Ernst & Young has agreed to pay more than $11.8 million to settle charges that it failed to detect an extensive accounting fraud at Weatherford International even though it had classified the oil services firm as a high-risk client.
The U.S. Securities and Exchange Commission on Tuesday accused EY of a “significant audit failure,” saying auditors ignored red flags as Weatherford accumulated a “phantom” $461 million income tax receivable between 2007 and 2010 by overstating net income and understating its effective tax rate.
Despite Weatherford’s reputation as “a particularly risky and difficult client” and “known deficiencies” in its controls over income taxes, EY accepted the client’s unsupported explanations for post-closing accounting adjustments, the SEC said in an administrative order.
EY’s payment of $9 million in disgorgement, $1,840,107 in interest, and a $1 million penalty will add to the $140 million settlement to which Weatherford agreed . The SEC also censured Craig Fronckiewicz, the EY partner who coordinated the audits, and Sarah Adams, a former tax partner who was part of the audit engagement team.
“Audit and national office professionals must appropriately address known deficiencies in their auditing of high-risk areas, and auditors must have the fortitude to refuse to sign off on an audit if important issues remain unresolved,” Andrew Ceresney, director of the SEC’s Division of Enforcement, said in a news release. “Ernst & Young failed to ensure that material post-closing accounting adjustments were justified by appropriate audit evidence, leading to a significant audit failure.”
Weatherford became a client of EY’s Southwest Region in 2001. According to the SEC, the firm concluded by 2004 that Weatherford posed a “significant risk,” citing, among other things, its “domineering CEO,” “acquisitive nature,” and history of completing significant or unusual transactions at quarter-end or year-end.
As a result, the energy company was designated for “close monitoring,” the highest-risk category that EY recognized, but it was not until February 2011 that the engagement team performed an additional review and discovered the phantom $461 million receivable.
“By failing to comply with PCAOB standards, [EY was] a cause of Weatherford’s issuance of materially false and misleading financial statements,” the SEC said.