Accountant Liability in the Accountant Liability in the Current Regulatory Environment:Current Regulatory Environment:Risk Control Is a Full Time Job!Risk Control Is a Full Time Job!

THOMAS P. VARTANIANTHOMAS P. VARTANIANFRIED, FRANK, HARRIS, SHRIVER & JACOBSON LLPFRIED, FRANK, HARRIS, SHRIVER & JACOBSON LLP

WASHINGTON, DCWASHINGTON, DCvartath@ffhsj.comvartath@ffhsj.com

Risk ExposuresRisk Exposuresg Criminal Liability

– Sarbanes –Oxley Provisionsg High Risk Areas

– Derivatives – FAS 133– Earnings Management– Independence/Conflicts of Interest– Risk Management– Off Balance Sheet Items– Mortgage Accounting – FAS 91– Reserves– Certifications– Client Fraud

Risk ExposuresRisk Exposures

gRegulatory Risks– Securities Laws & Regulations (SEC)– Public Company Accounting Oversight

Board (PCAOB)– Banking Laws & Regulations (OCC, OTS,

FDIC, FRB)

The SarbanesThe Sarbanes--Oxley EnvironmentOxley Environment

g “This law says to corporate accountants: the high standards of your profession will be enforced without exception; the auditors will be audited; the accountants will be held to account.”

gThe Act is designed to “deter and punish corporate and accounting fraud and corruption, ensure justice for wrongdoers, and protect the interests of workers and shareholders.”

- President George W. Bush

Criminal LiabilityCriminal LiabilitygArthur Andersen Prosecution/ConvictiongSupreme Court: Jury Instructions Incorrect

– Covered Innocent ConductgDocument Retention Policies

– Common Business Practice– Retention Policies Are Document Retirement

PoliciesgConsciousness of Wrongdoing Required

Criminal LiabilityCriminal LiabilitygSection 802 / 18 USC 1519

– Knowing Destruction, Alteration, Concealment or Falsification of Records, Documents or Tangible Objects

– Intent to Impede, Obstruct or Influence an Investigation or Proper Administration of Any Matter by Agency or in Relation or Contemplation of Such Matter

– 20 Years Incarceration

Criminal LiabilityCriminal LiabilitygSec. 804: Increases Statute of Limitations for

Securities Fraud to Earlier of:– 2 Years From Discovery.– 5 Years After the Violations.

gSec. 805: New Sentencing Guidelines.– Need to Be Harsher for White Collar Criminals

gSec. 807: New Penalties for Knowingly Defrauding Shareholders.

Criminal LiabilityCriminal LiabilitygSec. 903, 904: New Penalties for Mail Fraud, Wire

FraudgSec. 906: False Certifications

– Knowing• 10 Years

– Willful• 20 Years

Criminal LiabilityCriminal Liabilityg18 U.S.C. 1517

– Obstruction of an ExaminationgWhat are Attempts at Obstruction?

– Delaying Tactics.– Screening Tactics.– Alteration of Records.– Removal of Records.– Bad-faith Assertions of Privilege.– Misleading Company Counsel or Audit Committee.– Attacks on Examiners’ Credibility.

Criminal LiabilityCriminal LiabilitygSection 1102/18 USC 1512

– Corruptly –• Alters, Destroys, Mutilates or Conceals• With Intent to Impair the Object’s Integrity• Use in an Official Proceeding• Otherwise Obstructs, Influences or Impedes

Any Official Proceeding– 20 Years

Criminal LiabilityCriminal Liability

White Collar White Collar FraudFraud-No Criminal History

-Single Count of Securities Fraud

-20 Years in Prison

Armed RobberyArmed Robbery-No Criminal History:

-5 - 6 Years

-Two-Time Felon:

-7 - 9 Years

-Career Offender:

-15 - 20 Years

Securities LawsSecurities Lawsg SEC Rules of Practice 102(e):

– Provides for Censure, Suspension, or Debarment, for Unethical or Improper Professional Conduct.

g Securities Act of 1933 Sec. 8A & Securities Exchange Act of 1934 Sec. 21C:– Authority to Bring an Action Against Parties that Cause Another to Violate

Securities Laws.g Sarbanes-Oxley Act of 2002

– Imposes New Obligations Aimed at Encouraging Corporate Responsibility, Enhancing Financial Disclosures, Combat Corporate and Accounting Fraud.

– Creates the PCAOB.

