by Melissa Klein
Under pressure from accounting scandals at Enron, WorldCom, Tyco International and Bristol-Myers Squibb, lawmakers reached an agreement on legislation to overhaul the rules governing the accounting profession with lightening speed.
In a rush to craft a final bill before the August congressional recess, House and Senate members hammered out a compromise on reform legislation in less than a week and reached an accord on July 24.
The compromise calls for the creation of an independent accounting oversight board governed by the Securities and Exchange Commission. While details on what provisions of each bill made it into the compromise were still unfolding at press time, published reports said that it preserved Senate language placing stringent limits on the consulting services that audit firms could provide to public company audit clients. But it also included House measures on stiffer criminal penalties for corporate crimes.
Adoption of the legislation, which is expected to be quickly signed when it reaches the desk of President George W. Bush, would mark a mammoth shift for the accounting profession, which has, thus far, been self-regulated.
"If the legislation passes, what we’re going to have is the equivalent of the National Association of Securities Dealers with more power and less control by the profession than the brokerage industry has over the NASD," former SEC chairman David S. Ruder, a professor at Northwestern University’s School of Law, commented prior to the compromise.
In response to the compromise bill, Sen. Mike Enzi, R-Wyo., the only accountant in the Senate and a key architect of many compromise points in the Sarbanes bill, stated, "Make no mistake about it, this legislation is a federalization of the accounting industry. This bill places a federal government bureaucracy at the helm of accounting regulation.
Enzi, who expressed concerns over possible "unintended consequences" of the bill, added, "My hope is that this new oversight structure will renew the faith the public has in auditors and the financial statements which they help prepare."
A statement by the American Institute of CPAs noted, "We know the changes demanded by the legislation will be dramatic and challenging for the CPA profession. The AICPA will work cooperatively and closely with firms engaged in conducting public company audits in adapting to changes mandated by the new legislation."
SEC chairman Harvey Pitt lauded the congressional committee for its swift action. "It is deeply gratifying to see members of both parties, under the leadership of Chairman Sarbanes and Chairman Oxley, working together to reach consensus to enact reforms designed to restore integrity to the nation’s financial markets and to serve the interests of U.S. investors."
Under the Senate proposal, sponsored by Sen. Paul Sarbanes, D-Md., the oversight board would have the power to establish auditing, quality control, ethics and independence standards for public company auditors, and to investigate and discipline accountants. The Senate bill also applied to foreign firms that audit the financial statements of companies under U.S. securities laws, and provided public funding for Financial Accounting Standards Board.
Under the Senate measures incorporated in the compromise, accounting firms are barred from providing their public company audit clients bookkeeping or other services related to the accounting records or financial statements; financial information systems design, appraisal or valuation services; actuarial services; management functions or human resources; broker or dealer or investment advisor services; or legal services. However, the board would have the power to grant exceptions. A similar measure in the House bill, sponsored by Michael Oxley, R-Ohio, would have barred only consulting on system implementation and internal audits for audit clients.
Ruder would’ve liked to see those issues left to the board. "I don’t think Congress needs to set hard and fast rules regarding independence and non-audit services," he noted. "Those are matters better attended to by an expert regulatory body."
The compromise took the tougher line proposed by the House on penalties for corporate crimes, creating a securities fraud section that carries a maximum penalty of 25-year prison term, and increasing the penalties for mail and wire fraud to 20 years.
Intensifying demands for reform amid an already shaky market in the weeks leading up to the compromise, Clinton, Miss.-based long distance carrier WorldCom submitted the largest bankruptcy filing in history, listing more than $107 billion in assets and over $40 billion in debt.
The filing in Federal District Court in Manhattan July 21 came weeks after the company, which has been charged with fraud by the SEC and is under criminal investigation by the Justice Department, disclosed that it had improperly accounted for more than $3.8 billion of expenses.
Days before the compromise was announced, accounting industry insiders had voiced their thoughts on the Senate and House measures. Former Public Oversight Board Chair Charles Bowsher, a member of a group focused on audit reform headed by former Federal Reserve Chair Paul Volcker, said the Volcker group backed the Senate bill.
"We need an independent, legislative-based board and it should not be dominated by practicing accountants, which is what the [SEC chairman Harvey] Pitt and Oxley proposals lean toward," said Bowsher.
"We don’t think it’s the perfect solution, but we can support it," said Alan Feldstein, president of the Jericho, N.Y.-based National Conference of CPA Practitioners, said of the Senate legislation. "We think something needs to be done to restore public confidence.
"We’re taking a wait and see approach. Obviously, we’re going to agree that there has to be some type of independent oversight. But a concern is that they’re laying all of the blame at feet of the accountants," Feldstein said. "I don’t think you can legislate the audit process. Audit standards need to be put together by people who understand and know auditing."
Both bills called for chief executives and chief financial officers to certify their companies’ financial reports. Under the House bill, executives who fail to comply could face fines of up to $5 million and 20 years in jail, while under the Senate bill, fines are capped at $1 million, and the jail term capped at 10 years.
"It may prevent a lot of talented people from running companies," Feldstein said of the provision. "We understand the intent, but it may not have the desired effect."
Ruder, who called the tougher criminal penalties "unnecessary," noted, "We have to be careful how we interfere with operation of corporations. If we make it so likely people will go to jail, I think there will be less risk taking."
"The market meltdown is not due to criminal conduct or bad accounting," he added. "The problem is due to bad business decisions, bad business models."
The Senate bill required firms to rotate the lead partner in charge of the audit engagement and the review partner on audits every five years, and extends the statute of limitations for corporate crimes from three to five years, or two years from discovery.
The Sarbanes bill would make audit committees responsible for the appointment, compensation and oversight of outside auditors. It also called for faster disclosure of insider stock trades and banned loans made to company executives and directors. Both bills contained whistleblower protections and provisions regarding document shredding.
Regardless of what legislation gets passed, at least one accountant says it will not get to the root of the problem.
"None of the measures being discussed will fix the broken process that the audit profession uses," said Toby J.F. Bishop, president and chief executive of the Austin, Texas-based Association of Certified Fraud Examiners. "The profession needs a new process to better address the risk of material misstatements due to fraud, otherwise we’ll continue to disappoint investors, regulators and legislators."
"Accountants have done a poor job improving the nature of an audit to keep up with the changes in the business world that have led to more fraud being committed," said Bishop. "Accountants need to face up to the expectation gap that has existed for almost 100 years and fix it once and for all before the overwhelming tide of litigation and regulation makes auditing an intolerably dangerous practice."
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