In some of the headline-grabbing cases, accountants – along with lawyers, analysts and bankers – failed to ensure the accuracy of financial statements or freeflow of honest data in the markets, exposing problems that were systemic, rather than the efforts of a few bad apples.
The Big Five shrunk to the Formidable Four as a result of a Justice Department inquiry that shocked the profession in its toughness and unwillingness to find a compromise that might have saved Arthur Andersen, even when a Federal Reserve chairman Paul Volcker offered his mediation.
In response, Congress and regulators designed a series of reforms and created a Public Company Accounting Oversight Board intend to stop the worst abuses or curb incentives that encourage balance sheet sleight of hand. The empowering act orders the SEC and the accounting board to bar corporate auditors from selling certain other services and to regularly inspect auditing firms and discipline those that failed to meet standards.
The law gives the board the option of either adopting existing auditing standards or writing its own.
Joel Seligman, the dean of law at Washington University, has panned the planned reformers as offering one of the slowest and inept starts to a major change in US securities law. ‘They don’t have a full board, don’t have a budget, don’t have a staff, don’t have an office and don’t have a plan. It’s as sad a beginning as one can imagine,’ he said. At least they’re getting well paid – another point of controversy – as they will receive salaries of $452,000 (£274,000).
The chair, who is yet to be announced, will draw $556,000 – around three times the salary of the head of the Securities & Exchange Commission and more than $150,000 higher than President Bush’s. Reformers want the board to hire its own staff, conduct its own inspections and carefully check numerous audits each year. Many in the accounting industry merely want a system of peer reviews where one public accounting firm would check on another’s.
Then, last week, the Securities & Exchange Commission unveiled a host of new accountability rules required by last year’s Sarbanes-Oxley Act on business reform law.
After an onslaught of lobbying, it appears that earlier proposals intended to instill investor confidence by imposing tougher rules have been watered down, postponed or killed-off entirely.
It has backed away from proposals that would have restricted accountants from providing advice on tax shelters for the clients they audit, even though the same accounting company could find itself auditing the shelters it helped create. It has also weakened existing rules requiring public companies to disclose how much they pay to accountants for auditing services and consulting services.
Rules that would have required companies to rotate the partners supervising audits of a client after five years have been amended to require only the two lead partners to rotate after five years, other partners with a significant role in an audit would rotate after seven years.
Critics will claim its still too much red tape, despite the advocacy of reformers warning that only a get-tough approach would prevent another Enron or WorldCom.
Harvey Pitt, the hapless former chairman of the SEC who was forced to quit in November after a series of mis-steps, oversaw the rule making as his last major project before his replacement takes over.
Just adding to the red tape would have achieved nothing. But failing to learn from the lessons of the recent corporate crises could waste a lot of tough experience and fail the spirit of reform at a time when the profession is struggling to rehabilitate its image.
- Duncan Hughes contributes regularly to Accountancy Age ‘A BALANCED AND ROBUST APPROACH’ By Patricia Hewitt The collapse of Enron, Worldcom and Andersen in the US appalled investors all over the world. Shareholder confidence was badly dented and millions of people saw their savings and pensions collapse. It would have been a folly to sit back and say: ‘It couldn’t happen here’. We owed it to pensioners, savers and business to ensure our corporate governance structures remain among the best in the world. The package of proposals we announced last week I believe does just that. They are measured and proportionate but we have not flinched from being tough where toughness is required. Of course the approach to audit and accountancy standards in the UK are markedly different to those in the US. There was no need for us to rush into a Hewitt/Brown equivalent of the Sarbanes/Oxley Bill but we needed a considered, all-embracing approach to Enron. The Coordinating Group on Audit and Accounting Issues was set up precisely to take that approach. Their thoughtful report is the result of very careful study of the issues from a number of perspectives and wide-ranging consultation. The resulting measures reflect the Higgs and Smith reports into boardroom practices and the role of the company’s audit committee. Taken as a whole they represent a comprehensive and