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August 18, 2008

Ernst & Young US settles SEC independence hearing

Ernst & Young US (E&Y) has agreed to pay almost $3 million to settle Securities and Exchange Commission (SEC) proceedings over an independence issue. Two of the Big Four firm’s partners were also censured by the commission.

The settlement relates to what the SEC described as an independence-impairing relationship between E&Y and Mark Thompson. While Thompson served as a member of the board of directors of three of the Big Four firm’s audit clients, E&Y simultaneously collaborated with him in creating a series of audio CDs called The Ernst & Young Thought Leaders Series.

During the course of the relationship, E&Y paid Thompson compensation totalling $377,500. This sum, allegedly unknown to E&Y, comprised about half of Thompson’s net income at the time.

Despite the business relationship with Thompson, E&Y claimed to be independent in its audit reports for the three companies.

The two E&Y partners censured by the SEC were John Ferraro and Michael Lutze.

According to the SEC, Ferraro, the firm’s vice-chair for markets at the time, signed the agreement with Thompson to collaborate on the CDs despite knowing Thompson was a director in two companies that were E&Y audit clients.

“Notwithstanding this knowledge, Ferraro failed to seek, or perform, or otherwise obtain any auditor-independence assessment prior to executing the contract,” the SEC claimed.

Lutze was the co-ordinating partner for the audit engagement at one of the companies where Thompson served on the board. According to the SEC, Lutze discovered Thompson was serving on the board but took no follow-up action.

The SEC noted the remedial steps taken by E&Y since discovering the independence breach. “Since the conduct discussed in this order, E&Y has significantly improved its independence policies and procedures. E&Y has, among other things, established a new business-relationship evaluation process for review and evaluation of both existing and new business relationships,” the commission said.

E&Y agreed to pay disgorgement of $2,382,000 and prejudgment interest of $537,000 to the SEC.

Lutze was banned from appearing or practicing before the SEC as an accountant. He can apply for restatement after one year. Ferraro was ordered to cease and desist from causing any violations and any future violations of the Securities Exchange Act.

Commenting on the ruling, E&Y said: “We have revised our independence policies and procedures since this issue arose, which the SEC noted in its order. This settlement puts this matter behind us and we remain committed to taking every possible step to maintain our independence, which is the foundation of our audit work and our obligation to investors.”

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