Herbert M. Chain
Shareholder, Mayer Hoffman McCann P.C, Deputy Technical Director, Global Audit Group, Kreston Global
Herbert M. Chain is a highly experienced auditor and a financial expert with over 45 years of experience in business, accounting, and audit, having served as a Senior Audit Partner at Deloitte. He holds certifications from the National Association of Corporate Directors and the Private Directors Association, with knowledge of private company governance and effective risk management. He has extensive knowledge in the financial services sector, including asset management and insurance. Herbert sits on MHM’s Attest Methodology Group and is the Deputy Technical Director of the Kreston Global Audit Group.
Enforcement actions and the quality imperative in auditing
May 13, 2024
Lessons from recent SEC Sanctions on US Audit firm
The past 12 months have seen a notable uptick in SEC and PCAOB enforcement actions against audit firms, their personnel, and their networks. As if to put an exclamation point to this statement, in May 2024, the SEC took a sledgehammer to a firm that audited a significant number of smaller and medium-sized registrants and those in the registration process. While this was clearly an egregious breach of professional responsibilities, and the actions related solely to the public company practice of the firm, there are important considerations for firms as they attempt to differentiate themselves from competitors.
What is the enforcement action about?
On May 3, 2024, the SEC announced settled enforcement proceedings against audit firm BF Borgers CPA PC (Borgers) and its owner, Benjamin F. Borgers, charging them with deliberate and systemic failures to comply with PCAOB standards in their audits of approximately 350 public companies and broker-dealers, which were incorporated in more than 2,000 SEC filings from January 2021 through June 2023 (the Order).[1]
The SEC imposed severe penalties, including a $12 million civil penalty against the firm and a $2 million civil penalty against its owner, in addition to permanent suspensions against both parties from appearing and practising as accountants before the agency, effective immediately. Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, noted that “… Borgers and his sham audit mill have been permanently shut down.” (emphasis added)
What are the charges?
The SEC found that BF Borgers failed to perform its audit and review engagements in accordance with PCAOB auditing standards, including by failing to adequately supervise the engagements, failing to obtain engagement quality reviews in connection with the engagements, failing to prepare and maintain sufficient audit documentation, and fabricating certain audit documentation.
Specifically, the SEC found that at Benjamin Borgers’s direction, Borgers’ staff simply “rolled forward” work papers from previous engagements, changing only the relevant dates, and passed them off as work papers for current period engagements. These work papers documented engagement planning meetings that did not occur and falsely represented that Benjamin Borgers and a separate engagement quality reviewer had reviewed and approved the work.
Additionally, the SEC found that electronic “sign-offs” on the firm’s engagement workpapers that were attributed to the engagement partner, engagement quality reviewer, and staff auditor were in fact all applied by a single staff person within seconds of one another, using usernames provided by Benjamin Borgers himself.
Finally, Borgers did not have the required engagement quality review (EQR) on approximately 75% of the SEC filings (annual and quarterly filings, registration statements, registered broker-dealer filings, and OTC company annual reports), failing to have an EQR performed in 1,625 out of 2175 filings, in violation of PCAOB standards.[2]
How are Borgers’ clients affected?
Because Borgers has been denied the privilege of appearing or practising before the SEC, issuers that have engaged Borgers to audit or review financial information to be included in any Exchange Act filings to be made on or after the date of the Order (May 3, 2024) will need to engage a new qualified, independent, PCAOB-registered public accountant. Additionally, broker-dealers, investment advisers subject to the custody rule, and even private companies that engaged Borgers as their independent auditor will presumably need to find a replacement auditor.[3]
Each impacted registrant will need to file Form 8-K with the SEC when BF Borgers resigns or is dismissed. Issuers that are currently in the registration process will need to file a pre-effective amendment with a new auditor before their registration statements can be declared effective.
Finding a replacement auditor may be difficult due to reputation spillovers from being associated with the firm and a possible classification as a “higher-risk audit”. Additionally, there will be higher audit costs (including potential reaudits of prior periods), a “cost of switching” and disruption, and timing issues if SEC filings are required in a short time frame.
What are the key takeaways?
Bad actors taint the profession, networks and firms … and the clients they serve.
Networks and firms must thus differentiate themselves from other networks and firms by their commitment to quality throughout their organisation. While the Borgers matter is an egregious example, there is no doubt that clients will carefully scrutinise whom they engage to be their auditors and will ask the tough questions on a firm’s system of quality management: how it is designed, implemented and operating. Their culture of quality will be assessed. Boards and audit committees will wonder, and rightfully ask, “Could this happen to us based on our auditor selection?”. Their choice sends signals to stakeholders and the public.[4]
Now, more than ever, the audit industry must be associated with quality and consistency of service. Our stakeholders and clients demand it…and will increasingly require attention to quality and the assurance it brings them that a quality firm (and network) has effectively performed the audit. Their reputation is also on the line.
[1] The SEC’s order can be found here. It should be noted that the SEC’s order focused only on the firm’s public company audit and review engagements and did not address the firm’s work for private companies.
[2] PCAOB Auditing Standard 1220: Engagement Quality Review
[3] The SEC Division of Corporate Finance and Office of the Chief Accountant issued a “Staff Statement on Issuer Disclosure and Reporting Obligations in Light of Rule 102(e) Order against BF Borgers CPA PC” on May 3, 2024. It can be found here.
[4] Signaling theory suggests that firms and individuals send signals to the market to convey information about their quality or trustworthiness. In this case, being associated with a sanctioned auditor like Borgers sends a negative signal to investors and potential auditors, suggesting potential financial risks.
