Ernst & Young LLP received the usual kid-glove treatment given to too-big-to-fail enterprises when it reached a settlement with the U.S. Justice Department over illegal tax shelters it sold more than a decade ago. The government chose not to prosecute the Big Four accounting firm, and Ernst is getting off by writing a relatively small check.
The $123 million that Ernst must pay is equivalent to the fees it charged for the tax shelters in question. About 200 Ernst clients used the shelters to try to avoid more than $2 billion in taxes. The firm doesn’t even have to pay interest on the ill-gotten proceeds, under the deal revealed last week.
Two Ernst tax specialists were sentenced to prison, while two others had their convictions reversed last year on appeal. Ernst was required to admit that some of its personnel engaged in criminal wrongdoing. All in all, the firm came out fine. The public had forgotten about the investigation years ago.
Yet there was one area where Ernst made out beyond all reason: A veritable love letter at the bottom of the statement of facts that Ernst and the U.S. Attorney’s Office for the Southern District of New York agreed to as part of their accord. It said: “The wrongdoing in this case by a small group of professionals at E&Y represented a deviation from the more than 100-year history of ethical and professional conduct by E&Y and its partners.”
To which one can only respond: What? I asked Julie Bolcer, a spokeswoman for the U.S. attorney, what the factual basis was for the statement. She declined to comment. Amy Call Well, an Ernst spokeswoman, declined to answer the same question.
The best way to show the sentence’s problems is with a timeline. My space is limited. So rather than cover 100 years, I decided to go as far back as the merger between Arthur Young & Co. and Ernst & Whinney that created Ernst & Young in 1989. The firm has been in trouble over ethical violations and professional misconduct on a regular basis ever since. To wit:
-- The Securities and Exchange Commission barred Ernst from accepting new public-company audit work in the New York region for 45 days, after accusing it of professional misconduct during its audits a decade earlier at Norwalk, Connecticut-based U.S. Surgical Corp.
-- The SEC sued Ernst over auditor-independence violations, after finding that RepublicBank Corp., an audit client, lent millions of dollars to the firm’s partners and to tax-shelter, real-estate partnerships in which they invested. The case was settled in 1995. A judge ordered Ernst to comply with the SEC’s independence rules.
-- Ernst paid $400 million to resolve government claims related to the 1980s savings-and-loan crisis.
-- Ernst paid $335 million to settle investor lawsuits over its certifications of fraudulent financial statements at Cendant Corp. The SEC later suspended two Ernst partners, saying they aided the company’s securities-law violations.
-- Documents in an Arkansas court case showed that Ernst and other Big Four accounting firms had routinely overbilled clients for travel expenses by charging them full fare for airline tickets while pocketing large rebates they had negotiated in volume-discount contracts with carriers. Ernst reached an $18 million class-action settlement and said it stopped the practice.
-- Former Ernst partner Thomas Trauger was arrested on charges of obstructing government investigations. He later pleaded guilty and was sentenced to a year in prison for destroying documents related to the firm’s audits of NextCard Inc., a credit-card issuer. Two other former Ernst auditors entered guilty pleas in related cases.
-- Richard Bobrow, Ernst’s global chief executive, left the firm after his attempts to conceal his wealth during divorce proceedings backfired. The partnership’s innermost financial details were disclosed after the New York Times asked a judge to make the records public. Bobrow was in the job for about a year.
-- Sprint Corp. replaced Ernst as its auditor after the Internal Revenue Service began reviewing tax shelters the firm sold to top Sprint executives, who were forced out by the company’s board earlier that year.
-- The SEC barred Ernst from accepting new public-company audit clients for six months over auditor-independence violations, after uncovering a revenue-sharing agreement Ernst had with PeopleSoft Inc. when it was the company’s auditor.
-- Ernst agreed to pay $125 million to settle banking regulators’ claims over its audits of Hinsdale, Illinois-based Superior Bank FSB, which collapsed in 2001.
-- Ernst was censured by the SEC and paid $1.6 million to settle the agency’s claims of professional misconduct and auditor-independence violations related to its audit work for PNC Financial Services Group Inc.
-- The SEC censured Ernst and two partners for professional misconduct over a business relationship between the firm and a director on the boards of three Ernst audit clients, including Best Buy Co. Ernst paid $2.9 million to settle the SEC’s claims of auditor-independence violations.
-- A jury convicted former Ernst attorney and partner James Gansman on six felony counts of tipping his girlfriend about acquisition targets of Ernst clients. Gansman was sentenced to a year in prison.
-- Ernst paid $109 million to settle investor lawsuits over its audits for HealthSouth Corp., which disclosed a huge accounting fraud in 2003.
-- The SEC fined Ernst $8.5 million and disciplined six partners, including the former head of Ernst’s national office, for professional misconduct in approving fraudulent financial statements at Bally Total Fitness Holding Corp.
-- The Public Company Accounting Oversight Board censured Ernst audit manager Jacqueline Higgins for “improper removal, addition, and backdating of audit documentation prior to a board inspection.”
-- The accounting oversight board censured Ernst and fined the firm $2 million for auditing-standard violations at Medicis Pharmaceutical Corp. Four Ernst auditors also were sanctioned.
-- The Senate Permanent Subcommittee on Investigations released a report that criticized Ernst’s tax advice for audit client Hewlett-Packard Co., saying it was clear that some H-P transactions approved by Ernst had been done in an attempt to circumvent U.S. tax laws.
-- The SEC suspended Ernst auditor Wendy McNeeley for professional misconduct during the 2004 audit of AA Capital Partners Inc.
Aside from those episodes (and a bunch of others I left out, such as the firm’s see-no-evil audits for Lehman Brothers Holdings Inc.), it surely is accurate to say that most of Ernst’s thousands of employees usually act ethically and professionally. It’s also true that the Justice Department was wrong to make the sweeping generalization that it did on Ernst’s behalf. The firm has so many well-known blemishes on its record that this couldn’t have been an oversight of ignorance.
It would be nice to believe the prosecutors were on the public’s side here. Unfortunately it seems they were more concerned about protecting Ernst than they were anyone else.
(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)
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