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Bubble-Wrap Around Sealed Air’s Auditor Change—Punctured By SEC’s Blunt Tool

Aug. 25, 2021, 8:00 AM

It’s not disputed. Sealed Air Corporation’s replacement of KPMG with EY for its 2015 audit was corrupt.

The Securities and Exchange Commission so found. In proceedings dated Aug. 2, 2021 (here and here), the agency barred from practice and fined William Stiehl, the company CFO at the heart of the scheme, censured and fined EY $10 million, and imposed fines and practice bars on three of its partners (Paragraph 2):

“EY solicited and obtained from (Stiehl) competitive bid and other confidential documents and information on multiple occasions in an effort to secure the audit engagement.”

Alert to readers: This is not to question whether a selection of professional advisors should be tainted by the abuse of company confidences. It shouldn’t. This is not to defend or condone the conduct involved.

Instead, it is puzzling why the SEC should invoke its creaky, inefficient, and unpredictable rules for auditor independence (Paragraph 3):

“the manner in which EY obtained the engagement would cause a reasonable investor to conclude that EY was not capable of exercising objectivity and impartiality upon becoming (Sealed Air’s) independent auditor….”

The SEC approach was characterized as “weird” by a Bloomberg News columnist on Aug. 3, as he explored the unexceptional notion that auditors share common ground with lawyers, bankers, and other consultants:

“the actual service that these firms provide is basically ‘wise trusted advice,’ and to provide that service you really do need some relationship of personal trust.”

The columnist rightly notes that by opining on their clients’ financial statements, auditors bear a differentiating obligation from other advisors to public companies. Two observations address his perplexity:

First, consistency should matter. Both the misled but honest senior executives and directors of Sealed Air, and later the SEC alike, would have been no less insulted by a selection of lawyers, bankers, underwriters, or other advisors if perverted in the same way.

Second, which follows, the SEC had an available enforcement tool of broad and consistent application. Under its Rule of Practice 102(e)(1)(ii), it has authority to sanction any person in SEC practice, found “to be lacking in character or integrity or to have engaged in unethical or improper professional conduct.”

Full stop. Proceedings under that provision would lie, with analytic consistency, against professionals of any stripe. Putting them all on notice would spike whatever “weirdness” the columnist may find in Sealed Air.

On the flip side, the SEC’s lumbering invocation of the next provision of Rule 102)(e)—subsection (1)(iii)—goes astray, in its assumption that investors gave any importance to the Stiehl/EY machinations. Investor indifference to auditor performance in general is long-standing; the torpor is disturbed only if an outbreak of malfeasance is grave enough to animate the cry, “Where were the auditors?”

Which was not this case. On June 20, 2019, the company’s Form 8-K publicly announced Stiehl’s termination for cause, “relating to the process by which the company selected its independent audit firm for the period beginning with fiscal year 2015, and relating to the independence of that audit firm.”

So informed, the market reaction that day was a modest share price decline, from $43.67 to $41.70—just under $2 per share and less than 5% —on about four times typical volume.

Even that reaction was fleeting. By July 1—seven trading days later—the share price had recovered to $43.61—above which it stayed—while trading volume retreated to prior levels.

Put bluntly—the investor community, to whose interests the SEC is purportedly devoted, took a look for itself at the auditor environment at Sealed Air, yawned wearily, and returned to business as usual.

History provides another example—the Ventas affair of 2016. There, the SEC defined and applied the scope of Rule 102 to a “close personal and romantic relationship” between an audit partner and his client’s CFO—although, as discussed here, a senior agency official’s contemporaneous speech expressed the SEC’s lack of any appetite for rule-making to provide “bright lines and explicit guidance.”

As in Sealed Air, investor indifference to the audit turmoil at Ventas was reflected in its stock price: In the three-month period between the withdrawal of the incumbent auditor and the filing of an amended Form 10-K with the successor’s opinion, the company’s stock price increased by 3%.

In my youth, growing up in an agricultural village, I was schooled by mentors such as my grandfathers—a farmer and a country dentist—that a proper job requires the proper tools. For the SEC to deploy the elusive “principles” of independence in aid of its unhappiness is like weeding a field with a snow shovel, or using a spoon as a toothbrush—it could be tried, but the result would be sub-optimal in both theory and result.

It’s for fuller inquiry another time that the independence principles and rules for auditors—and their ill-formed and unloved offspring, the limitations on scope of practice for audit clients—have outlived whatever value they might once have had. Independence has no demonstrable upside; since the delivery by William Welch Deloitte of the first modern auditor’s opinion in February 1850, no companies, investors, or other sources of capital have aggrandized an auditor as an exemplar in observing the independence rules.

To the contrary, the elaborate machinery by which the “appearance of independence” is applied, regulated, and defended, becomes visible only with negative impact, in the inevitable and unpleasant handful of cases found non-compliant with hindsight.

Corporate reporting is under pressure to expand disclosures under the rubrics of environmental, social, and governance—lately extended to diversity, equity, and inclusion. Auditors will require expanded and diversified skills to offer meaningful and informative assurance. For which, the constraining influence of an archaic and obsolete independence structure is out of place at best.

In that context, the SEC’s awkward and unnecessary approach in the Sealed Air case is unfortunate.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Jim Peterson is a U.S. lawyer and a 19-year veteran of the in-house legal group of Arthur Andersen. His international practice concentrates on the accounting profession’s litigation and disputes, practice quality, and regulatory issues.

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