PCAOB Imposes Record Fine on E&Y in Public Proceeding

E&Y was censured and fined a record $2 million by the PCAOB in connection with repeated violations of professional standards. It was imposed in a proceeding that was filed in March 2011 as a non-public but which, for good cause shown, was made public. In the Matter of Ernst & Young LLP, PCAOB Release No. 105-2012-001 (February 8, 2012).

The Order centers on the audits for the fiscal years ended December 31, 2005, 2006 and 2007 of the financial statements of Medicis Pharmaceutical Corporation based in Scottsdale, Arizona. E&Y and firm partners Jeffrey Anderson, Robert Thibault, Ronald Butler and Thomas Christie were named as Respondents.

In the audits for the years ended December 31, 2005, 2006 and 2007 the Board concluded that the firm failed to properly evaluate the sales returns reserve which is a material part of the financial statements. Specifically, the audit firm failed to comply with the applicable professional standards in evaluating Medicis' sales returns reserve estimate including its practice of reserving for most of its estimated product returns at the cost of replacing the product. At the time SFAS No. 48, Revenue Recognition When a Right of Return Exists required that such reserves be based on estimates using the gross sales price. While the company claimed that it was eligible for an "exchange" exception, the audit evidence did not support the contention. By concurring in management's claims under these circumstances the audit team failed to identify and address a material departure from GAAP.

Subsequently, E&Y personnel conducted a 2006 AQR and questioned Medicis' reliance on the exchange exception. Messrs. Anderson, Thibault and Butler then concluded that the exception did not apply. Rather, they determined that the company's treatment was appropriate based on an analogy to warranty. Mr. Butler did not participate in making this determination but agreed with the theory. At the time Respondents knew that the returns were not of defective products pursuant to a warranty. Rather, they were based on the right to return expired products.

In 2006 and 2007 Messrs. Anderson, Butler and Christie also failed to appropriately test, or ensure the performance of adequate procedures to test, key assumptions for management's new estimation methodology for units-in-channel for the year end reserve. Rather, they placed undue reliance on the estimations of management.

On November 10, 2008 Medicis filed with the SEC restated financial statements for the years ended December 31, 2007 and 2006, the six months ended December 31, 2005 and the fiscal year ended June 30, 2005. In those statements the return reserve increased $94.6 million or 585% as of December 31, 2005, 52.1 million or 148% as of December 31, 2006 and $58.9 million or 600% as of December 31, 2007.

In resolving the proceeding the following sanctions were ordered in addition to the fine on the firm: Mr. Anderson, who served as the lead partner on the 2005 and 2007 engagements and participated in the audit quality review and consultation, was barred from associating with a PCAOB registered firm with a right to petition for removal after two years and fined $50,000; Mr. Thibault, who served as the independent review partner for the 2005 and 2006 audits and participated in the consultation in a National Office role as a member of the firm's Professional Practice Group, was barred with a right to petition for removal after one year and fined $25,000; Mr. Butler, who was the second partner on the 2005 audit, led the 2006 engagement and concurred with the consultation conclusion, was fined $25,000; and Mr. Christie, who was the second partner on the 2007 audit, was censured.

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