On Wednesday, February 8, 2012, the Public Company Accounting Oversight Board ("PCAOB") announced that it had settled a proceeding with Ernst & Young LLP ("E&Y"). PCAOB censured the accounting firm and imposed a $2 million penalty upon it, which was the largest civil money penalty ever imposed by the agency. In addition, four of its current and former partners were sanctioned for violating PCAOB rules and standards.
E&Y conducted audits of the financial statements of Medicis Pharmaceutical Corporation ("Medicis") for the periods ending December, 31, 2005, 2006 and 2007. E&Y allegedly failed to properly evaluate Medicis’ sales return reserve, which was a material component of the company’s financial statements. According to PCAOB, for all three years, E&Y and its partners failed to comply with PCAOB standards in evaluating Medicis’s practice (including: reserving most of its estimated product returns at the cost of replacing the product, instead of at gross sales price; failing to sufficiently audit key assumptions; and placing undue reliance on management’s representation that those assumptions were reasonable). Moreover, during an internal audit quality review of the audit of the 2005 financial statements, E&Y personnel identified the error, but wrongly decided in an internal consultation that another flawed accounting rationale supported the company’s practice. In 2008, when PCAOB Division of Registration and Inspections staff examined E&Y’s acceptance the audits in 2008, the accounting firm ultimately concluded that Medicis’ reserving for its sales returns was not in conformity with U.S. generally accepted accounting principles ("GAAP").
The accounting firm, three partners and one former partner agreed to resolve the proceeding with PCAOB without admitting or denying the findings. The firm was censured and required to pay at $2 million penalty. All four individuals were also censured, three of them will pay civil money penalties ranging from $25,000 to $50,000 and two of them were barred from associating with a PCAOB-registered accounting firm for periods of time of one and two years.
PCAOB Chairman James R. Doty noted that E&Y "failed to fulfill their bedrock responsibility." He stressed that "[t]he auditor’s job is to exercise professional skepticism in evaluating a public company’s accounting and in conducting its audit to ensure that investors receive reliable information, which did not happen in this case."