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December 30, 2015 Practice Points

Recent SEC Enforcement Actions Reinforce Focus on Independence Violations

The SEC’s enforcement actions reiterate its ongoing focus both on audit failures and on conduct that jeopardizes the independence of audits.

By James W. Thomas Jr., Arthur Luk, and Lindsay Vance Smith

The SEC recently suspended two accounting firms and five accountants associated with those firms from practicing before the Securities Exchange Commission (SEC). According to the SEC’s orders instituting settled administrative proceedings, the firms and accountants, which consented to the orders without admitting or denying the SEC’s findings, violated or caused violations of federal securities laws and engaged in improper professional conduct because they performed deficient audits and sub-standard engagement quality reviews (EQRs), backdated and falsified audit documentation, and violated the SEC’s rules requiring independence of audit firms and PCAOB standards regarding EQRs. These actions reiterate the SEC’s ongoing focus on independence and confirm that audit firms should continue to closely analyze potential conflicts that could compromise the independence of their audits.

The enforcement actions involve two Florida-based accounting firms and their affiliated partners: Messineo & Co., a small firm that is majority owned by Peter Messineo, that merged briefly in 2012 with DKM Certified Public Accountants, Inc., another small firm owned in part by Charles Klein.

Before the merger, Messineo served as the CFO of two companies (identified in the orders as Issuer A and Issuer B) who were clients of DKM. Messineo also owned stock in the companies. Although Messineo resigned as CFO of the companies prior to the merger, both companies later retained DKM to conduct audits of their businesses for the time during which Messineo was CFO. The SEC found that Messineo “caused DKM not to be independent” because as “a partner and shareholder of DKM—[he] was the [former] CFO of Issuer A and Issuer B during the audit period and in a position to influence DKM’s audit and interim reviews.” Order at 14, In the Matter of Messineo, SEC Administrative Proceeding No. 3-16993 (Dec. 10, 2015). As a result, the SEC concluded that Messineo’s conduct violated Regulation S-X Rule 20-1(c)(2) concerning independence with respect to employment relationships.

The SEC found that Messineo and his firm further violated the independence rules by allowing an employee of Messineo & Co., Richard Confessore, to perform EQRs of audits conducted by DKM for Issuer A and Issuer B during the period Messineo was still CFO of those companies. OrderIn the Matter of Richard Confessore, CPA, SEC Administrative Proceeding No. 3-16995; see also PCAOB Auditing Standard No. 7, Engagement Quality Review at ¶ 2 (explaining that the objective of an engagement quality reviewer “is to perform an evaluation of the significant judgments made by the engagement team and the related conclusions reached in forming the overall conclusion on the engagement”) and ¶ 6 (“The engagement quality reviewer must be independent of the company, perform the engagement quality review with integrity, and maintain objectivity in performing the review.”). In addition, Messineo supervised Confessore in performing an audit of another company, Issuer C, for the time period that Confessore had served as CFO of that company. The SEC also found two other Messineo employees engaged in improper professional conduct in violation of SEC Rule 102(e): (1) Joseph Mohr, who (a) falsely held himself out as a CPA despite having failed to renew his registration, and (b) backdated records of EQRs at the request of (2) firm senior accountant Robin Bigalke.

The SEC permanently barred Messineo and his firm from appearing or practicing before the SEC, and it suspended Mohr, Bigalke, and Confessore from appearing or practicing before the SEC for at least four, three, and two years, respectively.

Furthermore, the SEC found that Charles Klein, the DKM engagement partner for the audits of Issuer A and Issuer B, caused DKM to not be independent of Issuers A and B because of (i) Confessore’s employment by Messineo, (ii) Messineo’s role as the issuers’ CFO during the audit periods, and (iii) Klein’s knowledge that Messineo owned stock in the issuers. The SEC suspended DKM and Klein for at least two years.

The SEC’s enforcement actions reiterate its ongoing focus both on audit failures and on conduct that jeopardizes the independence of audits. Attorneys counseling firms auditing public companies should continue to advise rigorous attention to PCAOB standards and SEC independence rules, by, for example, ensuring the timely conduct of EQRs and adherence to restrictions on holding financial interests in audit clients to avoid conflicts that might give rise to similar enforcement actions. As these recent actions emphasize, closely held audit firms in smaller markets and their relationships with clients pose risks of impairing independence, particularly where there is lateral movement of partners between firms. In such situations, firms should analyze not only the current financial interest of new partners but also prior positions to avoid potential or apparent conflicts that might otherwise compromise the independence of the firm and subject the firm to SEC sanctions.

Keywords: professional services liability litigation, SEC, accounting, auditing, independence

— James W. Thomas Jr., Arthur Luk, and Lindsay Vance Smith, Arnold & Porter LLP, Washington, D.C.

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