mutually re-inforcing package of reforms to raise standards of corporate governance in listed companies, to strengthen the accountancy and audit professions and to introduce more effective regulation. In summary, our proposals establish a bigger role for audit committees; introduce tougher requirements for auditors on independence and on transparency; and require more and active enforcement of accounting standards by a beefed-up Financial Reporting Review Panel and the FSA. We also announced a much stronger regulatory framework under the Financial Reporting Council, with responsibility for auditor independence standards, ethical guidance and monitoring removed from the accountancy profession itself and passed to the Auditing Practices Board. The first issue it will consider is the provision of services such as IT systems and tax advice by the audit firm. And a new audit inspection unit is being created so that the professional bodies are no longer responsible for monitoring the auditors of listed companies. We decided against two more extreme ways of addressing auditor independence, which some commentators have advocated. Two issues have been raised: should we have imposed compulsory audit firm rotation and introduced a total ban on audit companies carrying out non-audit services? The group considered both of these but were unanimous in recommending against them. The UK approach has always been to rely on principles supported by safeguards and in that our approach remains the best one. We do not want to go down the discredited US rules-based approach. Objectives of mandatory rotation can be better achieved by an enhanced role for the audit committee in the appointment of the auditor. Tougher standards, greater audit firm transparency and more independent oversight are preferable to a blanket ban on the provision of non-audit services. We looked at compulsory rotation and concluded there were more effective ways of guarding against the development of cosy relationships between auditor and client. A balance must be struck in safeguarding auditor independence that does not destroy the expertise built up by an audit team in a client firm. The theme of my reform package is the promotion of auditor independence and measures that strengthen the company audit committees and create a new independent unit to monitor audit quality. Independence is further safeguarded by the profession’s rule changes to ensure lead audit partners are rotated within five years and to institute a two-year ‘cooling off’ period for partners and senior employees of audit firms. This is a balanced but robust approach. Structures, standards and regulations can never be a complete defence against individuals bent on wrongdoing. But we have been determined to reinforce our defences to protect savers and honest businesses and the reputation of the profession. And we are doing so by strengthening not just professional standards but the toughening up the oversight, monitoring and enforcement of them. DECEMBER 2001 Enron files for bankruptcy with estimated debts of around $80bn (#48.55bn). Andersen’s chief executive Joe Berardino tells US House of Representatives Committee on Financial Services: ‘Our team made an error in judgment. An honest error, but an error nonetheless.’ JANUARY 2002 Foundation’s Ethics Board announces plans to launch inquiry into auditor independence; Andersen clients begin to distance themselves from embattled auditor. FEBRUARY Concerns grow over potential rises in professional indemnity insurance; UK Andersen managing partner John Ormerod tells Accountancy Age: ‘We’re not shifty’. MARCH Ormerod signals end of Big Five by announcing KPMG merger; E&Y enters talks to take on Andersen UK offices. APRIL Andersen/KPMG global merger in ruins after rivals pick up non-US Andersen offices; Deloitte & Touche announces plans to take over Andersen UK. MAY Foundation looks at radical changes to auditor selection process. JUNE Andersen receives guilty verdict in US, signalling end of Big Five; ICAEW proposes new rules to improve auditor independence; WorldCom – audited by Andersen – restates 2001 accounts. JULY WorldCom files for Chapter 11 bankruptcy; Audit fees rise in wake of Enron and WorldCom scandals. AUGUST WorldCom CFO Scott Sullivan charged with fraud. OCTOBER DTI trade minister tells US to lay off UK audit firms and reform Sarbanes Oxley Act; Two more WorldCom execs plead guilty. NOVEMBER John Ormerod voted Accountancy Age Personality of the Year; SEC chief Harvey Pitt resigns. DECEMBER Big Four begins to lose work to mid-tier over fears of conflicts of interest; Industry told to shake up disciplinary and complaints procedures. JANUARY 2003-02-03 Publication of DTI report on accountancy reforms which restructures the regulation of accountants and brings in the Financial Services Authority to help identify risk areas. Patricia Hewitt is secretary of state for trade and industry. She announced the review of audit and accountancy, which reported last week, in July 2002.