On September 20, 2004, Stephen M. Cutler, the Director of the Division of Enforcement of the SEC, presented a speech in which he noted that the outside accounting firm is one of the four key gatekeepers. Cutler said the sentries to the marketplace are: the auditors who sign off on companies' financial data; the lawyers who advise companies on disclosure standards and other securities laws requirements; the research analysts who warn investors away from unsound companies; and the board of directors responsible for oversight of company management.

With respect to the auditors, Cutler acknowledged that in the past the SEC had focused only on individual auditors for deficient audits, but it now more regularly grapples with the question of firm responsibility for those audits. Here is an excerpt from his speech:

In August, for example, the Commission imposed a $1.5 million fine against the firm of Grant Thornton, in connection with the financial reporting failure at MCA Financial Corporation. In addition to the penalty, the Commission required Grant Thornton to invest in fraud-detection training for all of its auditors, the first time we have imposed such a sanction. And just a few months earlier, we obtained a $2.4 million penalty against PricewaterhouseCoopers for aiding and abetting the reporting violations of Warnaco. Earlier this year, we barred Ernst & Young from taking on new audit clients for six months for violating the auditor independence rules. And, as widely reported, we are currently litigating with KPMG in connection with what we believe to have been that firm's deficient audits of Xerox Corporation.
 
What good, you might ask, does it do to hold an entity responsible for securities law violations? After all, you might say, organizations don't commit crimes; people do. But actually, they both do. Securities law violations are very often the product of the corporate culture in which they arise. And enterprise liability can have a significant deterrent and preventive effect. Faced with the prospect of liability in Commission actions, it is our hope that accounting firms will take an even greater role in ensuring that individual auditors are properly discharging their special and critical gatekeeping role.
 
Now I want to be clear: We do not view firm liability as a substitute for individual accountability. Thus, we have also continued to be quite diligent about pursuing individual auditors. Most recently, the Commission barred from practice before it a PricewaterhouseCoopers engagement partner who, we alleged, failed to heed red flags during his audit of Anicom. We have also brought actions against individuals of other well-known firms who ignored evidence of fraud in issuing their audit opinions, including the two Ernst & Young audit partners who failed to detect that Cendant's financial statements did not meet GAAP, and the group of four KPMG partners, including the head of the firm's department of professional practice, that we have sued for their participation in Xerox's accounting scheme.

In addition to focusing on the gatekeepers and standards of proper professional behavior, the SEC has also focused on investigations of those who fail to adhere to those standards. Examples are the obstruction of justice charges levied against Arthur Andersen, as well as those leading to the convictions and jail terms for Frank Quattrone and Martha Stewart for obstructing SEC investigations. Not only is the SEC focusing on civil enforcement actions on companies such as Banc of America Securities, Halliburton and Deutsche Bank, but it has also focused on the accountant's tampering with records after having been put on notice of an SEC inquiry or investigation. The SEC filed an action against several Ernst & Young auditors based on allegations that they had altered work papers and destroyed other documents relating to their audit of NextCard. Even more recently, the SEC barred the accounting firm of Levine, Hughes & Mithuen, Inc. from public auditing for three years, in part because that firm had altered and destroyed some of its work papers after learning of an investigation relating to one of its audit clients.
 
This recent speech by Cutler is another example of how the landscape for financial professionals is changing. If anyone wants a complete copy of the speech, it is on the SEC Web site at www.SEC.gov/news/speech/spch092004smc.htm. It you have any particular questions, please do not hesitate to contact me at either hechtlawoffice@aol.com or www.securitiescounselors.com.

CHARLES HECHT has been a principal of his own law firm specializing in securities law since 1971. He was previously on the staff of the Division of Corporate Finance of the Securities and Exchange Commission at its headquarters in Washington, DC. Contact him at 212.490.3232 or visit www.securitiescounselors.com