SEC’s Dropped Auditing Charges Shows Damage of Jarkesy Decision

The Securities and Exchange Commission’s recent decision to drop misconduct charges against a handful of auditors proves the SEC v. Jarkesy ruling threatens the agency’s ability to protect the investing public and to police auditors and public accounting firms that violate their duty of care.

The message from the US Supreme Court justices was clear: If you violate the law as an auditor, the SEC is limited in how it can hold you accountable. Yes, laws such as the Sarbanes-Oxley Act are still on the books setting standards for financial recordkeeping and reporting. And in an ideal world, auditors would follow the law without the threat of enforcement, and the need for sanctions, fines, and prohibitions on practicing before the SEC would be superfluous.

But if you look at the failings of BF Borgers this year and the parade of fines among the Big Four and other large accounting firms in the past few years, it’s clear we aren’t in an ideal world.

While the SEC can still bring civil charges against the most egregious offenders in federal court, many other lower-profile violations—such as failing to maintain independence or report material misstatements—may go uncharged and unpunished. This new era will make it harder to determine good audits from bad ones, because auditors that fail to properly follow auditing standards more likely will be able to keep auditing public clients (absent the SEC taking them to a jury trial).

Audit firms also will still be subject to inspections by the Public Company Accounting Oversight Board, but those will occur at the overall firm level and not at the individual audit partner or auditor level.

The result? Audit quality will suffer. Investors will suffer. And the profession’s reputation will suffer, as the lines between good and bad auditors will be less identifiable.

And yet, the auditors who are most likely to violate the law and regulations will benefit from the reduced enforcement. At a time when we should be putting more confidence into financial markets and institutions, Jarkesy opens the possibility that investors will have less information about auditors and less trust that regulators are able to hold bad actors accountable.

If investors lose confidence that auditors will act in the best interest of investors and not their own self-interest or the client’s financial interest, the audit opinion’s value and the value of our profession become essentially worthless. Jarkesy removed a major stick to encourage auditors to keep the interest of the public above all else.

Coupled with the decision in Loper Bright v. Raimondo, in which the US Supreme Court overturned the Chevron doctrine that required lower courts to defer to agencies’ reasonable interpretation of statutes, the larger assault on expertise and intellectualism points to a troubling trend.

Whether it’s the SEC’s ability to regulate financial statement fraud and auditor misconduct or the Environmental Protection Agency’s ability to regulate greenhouse gases, the Supreme Court has taken more of the rulemaking, rule interpretation, and rule enforcement away from experts and agency judges who are best-positioned to understand and apply them. Expertise and institutional knowledge have been devalued.

Many audit failures and financial statement frauds are complex and require a deep knowledge of accounting, auditing standards, financial reporting, and securities law. Pre-Jarkesy, the SEC’s expert in-house judges could address these complexities directly. Now, a judge or jury in a civil trial with no experience or expertise in these areas will be the ones making the final determination for civil actions. (Jury trials were already required in criminal complaints.)

Because institutional expertise has been removed from the equation, some auditors may see how far they can push the SEC without the agency holding them accountable in a civil jury trial. This would require the agency expend more resources in time and money than they had to with in-house judges.

The good auditors, which represent the overwhelming majority of those in the profession, will continue to follow the SEC’s rules and regulations with or without the threat of enforcement through in-house judges that existed prior to Jarkesy. These professional and ethical auditors would follow their relevant laws and regulations even if there were no enforcement provisions.

But the rare few auditors that are prone to cutting corners, that put their own financial interests above those of the public, or that fail to meet the minimum standards the profession demands, are now more likely to know the SEC is severely limited. And because of Jarkesy, they just might get away with it.

The case is SEC v. Jarkesy, 2024 BL 219548, U.S., 22-859., 6/27/24.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Jack Castonguay is a CPA, assistant professor of accounting at Hofstra University, and vice president of content development at KnowFully Learning Group.

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