Case 4-10
Independence Violations at PricewaterhouseCoopers
PricewaterhouseCoopers (PwC) was involved in a series of independence violations in the late 1990s and
early 2000s that resulted in strengthening the independence rules for auditors We discuss these situations in
two parts.
Part I
On January 6, 2000, the SEC made public the report by independent consultant Jess Fardella, who was
appointed by the commission in March 1999 to conduct a review of possible independence rule violations
by PwC arising from ownership of client-issued securities. The report found significant violations of the
firm’s, the profession’s, and the SEC’s auditor independence rules.
Background
On January 14, 1999, the commission issued an Opinion and Order Pursuant to Rule 102(e) of the
Commission’s Rules of Practice, In the Matter of PricewaterhouseCoopers LLP (Securities Exchange Act
of 1934, Release No. 40945) (“Order”), which censured PwC for violating auditor independence rules and
improper professional conduct. Pursuant to the settlement reached with the commission, PwC agreed to,
among other things, complete an internal review by Fardella to identify instances in which the firm’s
partners or professionals owned securities of public audit clients of PwC in contravention of applicable
rules and regulations concerning independence.
The independent consultant’s report discloses that a substantial number of PwC professionals,
particularly partners, had violations of the independence rules, and that many had multiple violations. The
review found excusable mistakes, but also attributed the violations to laxity and insensitivity to the
importance of independence compliance. According to Fardella’s report, PwC acknowledged that the
review disclosed widespread independence noncompliance that reflected serious structural and cultural
problems in the firm.
Results of the Independent Consultant’s Report
The report summarizes results of the internal review at PwC, which included two key parts: PwC
professionals were requested in March 1999 to self-report independence violations; and the independent
consultant randomly tested a sample of the responses for completeness and accuracy. The results are as
follows:
1. Almost half of the PwC partners—1,301 out of a total of 2,698—self-reported at least one independence
violation. The 1,301 partners who reported a violation reported an average of 5 violations; 153 partners
had more than 10 violations each. Of 8,064 reported violations, 81.3 percent were reported by partners
and 17.4 percent by managers; 45.2 percent of the violations were reported by partners who perform
services related to audits of financial statements.
2. Almost half of the reported violations involved direct investments by the PwC professional in securities,
mutual funds, bank accounts, or insurance products associated with a client. Almost 32 percent of
reported violations, or 2,565 instances, involved holdings of a client’s stock or stock options.
3. A total of 6 out of 11 partners at the senior management level who oversaw PwC’s independence
program self-reported violations. Each of the 12 regional partners who help administer PwC’s
independence program reported at least 1 violation; one reported 38 violations and another reported 34
violations.
4. In addition, 31of the 43 partners who comprise PwC’s Board of Partners and its U.S. Leadership
Committee self-reported at least 1 violation. Four of these had more than 20 violations; one of these
partners had 41 violations and another had 40 violations.
These random tests of the self-reporting process indicated that a far greater percentage of individuals had
independence violations than were reported. Despite clear warnings that the SEC was overseeing the selfreporting process, the random tests of those reports indicated that 77.5 percent of PwC partners failed to
self-report at least one independence violation. The combined results of the self-reporting and random tests
of those reports indicated that approximately 86.5 percent of PwC partners and 10.5 percent of all other
PwC professionals had independence violations.
The independent consultant’s report identifies key weaknesses in the systems PwC had used to prevent
or detect independence violations.
1. Reporting systems relied on the individuals themselves to sort through their own investments and
interests for violations.
2. Efforts to educate professionals about the independence rules and their responsibilities to the client to
comply with the rules were insufficient.
3. Resolution of reported violations was not adequately documented.
4. Reporting systems did not focus on the reporting of violations that were deemed to be resolved before
annual confirmations were submitted.
The consultant’s report concludes that the numbers of violations alone, as PwC acknowledged, reflect
serious structural and cultural problems that were rooted in both its legacy firms (Price Waterhouse and
Coopers & Lybrand). Although a large percentage of the reported and unreported violations is attributable
solely to the merger, an even larger portion is not; thus, the situation revealed by the internal investigation
is not a one-time breakdown explained solely by the merger. Nor can the magnitude of the reported and
unreported violations be attributed simply to less familiar independence rules such as those pertaining to
brokerage, bank, and sweep accounts. At least half of the reported and unreported violations consisted of
interests held by a reporting PwC professional himself or herself, and most of the violations arose from
either mutual fund or stock holdings. Independence compliance at PwC and its legacy firms was dependent
largely on individual initiative. This system failed, as PwC has acknowledged.
Changes Needed
As accounting firms have grown larger, acquired more clients, and provided more services, and as
investment opportunities and financial arrangements have increased in number and complexity, welldesigned and extensive controls are needed both to facilitate independence compliance and to discourage
and detect noncompliance. The violations discussed in the consultant’s report had come to light as a result
of a commission-ordered review after professional self-regulatory procedures failed to detect such
violations. As a result, the SEC requested the then-current Public Oversight Board (largely replaced by
PCAOB) to sponsor similar independent reviews at other firms and oversee development of enhancements
to quality control and other professional standards. The firm also agreed in a settlement to conduct the
review and create a $2.5 million education fund after the SEC alleged that some of its accountants
compromised their independence by owning stock in corporations they audited.
PwC promised at the time to take steps to ensure that it didn’t happen again. As a result of the inquiry,
five partners of the firm and a slightly larger number of other employees had been dismissed, and other
employees were disciplined but not fired.
Two changes that resulted from the problems at PwC were (1) to clearly define family members and
other close relatives of members of the attest engagement team that might create an independence
impairment for the auditors because of the formers’ ownership interests in a client and/or their position
within the client including having a financial reporting oversight role (Interpretation 101-1); and (2) to
restrict the ability of audit personnel from having loans to or from banks and other financial institution
clients (Interpretation 101-5).
