SEC Discusses Auditor Independence, Cooperation Credit, And Crypto – Securities

On June 9-10, 2022, Arnold & Porter co-sponsored and
co-chaired the American Law Institute’s Accountants’
Liability Conference in Washington, DC. The event kicked off with
Arnold & Porter Partner Paul Fishman sitting down for a
“fireside” chat with SEC Enforcement Director Gurbir
Grewal and Acting Chief Accountant Paul Munter to discuss emerging
issues related to accountants’ liability. The conference also
featured discussions with PCAOB Director of the Division of
Registration and Inspections, George Botic, and a faculty of
high-ranking government officials, general counsel from
international firms, and seasoned outside counsel and forensic
experts. The following are several high-level takeaways from the
conference.

Comments by SEC Enforcement Director Grewal and
Acting Chief Accountant Munter. Echoing a statement issued one
day prior to the conference, Acting Chief Accountant Munter and
Director Grewal emphasized the importance of auditor independence
under Rule 2-01(b) of Regulation S-X. According to Rule 2-01(b),
auditors must be independent in fact and in appearance, as measured
by “a reasonable investor with knowledge of all relevant facts
and circumstances.” The rule also includes a non-exclusive
list of circumstancesparagraphs (c)(1) through (c)(5)
that the Commission finds inconsistent with independence
requirements. Acting Chief Accountant Munter cautioned auditing
firms and issuers, however, against viewing Rule 2-01 and auditor
independence with a checklist mentality. The circumstances listed
under Rule 2-01(c) are necessary but not sufficient to achieve
auditor independence under Rule 2-01(b).

Director Grewal and Chief Accountant Munter also reaffirmed the
Commission’s intent to pursue auditing firms and issuers for
accounting improprieties. In a recent settlement, the Commission
charged an auditing firm and three of the firm’s partners with
improper professional conduct related to two clients, imposed a
$1.9 million penalty against the firm, and imposed bars against two
partners while censuring the national office partner. The SEC cited
the firm’s deficient quality control system and repeated
failures to exercise due professional care at all levels, from the
engagement team up through the firm’s national office, not only
allowed but were a cause of the clients’ disclosure violations.
Director Grewal and Chief Accountant Munter echoed the comments
from Melissa Hodgman, Associate Director in the Division of
Enforcement, at the time the settlement was announced:
“Auditors are critical gatekeepers that must employ a robust
system of quality control to ensure faithful adherence to
professional standards.” In another recent settlement, this
time with Synchronoss, the SEC
used all available sanctions and remedies to claw back $1.3 million
in stock sale profits and bonuses from the company’s founder
and former CEO, despite bringing no misconduct charges against him.
In a press release discussing the matter, Director Grewal stated
that the Synchronoss case should “put public company
executives on notice that even when they are not charged with
having a role in the misconduct at issue, we will still pursue
clawbacks of compensation.”

Finally, Director Grewal and Chief Accountant Munter expressed
concern over the technology and regulatory risks presented by
digital assets. The Commission has issued guidance, Staff Accounting Bulletin
No. 121, on accounting for obligations to safeguard
crypto-assets an entity holds for its platform users. The
Commission issued SAB No. 121 because digital assets present unique
legal questions that do not exist in other custodial relationships.
And for Acting Chief Accountant Munter, these kinds of risks
manifest as an accounting liability that should be on the balance
sheet and measured at fair value of the digital asset safeguarded.
Given the difficulty with identifying a digital asset, the
SEC’s Division of Corporation Finance and Strategic Hub for
Innovation and Financial Technology are offering consultations to
identify whether assets held by trading platforms qualify as
digital assets. The Commission intends to ensure that all digital
offerings, products, and platforms fall within the SEC’s remit
and follow the agency’s rules.

SEC Enforcement Priorities and Trends According to
SEC Staff. When responding to an SEC request or
subpoena, the SEC staff recommend responding quickly and completely
so that a determination may be made efficiently. It is an animating
principle of the Commission to enhance public trust in financial
institutions, regulators, and markets by moving cases forward
quickly. The SEC may tailor remedies, such as imposing a lesser
penalty or no penalty at all, as a result of a firm’s
cooperation or remediation throughout the investigative process.
The staff clarified, however, that cooperation does not mean merely
complying with a subpoena. Instead, cooperation may include
self-reporting workpapers that may be otherwise difficult for the
SEC to detect, providing an analysis to the SEC that would be
otherwise time consuming for the agency to conduct, or providing
documents outside the scope or date range of a subpoena relevant to
an investigation.

The staff also recommend conducting remediation throughout the
SEC’s investigative process. A firm’s ability to isolate
and address a problem may lower an SEC sanction. Moreover, updating
or revising a firm’s policies, procedures, or controls is not a
form of admission, according to the staff. However, slowing or
preventing an SEC investigation will deter the staff from
maintaining an open mind or applying a cooperation or remediation
credit to an audit firm’s sanction. According to Director
Grewal, the staff has seen defense counsel slow the investigative
process by coaching witnesses, threatening SEC attorneys, slow
rolling document production, and inappropriately asserting
privilege.

The PCAOB Inspection Program. In 2022,
the PCAOB’s inspection focus remains COVID-19. The PCAOB is
examining how auditing firms navigate a hybrid workforce, increased
costs and inflation, the Great Resignation, and SPAC and De-SPAC
transactions. In addition, the PCAOB has deployed a team of ten
individuals to perform “targeted inspections” of emerging
issues, such as C-suite commitments to carbon neutrality and
delivery centers for excellence. Targeted inspections are random
and follow a risk-based selection approach. In May, the Office of
the Chief Auditor published an updated standard-setting
agenda, including near and mid-term projects related to quality
control, attestation standards, and fraud.

Conclusion

The SEC and PCAOB’s enforcement priorities are rapidly
shifting in response to emerging issues within the US audit
profession. These priorities reveal a period of increased
compliance enforcement against issuers and firms. Market
participants should take notice of the shift in approach, including
external messaging related to auditor independence, cooperation and
remediation credits, and crypto-assets, and take proactive steps to
ensure compliance with the federal securities laws.

Arnold & Porter is continuing to monitor and report on key
enforcement and regulatory developments at the SEC and PCAOB. In
the meantime, please reach out to any author of this Advisory or
your regular Arnold & Porter contact with any questions.

*Trevor Kirby contributed to this Advisory.

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