SEC Enforcement Actions Support Critical Skills-based Ethics Training

By: Roxane DeLaurell, JD, LLM, PhD, Roger B. Daniels, PhD, CPA (inactive) and Josette Pelzer, PhD, CPA

 

The question of how to teach ethics has plagued academics for generations, with some even wondering whether it can be taught at all. Steven Mintz, an expert in ethics education, captured the landscape of ethics education in accounting in a recent decades-spanning review in The CPA Journal (https://bit.ly/3IUhcRE). The challenge of ethics education is being dealt with differently across the states.

 

To gain insight into which areas of ethics education should be strengthened, the authors looked at which ethical issues are causing CPAs to be sanctioned by regulators, specifically the SEC. A review of SEC enforcement actions over the last five years was linked to the AICPA Code of Conduct, which has been designed to guide the ethical behavior of accounting professionals.

 

Historical Background

The basic tenets of the AICPA Code of Professional Conduct, including its six foundational principles, have evolved for over a century.

 

In 1917, the American Institute of Accountants (AIA, now the AICPA) issued its Code of Professional Ethics. This early statement contained rules that addressed false and misleading financial information, kickbacks, and due diligence in professional work. By the 1920s, the code had been expanded to include matters involving contingent fees, conflicts of interest, and client confidentiality.

 

In 1946, John Carey’s Professional Ethics of Public Accounting was published by the AIA. This work provided a public-interest perspective on accounting practice issues such as independence, false and misleading statements, contingent fees, and advertising. The public interest perspective became an important guiding theme as the importance of ethical codes of conduct gained momentum in the accounting profession. Among the early academic proponents of ethics, education, and the public interest was A.C. Littleton, who wrote in 1952:

 

By education and examination a profession undertakes to guarantee at least minimum standards of competency. In return, the public protects that profession from the incompetent judgment and adverse effects of the unqualified by giving professional men a special status by law. Professional status is therefore an implied contract to serve society, over and beyond all duty to the client or employer, in consideration of the privileges and protection that society extends to the professional. (“Essays on Accountancy,” by A.C. Littleton, University of Illinois Press, 1961; first published in New York Certified Public Accountant, 1952)

 

Beginning in 1965, the AIPCA Ethics Committee began a comprehensive review of the code that resulted in a restructured code in March 1973. Some contend that the most signifi-cant revision of the 1973 code was the inclusion of Rule 203, which “effectively combines ethics enforcement, [GAAP] and [GAAS] into a unified structure.” In short, the code states that a qualified opinion is necessary when the financial statements contain departures from GAAP.

 

Accountants are bound to the code through their licenses, and their ethical behavior is assessed in relation to the code. Over time, ethical behavior has fluctuated, but the foundational principles of the code remain as a constant.

 

Applying AICPA principles to SEC sanctions should provide a structure that enables the categorizing of SEC enforcement actions. This categorization should allow for conclusions to be drawn as to which principles CPAs violate most frequently, which in turn should instruct educators on how to focus their ethics education efforts.

 

SEC Actions

SEC enforcement actions against CPAs are published on the SEC’s web-site at https://www.sec.gov/divisions/enforce/friactions.htm. A review of these enforcement actions over the last five years was conducted: each enforcement action was linked to one of the principles of the Code of Professional Conduct. Although the review showed that the number of actions against individual CPAs was relatively stable each year, drilling down to the nature of the actions yielded interesting results. The breakdown in CPAs’ behavior appears to be happening at the level of individual professional judgment, not at the level of bright line rules. This finding has significance for ethics education and training moving forward.

 

Linking the Principles

Determining the nature of the SEC enforcement actions and their relation to specific ethics failures is critical to identifying where the weakness in ethics education and training lies. The authors devised a template that linked the language used by the SEC in issuing its decisions to the language used in the six principles of the AICPA Code of Professional Conduct so that enforcement actions could be linked to one of the six principles. As noted above, these principles are considered the foundation of ethical behavior for the profession. The six principles are shown in Exhibit 1.

