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Corporate Governance

: The Race to the Bottom

Director Independence and SEC Enforcement (Part 1)

By J. Robert Brown

The other day, the Commission brought an action against Ernst & Young for violating accountant independent standards.  According to the administrative proceeding, E&Y was paying for services from Mark C. Thompson at the same time Thompson sat on the board of three public companies where E&Y conducted audits (two listed on the NYSE, one on Nasdaq) and, in one case, a a company's audit committee.   According to the WSJ:

• Mr. Thompson began as a director at Best Buy, the Minneapolis-based consumer-electronics retailer, in March 2000, and sat on its audit committee until August 2003. Best Buy secured his resignation in May 2004, after E&Y informed the company about its relationship with Mr. Thompson.

• Mr. Thompson was a director at Korn/Ferry, an executive-search firm based in Los Angeles, from March 2000 until September 2003, and a director of TeleTech Holdings Inc., a Denver technology-consulting firm, from February 2004 until May 2004. Of the three, only Korn/Ferry is still an E&Y client.

As settlement of the case, E&Y among other things had to pay disgorgement of $2,381,965 and prejudgment interest of $537,022.79.

The most interesting thing about the case, however, was that the Commission also charged Thompson.  In a separately settled administrative proceeding, the Commission found that Thompson in filling out his annual D&O questionnaire "did not fully furnish the details of his relationship with E&Y in response to these items."  In addition, as a director, he participated in votes to retain E&Y as outside auditor but, at the time of the vote, "did not disclose his business relationship with E&Y, and the proxy solicitations likewise did not disclose the relationship."   In other words, Thompson, according to the Commission, did not make adequate disclosure of his relationship to E&Y to the companies where he sat as director. 

So what was the charge against Thompson since non-disclosure to a board doesn't per se violate the securities laws?  The Commission concluded that the companies violated the proxy rules and the periodic reporting requirements by filing financial statements from non-independent audit reports and "by recommending E&Y?s retention as auditor without disclosing that one of the directors favoring the recommendation had a business relationship with E&Y."  Thompson was required to disclose $100,662.33 and prejudgment interest of $23,254.94, for a total of $123,917.27.  

This is a ground breaking case and we will offer some observations on it in a post later today.

Full post as published by The Race to the Bottom on August 11, 2008 (boomark / email).