SEC Reaches Way Back for EY Independence Case

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On May 20, 2002, the Securities and Exchange Commission (SEC) announced proceedings against Ernst & Young (EY). The case reaches back to the years before EY's consulting practice was sold to Cap Gemini. It involves alleged independence violations due to product sales and consulting fees related to PeopleSoft software, while PeopleSoft was an EY audit client.

The SEC alleges that EY and PeopleSoft co-developed and co-marketed a software product called "EY/GEMS for PeopleSoft." These allegations focus on EY's use of components of PeopleSoft's proprietary source code in software previously developed and marketed by the accounting firm's tax department. In return for the code, SEC says EY agreed to pay royalties ranging from 15% to 30% from each sale of the resulting product.

Additionally, the SEC finds fault with hundreds of millions of dollars in consulting revenues from implementing PeopleSoft software for clients. The SEC says the revenues were derived from close coordination and co-marketing. As evidence, it cites reciprocal endorsements, links to each other's Web sites, holding themselves out as "business partners" of one another, and sharing customer information, customer leads, and "target accounts."

EY's Reaction

In response to SEC's anouncement, Ernst & Young released this statement:

Given the many financial reporting and accounting challenges facing the business community, the accounting profession, and the SEC, we are surprised and disappointed that the SEC has chosen to take action on this matter. Our conduct was entirely appropriate and permissible under the profession's rules. It did not affect our client, its shareholders, or the investing public, nor is the SEC claiming any error in our audits or our client's financial statements as a result of them. Moreover, the issues the SEC has raised are purely technical and relate to judgments we made and actions we took in good faith years ago.

The SEC's main focus is on the activities of our former consultants in implementing PeopleSoft software for third parties. These occurred between 1994 and 1999 and have no bearing on our current business. In fact, we sold our consulting business to Cap Gemini in May 2000. The SEC's other focus is on a software license agreement between Ernst & Young and PeopleSoft entered into when the parties were making an EY software product compatible with PeopleSoft. This issue is also purely historical. The license agreement terminated years ago and the PeopleSoft-compatible version of the product is no longer sold.

For the record, we did carefully consider the potential independence implications of our consultants' actions before they undertook them. We correctly concluded at the time that the actions were permissible under the profession's rules and that they were commonplace. Therefore, we are confident that our conduct was entirely appropriate and we will defend ourselves vigorously.

-Rosemary Schlank


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