Exhibit 1: Principles of the AICPA Professional Code of Conduct

 

The authors decided to focus the linkage on principles 3, 4, 5, and 6, because principles 1 and 2 could apply to every enforcement action. A template was designed and tested to ensure reliable results among those who study and teach accounting ethics. The coding template was pretested by having several professionals with accounting knowledge classify a sample of the SEC decisions. Coders then used the template to review all SEC decisions for the time period studied.

 

Enforcement Action Analysis

Exhibits 2 and 3 outline the number of cases reviewed that were linked to principles 3, 4, 5, and 6 during the years examined (2016–2020). The total number of actions against CPAs remained relatively consistent over this time period. A deeper examination revealed that the most commonly violated principles also remained consistent during this time. Principles 3 (Integrity) and 5 (Due Care) accounted for the highest number of violations year after year.

 

Exbibit 2: SEC Enforcement Action Coding Results, 2016-2020

Exhibit 3: SEC Enforcement Cases Against CPAs, 2016-2020

 

The code describes integrity as requiring members “to be, among other things, honest and candid within the constraints of client confidentiality” (0.300.040.03). Actions linked to this category demonstrated the member had been dishonest with either their client, the public, or both.

 

Due care requires members to “discharge professional responsibilities with competence and diligence” (0.300.060.02). Competence is defined as having and maintaining the knowledge base required to provide a service; diligence is using that knowledge base to carefully and thoughtfully apply technical and ethical standards. Actions linked to this category demonstrated that the member had either offered services without possessing the requisite knowledge to do so, or provided services in a manner that was careless and disregarded relevant standards.

 

Exhibit 2 shows the total number of disciplinary cases brought by the SEC during each year alongside a breakdown of the specific references made by the SEC to the principles in its decision. The relative stability of enforcement actions over the five-year period could mean there is a fixed number of bad apples that the market must bear. To tease out even more useful information for ethics educators, the authors focused on the nature of each disciplinary action. As noted, the number of cases brought each year was fairly consistent over the period reviewed. Each case generally involved more than one related ethical principle, and some involved all of them.

 

Can Integrity and Due Care Be Taught?

An analysis of the nature of the SEC enforcement actions filed over the five-year period clearly demonstrates that principles 3 and 5—Integrity and Due Care—were most often at issue. These principles represent the subjective nature of the code. Integrity is an ethical standard without definition. Does it come from compliance with bright-line rules, or something more? Is it something intangible? Due care may be easier to define because of its legal significance.

 

Due care lies at the heart of reasonable behavior under any legal standard; failure to meet due care can result in legal liability. So, what is due care? It requires that a CPA be aware of their profession’s standards and at the very least meet them. It is not a bright line, but rather an exercise of professional judgment on a case-by-case basis. Memorization of bright line rules will not protect CPAs. At each turn, CPAs must exercise judgment and assess their own behavior as reasonably meeting the professional standard; this requires critical thinking skills. Ethics education and training must provide these skills, and it can do so through case-based studies that fine-tune critical thinking skills.

 

Opportunities for CPAs to test their own judgment against a known standard should help sharpen skills. Through the practice of exercising judgment, that judgment will improve with each failure. Providing case studies and hypothetical scenarios to students throughout the accounting curriculum will make ethics a part of every decision they make as a professional accountant.

 

Skills-based instruction fine-tunes the judgment needed as the profession moves to more discretion and exercise of judgment on the part of the accountant (e.g., the inclusion of critical audit matters in the auditor’s report). In addition, as automation and artificial intelligence take over many of the perfunctory functions of accounting, a professional’s knowledge base must move beyond bright-line memorization and enter the realm of exercising sound professional judgment. The more critical thinking skills that can be taught, the better—not only will they serve in improving ethical behavior, but they will also make for a stronger professional who can face the challenges of a post-pandemic economy.

 

Roxane DeLaurell, PhD, is a professor of business law at the College of Charleston, Charleston, S.C.

Roger B. Daniels, PhD, CPA (inactive), is a professor of accounting at the College of Charleston.

Josette Pelzer, PhD, CPA, is an assistant professor of accounting at the College of Charleston.