SEC Drops Auditor Misconduct Cases After In-House Judges Ruling

The SEC has dropped misconduct charges against at least eight auditors in the wake of a recent Supreme Court ruling that limited the regulator’s use of its in-house courts.

The accountants had faced Securities and Exchange Commission charges of shoddy audit work that failed to catch in some cases misstatements, even fraud. They faced suspensions or permanent bars from working as accountants before the regulator, an onerous penalty that can end careers.

Among the cases the regulator tossed out in August was an action against a Marcum LLP audit partner who is suing the SEC challenging its administrative enforcement process. The SEC also dismissed a case against a former audit partner at PwC, also known as PricewaterhouseCoopers. The commission said the former partner had failed to document and report a $109 million error in toymaker Mattel’s financial statements.

The SEC declined to comment on the reason for the dismissals, but securities lawyers say the regulator is taking stock of how the high court’s June SEC v. Jarkesy decision could alter which cases to pursue before its in-house judges. In the ruling, the Supreme Court found that defendants accused of securities fraud, like former hedge fund manager George Jarkesy, have the right to a jury trial when the SEC seeks financial penalties.

Bars and suspensions could be considered punitive under the Jarkesy decision, said Richard Hong, a former SEC trial attorney and partner with Morrison Cohen LLP.

“The SEC might be concerned that Jarkesy can be read broadly to cover those things,” Hong said.

The ruling’s impact was expected to reach beyond the US securities regulator to administrative courts at agencies throughout the federal government. But even without any additional legal challenges, the decision has quietly altered the SEC enforcement landscape.

The commission’s sweep of the auditor misconduct charges could quash a powerful tool the regulator has long relied on to police accountants and lawyers accused of improper conduct including violations of SEC rules or professional standards.

Fighting the SEC

The stakes are high for those facing disciplinary actions that range from suspensions lasting several years to permanent bars from appearing before the commission.

Ira Viener plans to steer clear of auditing and stick to providing his clients with tax and financial consulting services after his brush with the SEC that “upset my entire life,” he said. The regulator accused the New Jersey accountant with not being independent of his client for preparing the same financial statements he was hired to audit, among other violations.

“I pride myself on being very honest and doing business on a handshake,” Viener said. “Keeping my reputation is more important than anything else.”

Attorneys for Edward Hackert, the Marcum partner, declined to comment on his dismissed disciplinary case but stood by the constitutional arguments laid out in his suit against the commission. Hackert in February sought to block the SEC’s administrative proceeding against him, saying that its in-house process violates his right to a jury trial.

Other auditors whose cases were dismissed did not respond to requests for comment.

The tossed cases included one in which accountants issued clean audit opinions despite signs of revenue fraud at biotech company MiMedx Group Inc. and another that involved undisclosed related party transactions at grocer iFresh Inc.

Hackert’s suit compounds the litigation risks posed by the Supreme Court ruling in Jarkesy and staff may have decided to drop the cases rather than risk losing again in court, said Christina Zaroulis Milnor, a partner with Mincey Bell Milnor and a former SEC attorney specializing in administrative cases.

History of In-House Scrutiny

The SEC has increasingly filed securities law violations in federal district courts amid questions over the constitutionality of its administrative court. But unlike most other enforcement cases, the regulator must use its in-house review to seek professional suspensions and bars.

The commission for decades had the ability to seek suspensions and bars, in addition to censures, for gatekeepers like accountants under a rule called 102(e). Congress added the measure to US securities laws in 2002 as part of a corporate governance and accounting reform law known as the Sarbanes Oxley Act.

Jarkesy successfully argued that he was due his day in court, and so accountants also could prevail under a similar argument that a jury trial is required, Milnor said.

SEC “staff is probably really thinking about the consequences of Jarkesy and trying to be strategic,” Milnor said. “And that might mean that they’re going to go pencils down with a lot of administrative activity.”

The commission similarly scratched active cases from its enforcement docket last year after discovering that its enforcement staff had access to records meant for its in-house adjudication employees, leading to 42 dropped cases.

Still this doesn’t mean the end of the SEC’s administrative options, Hong said. “It is severely impaired, but I don’t think it’s dead.”