Powers of the RegulatorsPowers of the Regulators

YESYESYESImpose Sanctions

FDIC--Civil Suit for Damages

YESNOYESDemand Client Records

YESNO(Must Seek SEC

Subpoena)

YESSubpoena Accounting Materials/Testimony

YESYESYESDemand Accounting Materials

Banking Banking AgenciesAgencies

PCAOBPCAOBSECSEC

Sanctions Available to the RegulatorsSanctions Available to the Regulators

YESYESYESRequire Corrective Measures

YESYESYESCensure

YESYESYESCMP/Restitution

YESYESYESDebarment, Suspension etc

YESYESYESC&D

Banking Agencies

PCAOBSEC

Bank Regulatory AgenciesBank Regulatory Agencies

g12 U.S.C. 1813(u)(1)– Provides Jurisdiction Over Accountants Employed By the

Companyg12 U.S.C. 1813(u)(4)

– Provides Jurisdiction Over Independent Contractors Who Act Knowing or Recklessly.

gConduct:– Violation of Law or Regulation.– Engage in Unsafe or Unsound Practices.– Breach of Fiduciary Duty.

Bank Regulatory AgenciesBank Regulatory Agencies

g12 U.S.C. 1831m– Removal, Suspension, or Debarment From Performing

Audit Services.– For “Good Cause”.

gWho is covered?– Independent Public Accountants– Accounting Firms

Bank Regulatory AgenciesBank Regulatory AgenciesgWhat Constitutes “Good Cause” for Debarment?

– Lack of Requisite Qualifications.– Knowing or Reckless Conduct that Violates Professional

Standards, Including SEC or PCAOB Standards.– Unreasonable Conduct.– Providing False or Misleading Information to Regulators.– Violation of Banking or Securities Laws, or Sarbanes-

Oxley.– Other Disciplinary Action by Federal or State

Authorities.

Bank Regulatory AgenciesBank Regulatory Agenciesg New Interagency Guidelines Proposed by OCC, OTS, FRB, FDIC, and NCUA

(May 10, 2005).– Limitation on Liability Provisions.– Auditor Independence.– Alternative Dispute Resolution.

g A response to Keystone and Superior.– Keystone: Regulators Alleged That the Auditors’ Lack of Independence, Lack

of Professional Skepticism, and Tendency to Advocate for the Bank Caused it to Neglect Key Audit Processes and Red Flags of Wrongdoing.

– Superior: Outside Auditor Attempted to Limit Its Liability by Requiring Alternative Dispute Resolution and Liability Limiting Provisions in Its Engagement Agreements.

Independent Auditor Focus in Post-Sarbanes-Oxley Era

gAudit Committee Responsibility for Audit Relationship.

gNothing Less Than Absolute Independence.

gIntegrity and Professionalism Over Cost-Effectiveness.

Regulatory Red Flags Regarding Internal Audit Functions

gManagement Does Not Implement Procedures to Remedy Internal Control Deficiencies.

gManagement Suspends the Internal Audit Function.gManagement Has Dual Operations Responsibilities.g Internal Auditor Reports to Management Instead of the Board

or Audit Committee.

Case StudiesCase Studies

gGoldstein & Morris, CPAs, P.C. (PCAOB – May 24, 2005)– Partners Attempted to Conceal Improper Accounting

Methods Used in Public Audits.– Partner-in-Charge and the Firm were Debarred.

Case StudiesCase StudiesU. S. v. Thomas C. Trauger, CPA (2003)

gFormer Partner With an Outside Auditor, While Auditing NextCard, Inc., Altered or Destroyed Documents to Impede an Investigation.

gArrested by FBI for Obstruction of SEC and OCC.gPled Guilty, Sentenced to 12 Months Imprisonment, $5,000

Fine, and 2 Years Supervised Release. gSignificance: One of the First Cases of an Auditor Pleading

Guilty to Destroying Key Documents in an Effort to Obstruct a Federal Investigation.

Case StudiesCase StudiesIn Re Grant Thornton, OCC-AA-EC-2004-02/03 (November 2004)

g OCC Alleged That Grant Thornton Was Engaged to Conduct an Audit of FNB of Keystone.

g In 1999 Grant Thornton Issued an Unqualified Audit Opinion of Keystone’s 1998 Financial Statements.

g Regulators Later Discovered that the Financial Statements Were Overstated by Nearly $500 Million.

g OCC Alleged That Grant Thornton:– Failed to Comply With the Requirements of GAAS and GAAP.– Exhibited Reckless Unsafe and Unsound Practices.– Ignored Professional Standards of Independence and Professional Skepticism.

g OCC is Seeking Fines and Corrective Measures.g Decision Expected Summer 2005.g Significance: Bank Regulator Proceeding Against an Entire Firm.

Avoiding Problem ClientsAvoiding Problem ClientsgPre-Engagement Considerations

– Client’s Regulatory History.– Independence and Professional Skepticism.– Dealing With the Regulators.– Auditing v. Consulting.

gWell-developed Acceptance and Retention Policies.gContents of Engagement and Retention Policies.gMaintaining Independence in Fact and Appearance.gOn-going Engagement Evaluation.