In the latest example of an independent auditing firm receiving unwanted regulatory attention, the Securities and Exchange Commission's (SEC) Enforcement Division launched administrative proceedings against a PricewaterhouseCoopers audit partner in connection with his work on behalf of a venture capital fund.
The allegations – part of a recent trend of enforcement actions against various gatekeepers and, in particular, auditors – demonstrate that the SEC's emphasis on private funds' compliance policies and procedures extends beyond the funds themselves to the work performed by various service providers to the funds. Independent auditors provide expert oversight of investment funds' public disclosures and reporting practices, providing investors with essential information and reassurance that their interests are adequately protected. In particular, investors in private funds place significant reliance on the accuracy of the audited financial statements issued by the auditors of the fund. The SEC's focus on the role of gatekeepers is particularly significant in the venture capital fund area, where most of the investment advisers are not subject to inspection by the SEC since many of them can rely on an exemption from registration with the SEC as an investment adviser. As a result, auditor activities have come under increased scrutiny from the SEC and other agencies.
In this instance, the SEC alleged the auditor failed to follow generally accepted auditing standards while examining millions of dollars that were drawn down from a venture capital fund under the guise of "advanced" management fees. In addition, while serving as engagement partner for the independent audits of the fund's financial statements from 2009 to 2012, the auditor allegedly "failed to inquire [whether the fund's adviser] had the authority to take the unusual payments, nor did he scrutinize the rationale for the payments" and failed to ensure that the transactions were properly disclosed in the fund's financial statements. The allegations were brought pursuant to Section 4C of the Securities Exchange Act of 1934 and Rule 102(e)(1)(ii) of the SEC's Rules of Practice. Upon learning about the payments, the SEC indicated that the auditor failed to make appropriate inquiries into the reason for them despite their "significant and unusual nature," representing a lack of due professional care.
The San Francisco-based biotech venture capital fund at the center of the case sued its investment adviser and certain individuals that owned and controlled the investment adviser in 2015, claiming the misconduct caused it more than $30 million in losses as a result of funds that were embezzled to pay personal expenses and support other business entities over the course of several years. With respect to claims brought by the SEC, the investment adviser and these individuals reached an approximate $6 million settlement with the SEC in March 2016, in which they neither admitted nor denied the regulator's allegations.
PricewaterhouseCoopers has not been charged by the SEC. However, the firm stated it fully supports the auditor as he contests the SEC's allegations, adding the payments the SEC is questioning "were repeatedly and accurately disclosed, year after year, in financial statements provided by the fund to its highly sophisticated investors." The auditor now faces an administrative proceeding that could result in his suspension from appearing or practicing before the SEC as an accountant, including the audits of publicly traded companies' financial statements.
Other auditors have run afoul of regulators in recent months. For example, one firm agreed to pay $11.8 million to settle SEC allegations it disregarded red flags of deceptive accounting practices at an oil-services company, while another settled allegations of fraudulent audit reports regarding municipal bond offerings by a town in New York. These cases and others highlight the SEC's and other regulators' focus on the fundamental role of gatekeepers and independent auditors, in particular, within financial markets and underscore their importance in protecting investors by scrutinizing the operations and decisions of investment funds.
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