The SEC separately has initiated litigation against Joshua Abrahams, Mattel’s former lead engagement partner, who resigned from PwC in 2019, “to determine whether he engaged in improper professional conduct and violated auditor independence rules,” the SEC said.

According to the SEC’s order, Mattel understated the tax-related valuation allowance for the third quarter of 2017 by $109 million and overstated the tax expense for the fourth quarter of 2017 by the same amount. As a result, Mattel’s third quarter and fourth quarter 2017 net loss and net loss per share were understated by 15 percent and overstated by 63 percent, respectively.

Mattel had been alerted to the alleged material misstatements in August 2019, when Mattel disclosed in a Form 8-K that it was made aware of an anonymous whistleblower letter alleging accounting errors and questioning Abrahams’s independence. An investigation by the audit committee concluded that there were material misstatements, according to the SEC order. “The audit committee also concluded (as did PwC in its own investigation) that Abrahams violated auditor independence rules,” the SEC order stated.

The SEC’s order further found that, at the time, Mattel had no internal control specifically related to calculating a valuation allowance. Until Mattel’s November 2019 restatement, the $109 million tax expense error remained uncorrected, and the lack of internal control for financial reporting related to the error remained undisclosed, according to the order. Neither Mattel’s CEO nor its audit committee were allegedly informed of the expense error.

The SEC’s order against Mattel, which neither admitted nor denied the findings, found the company violated the negligence-based antifraud provisions and the reporting, books and records, and internal controls provisions of the securities laws. In determining to accept Mattel’s settlement offer, the SEC said it considered the company’s cooperation with the investigation and its remediation measures.

‘Failure to Maintain Independence’

The SEC’s order against Abrahams alleges he violated “numerous professional standards” in the third quarter 2017 interim review and the 2017 annual audit of Mattel’s financial statements. According to the order, Abrahams failed to verify that the uncorrected $109 million error was documented, “despite knowing of it,” the SEC said. He also allegedly “failed to communicate the error to Mattel’s audit committee,” the SEC stated.

The order further alleged “Abrahams failed to maintain independence by providing prohibited human resource advice to Mattel, including suggesting to Mattel’s then-CFO which candidate would be the best fit for a senior position at the company, as well as who should not be hired.”

“An auditor’s adherence to professional standards and independence is critical to preserving investors’ trust in a company’s financial statements,” said Alka Patel, Associate Director of the SEC’s Los Angeles Regional Office. “Auditors who advise their clients on who to hire will have an interest in the success of such hires and could therefore be less critical of their effectiveness, all of which undermines the auditor’s independence.”

A public hearing before the Commission will be scheduled to decide if the Enforcement Division has proven the allegations in the order and what, if any, remedial actions are appropriate. 

Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.

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The Public Company Accounting Oversight Board inspects and investigates public accounting firms in more than 50 jurisdictions around the world, consistent with its mandate under the Sarbanes-Oxley Act. But for more than a decade, positions taken by authorities in the People’s Republic of China (PRC) have obstructed the PCAOB’s access to completely inspect and investigate registered public accounting firms in mainland China and Hong Kong.

The PCAOB received a leg up in 2020, when Congress passed the Holding Foreign Companies Accountable Act (HFCAA), which called on the Securities and Exchange Commission to ban trading of U.S.-listed securities of China-based companies if obstacles to PCAOB access persist. “The U.S. Congress sent a strong message with the passage of the [HFCAA] that access to the U.S. capital markets is a privilege, not a right,” stated PCAOB Chair Erica Williams. “The PCAOB has been working to execute our mandate under the law.”

As part of this ongoing effort, the PCAOB signed a “Statement of Protocol” with the China Securities Regulatory Commission and the Ministry of Finance of the People’s Republic of China this week. “On paper, the agreement…grants the PCAOB complete access to the audit work papers, audit personnel, and other information we need to inspect and investigate any firm we choose, with no loopholes and no exceptions—but the real test will be whether the words agreed to on paper translate into complete access in practice,” Williams said.

According to the PCAOB, the Statement of Protocol grants the PCAOB complete access in the following three important ways:

• The PCAOB has sole discretion to select the firms, audit engagements and potential violations it inspects and investigates—without consultation with, nor input from, Chinese authorities.
• Procedures are in place for PCAOB inspectors and investigators to view complete audit work papers with all information included and for the PCAOB to retain information as needed.
• The PCAOB has direct access to interview and take testimony from all personnel associated with the audits the PCAOB inspects or investigates.

Last year, the PCAOB said it determined the positions taken by PRC authorities prevented it from inspecting and investigating in mainland China and Hong Kong completely. The PCAOB must now reassess its determinations by the end of 2022. The PCAOB inspection team has been directed to finalize their preparations to be on the ground by mid-September to “put this agreement to the test,” Williams said.

“Our dedicated teams of professionals have been preparing for this moment for months, and they are ready to work swiftly, but thoroughly, to carry out our inspections and investigations,” Williams added. “Whether our teams are able to complete that work without obstruction will inform the PCAOB’s determinations at the end of this year.” 

Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.

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The SEC also charged EY with withholding evidence of this misconduct from the SEC’s Enforcement Division during its investigation of the cheating scandal.

EY admitted that, over multiple years, “a significant number of EY audit professionals cheated on the ethics component of CPA exams and various continuing professional education courses required to maintain CPA licenses, including ones designed to ensure that accountants can properly evaluate whether clients’ financial statements comply with Generally Accepted Accounting Principles,” the SEC stated.

An EY spokesperson told NPR that EY was taking extensive actions to address the cheating scandal. “At EY, nothing is more important than our integrity and our ethics. These core values are at the forefront of everything we do,” Brendan Mullin, a spokesperson for Ernst & Young, said in an email to NPR. “Our response to this unacceptable past behavior has been thorough, extensive, and effective.”

EY further admitted that it made a submission conveying to the Enforcement Division that it didn’t have issues with cheating “when, in fact, the firm had been informed of potential cheating on a CPA ethics exam,” the SEC stated. EY further admitted it didn’t correct its submission even after beginning an internal investigation.

Nor did EY cooperate in the SEC’s investigation regarding its materially misleading submission, the SEC stated. “It’s simply outrageous that the very professionals responsible for catching cheating by clients cheated on ethics exams of all things, and it’s equally shocking that Ernst & Young hindered our investigation of this misconduct,” stated SEC Enforcement Division Director Gurbir Grewal. “This action should serve as a clear message that the SEC will not tolerate integrity failures by independent auditors who choose the easier wrong over the harder right.”

Remediation Requirements
In addition to paying a $100 million penalty, EY must retain two separate independent consultants to help remediate its deficiencies. “One consultant will review the firm’s policies and procedures relating to ethics and integrity,” the SEC stated. “The other will review EY’s conduct regarding its disclosure failures, including whether any EY employees contributed to the firm’s failure to correct its misleading submission.”

The SEC order also found EY “violated a Public Company Accounting Oversight Board (PCAOB) rule requiring the firm to maintain integrity in the performance of a professional service, committed acts discreditable to the accounting profession, and failed to maintain an appropriate system of quality control.” 

PHOTO: Creative Commons Attribution-ShareAlike 4.0 International License (CC BY-SA 4.0)

Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.

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