty will do the trick instead.

Issuers in Similar Situations

But the issuer should be another matter.  The order tells us precious little about it.  All it says is, “Issuer A, a Delaware corporation, is a biotech company. Issuer A’s stock is registered pursuant to Section 12(b) of the Exchange Act.”  That could mean almost anything.  Regardless, Issuer A should consider whether the professional services firms it hires – auditors, lawyers, tax advisers, etc. – are up to the task.

I don’t think it’s crazy to think that a firm whose logo misspells “consultants” might cut some corners in other areas.  The order assumes Issuer A’s violations of Section 13(a) of the Exchange Act and Rule 13a-1, so some clear trouble already looms on the horizon.  Be sure your professionals have your back and are equipped to do the work they say they will.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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