The Securities and Exchange Commission has settled an $8.5 million enforcement action with Big 4 audit firm Ernst & Young, with charges reaching into the highest levels of the firm’s audit practice.

The SEC charged Ernst & Young, three current partners and three former partners with issuing false and misleading audit opinions for Bally Total Fitness, headquartered in Chicago, from 2001 through 2003. The SEC said the partners failed to exercise appropriate professional skepticism when presented with a plan by Bally to accelerate revenue related to reactivating expired customer memberships to Bally’s fitness centers.

Randy Fletchall, partner in charge of E&Y’s national office, was censured by the SEC. Mark Sever, national director of area professional practice, and Kenneth Peterson, an area professional practice director, also were disciplined. Sever may not appear before the Commission for three years and Sever is barred for two years.

Former E&Y partners also charged by the SEC include Thomas Vogelsinger, who was an area managing partner through October 2003, William Carpenter, who was Bally’s engagement partner for the 2003 audit, and John M. Kiss, engagement partner for the 2001 and 2002 audits.

The action also included charges against Bally’s former CFO John Dwyer and former controller Theodore Noncek. The SEC previously settled charges of accounting fraud with Bally in 2008.

Robert Khuzami, director of the SEC’s enforcement division, said in a statement the $8.5 million settlement is one of the highest ever paid by an accounting firm, reflecting the seriousness of the event in the eyes of the Commission. “This case is a sharp reminder to outside auditors that they must carry out their duties with due diligence,” he said. The case predates the formation of the Public Company Accounting Oversight Board, which now investigates audit failures as part of its mandate under the Sarbanes-Oxley Act of 2002.

E&Y had no comment on whether the three partners still employed by the firm face any internal disciplinary actions. “These settlements allow us and our partners to put this matter behind us and resolve issues that arose more than five years ago,” the firm said in a brief prepared statement.

The SEC said E&Y identified Bally as one of its riskiest audit clients because its managers were former E&Y audit partners known for aggressiveness in setting of accounting principles and estimates and because the company’s compensation plan placed heavy emphasis on reported earnings. The SEC said of E&Y’s 10,000 audit clients in North America, Bally was in the top 18 riskiest accounts and the riskiest in the Lake Michigan area.

Topics