Step Up, Gatekeepers! The SEC is Calling on Auditors and Audit Committees

The Securities and Exchange Commission (“SEC”) has stepped up “Operation Broken Gate,” an enforcement effort originally begun in 2013 focused on auditors and audit committees.  The SEC sees external auditors and audit committee members as critical gatekeepers in the financial reporting process, each charged with the responsibility of fostering high quality, reliable, financial reporting.  In particular, external auditors are charged with making sure that registrants follow processes and procedures that are built on strength and integrity for the preparation and disclosure of financial information.  

SEC Chair Mary Jo White viewed “Operation Broken Gate” as a means of providing tighter oversight of those individuals it considers to be those gatekeepers.  In a speech, Ms. White said “…investors in our markets want to know that there is a strong cop on the beat, not just someone sitting in the station house waiting for a call, but patrolling the street and checking on things.  They want someone who understands that even the smallest infractions have victims.” 

With respect to external auditors, “Operation Broken Gate” looked at the quality of audits to identify auditors who missed, or ignored, red flags, did not have adequate documentation to support their conclusions and did not follow professional standards. Since the start of “Operation Broken Gate,” according to Andrew Ceresney, a director in the SEC’s Division of Enforcement, “the SEC has succeeded in significantly increasing the quality and number of financial reporting cases.”  Many of those have been brought against registrants’ auditors.  

Auditors need to assume that every material audit issue they encounter during their engagement will be subject to SEC scrutiny. Auditors need to be aware of the following missteps that could lead to trouble.  They include:

• Insufficient testing of potentially material issues;
• Failure to show skepticism; 
• Acceptance of management representations at face value;
• Failure to properly document audit procedures;
• Inappropriate supervision of audit staff;
• Ignoring, or inappropriately responding to, red flags.

Financial law experts say that auditors can mitigate certain liabilities by taking certain steps.  They include:

• Assess and address risks;
• Pay attention to internal controls;
• Be skeptical;
• Check and re-check for conflicts of interest;
• Keep good documentation;
• Address red flags.

Audit committee members also find themselves in the SEC’s crosshairs.  According to Mr. Ceresney, in the past the SEC had not brought many cases against audit committee members because the SEC felt they, in most cases, carried out their responsibilities and duties with appropriate precision.   Recently though, the SEC had brought some case against audit committee members  because “... the audit committee member approved public filings that they knew, were reckless in not knowing, or should have known, were false because of other information available to them.”  The bottom line here is that when an audit committee member becomes aware of information suggesting that the company’s filing are materially inaccurate, they must take action and review all the relevant facts and stop the company from filing reports until they are satisfied that the reports are accurate.