1. Explain how pressures and incentives drove the actions taken by Hudgins and Kitay to commit financial statement fraud.
2. Describe the problems in the audit of Weatherford International by Ernst & Young. Are any of these issues reflective of a violation of the rules of conduct in the AICPA Code? Explain.
3. Describe the deficiencies in the internal accounting systems, ICFR, and corporate governance at Weatherford. Were there any violations of the rules of conduct in the AICPA Code by Hudgins or Kitay? Explain.
4. Explain how Weatherford and Hudgins used aggressive accounting positions in the area of income tax accounting.

Switzerland, with U.S. offices in Houston, Texas. Weatherford’s shares are registered with the SEC and are listed on the NYSE. Weatherford files periodic reports, including Forms 10-K and 10-Q, with the Commission pursuant to Exchange Act Section 13(a) and related rules thereunder.
James M. Hudgins, CPA, served as Weatherford’s Director of Tax from January 1999 until mid-2000, when he became Vice President of Tax, and as an Officer from February 2009 until his resignation on March 31, 2012.
Darryl S. Kitay, CPA, served as Weatherford’s Tax Manager and Senior Manager from April 2004 until 2011, then as Weatherford’s Tax Director through January 2013. Kitay reported to Hudgins from April 2004 until March 2012. Weatherford relieved Kitay of all supervisory responsibilities associated with Weatherford’s income tax accounting in May 2012, after the filing of the Second Restatement of financial statements. Weatherford terminated Kitay’s employment in July 2013.
Ernst & Young LLP was Weatherford’s external auditor from 2001 to March 2013. On March 7, 2013, Weatherford’s audit committee decided not to re-appoint EY.
SEC Order Against EY
On October 18, 2016, the SEC announced that EY agreed to pay more than $11.8 million to settle charges related to failed audits of Weatherford based on the auditors’ failure to detect deceptive income tax accounting to inflate earnings. The EY penalty is in addition to the $140 million penalty already agreed to. The combined $152 million will be returned to investors who were harmed by the accounting fraud. The Commission also charged the EY partner who coordinated the audits, Craig Fronckiewicz, and a former tax partner who was part of the audit engagement team, Sarah Adams. Both agreed to suspensions to settle charges that they disregarded significant red flags during the audits and reviews.
The SEC’s order stated that, despite placing the Weatherford audits in a high-risk category, EY’s audit team repeatedly failed to detect the company’s fraud until it was more than four years ongoing. The audit team was aware of post-closing adjustments that Weatherford was making to significantly lower its year-end provision for income taxes each year, but it relied on Weatherford’s unsubstantiated explanations instead of performing the required audit procedures to scrutinize the company’s accounting. The SEC’s order also found that EY did not take effective measures to minimize known recurring problems its audit teams experienced when auditing tax accounting.2
Facts of the Case
Between 2007 and 2012, Weatherford, a large multinational provider of oil and natural gas equipment and services, issued false financial statements that inflated its earnings by over $900 million in violation of U.S. GAAP. Weatherford issued materially false and misleading statements about its net income, EPS, effective tax rate (“ETR”), and other key financial information. Weatherford did not have sufficient internal accounting controls to identify and properly account for its accounting of income taxes throughout the relevant period.
As a result, Weatherford was forced to restate its financial statements on three separate occasions over eighteen months. The first restatement was made public on March 1, 2011, when Weatherford announced that it would restate its financial results for 2007-2010 and that a material weakness existed in its ICFR for the accounting of income taxes. That restatement, filed on March 8, 2011, reduced previously reported net income by approximately $500 million (the “First Restatement”). $461 million of the First Restatement resulted from a four-year income tax accounting fraud orchestrated by Hudgins and Kitay. Hudgins and Kitay made numerous post-closing adjustments or “plugs” to fill gaps to meet ETRs that Weatherford previously disclosed to financial analysts and the public. This deceptive intercompany tax accounting improperly inflated Weatherford’s earnings and materially understated its ETR and tax expense.
The fraud created the misperception that the tax structure Weatherford designed to reduce its tax expense and ETR was far more successful than it actually was. From 2007 to 2010, Weatherford regularly promoted its favorable ETR to analysts and investors as one of its key competitive advantages, which it attributed to a superior international tax avoidance structure that Hudgins constructed at the urging of senior management.
After announcing the First Restatement, Weatherford’s stock price declined nearly 11 percent in one trading day ($2.38 per share), closing at $21.14 per share on March 2, 2011. The decline eliminated over $1.7 billion from Weatherford’s market capitalization.
Weatherford announced additional restatements in February 2012 and July 2012 (the “Second Restatement” and “Third Restatement,” respectively). After the First Restatement, Weatherford attempted to remediate its material weakness in internal control over income tax accounting. Throughout its remediation efforts in 2011, Weatherford filed its Forms 10-Q on a timely basis and falsely reassured investors that it was performing additional reconciliations and post-closing procedures to ensure that its financial statements were fairly presented in conformity with GAAP. However, Weatherford, through Hudgins and Kitay, failed to review, assess, and quantify known income tax accounting issues that had a high risk of causing additional material misstatement as early as July 2011. When Weatherford filed its Second Restatement on March 15, 2012, Weatherford reported a $256 million drop in net income from 2007-2011 as a result of additional errors in its income tax accounting, and its material weakness in internal control over income tax accounting remained. At least $84 million of that drop in net income resulted from an income tax accounting GAAP violation Hudgins and Kitay knew about, but failed to assess and quantify, before Weatherford filed its third quarter financial statements.