In just under two years at the helm of the Public Company Accounting Oversight Board, Chairman William McDonough has gone from being a respected figure in banking to being the most influential - and often feared - figure in accounting.
McDonough, who had had a distinguished career at First Chicago Bank and later served as president of the Federal Reserve Bank of New York, assumed the chairmanship of the PCAOB in July 2003, when the fledgling board - created a year earlier by Congress as a result of the passage of the Sarbanes-Oxley Act - was in a state of disarray.
Upon assuming his new post, the no-nonsense McDonough continually stressed a mantra of looking for "tone at the top," and proceeded to administer the oversight board's mantra of tough love to auditors and public issuers alike.
The board wrested authority over auditing standards from the American Institute of CPAs, and its first round of Big Four firm audit inspections raised more than a few eyebrows when it uncovered gaping deficiencies in the firms' respective engagements.
Thus far, more than 1,400 accounting firms - including many without Securities and Exchange Commission practices - have registered with the board.
Recently he spoke to Accounting Today editor-in-chief Bill Carlino about the PCAOB's 2005 agenda, its future firm inspections, and the challenges in both procedures and staffing that lie ahead.
When you were first appointed in 2003, you made a statement that reiterated the board's mission of restoring faith in the profession and that company statements certified by audit firms "present a complete, true and timely report that can be relied on." In your opinion, how close are we to that, or has it been a slow build?
McDonough: I would say it's a bit better than a slow build, but we still have a long way to go. The scandals are too new in people's minds, and it's a step back when you read that highly regarded financial institutions have to restate earnings. But accountants are moving in the right direction, and the managements of public companies are aware of their duties. But there are still too many days when you see headlines of another scandal, and that makes the average person nervous.
How much of a learning curve was there going from bank regulation to policing the CPA profession, which, in your former life, you touched only peripherally?
McDonough: I had served on the Basel Committee and had been a chief financial officer, so I knew what an auditor did. It was more of getting to know the auditing profession.
You've now held the top position at the PCAOB for nearly two years. How do you think someone who follows the profession closely would define/critique your term as chairman thus far?
McDonough: In one of my first public speeches after taking over as chairman, one learned journalist described it as "tough love." I think people in the accounting profession would say I'm very supportive, but tough.
In last year's inspections of the Big Four, your auditors uncovered some disturbing deficiencies in each of the firms' respective engagements. Do you think that ultimately served as a wake-up call for the profession, whereas many of the accounting scandals did not? Why or why not?
McDonough: Make no mistake - the scandals were a wake-up call. I think what our inspections showed the leaders of the firms is that our inspectors are very demanding, nosy, tough and insistent on getting the information they want. We hire very good people. The reports were very thorough on what they had to say. We think we were very straightforward.
Many companies have complained about the cost and human capital burden that SOX compliance, and in particular Section 404, has placed upon them and, by proxy, their auditors, who have to allocate more resources to ensure compliance. Is it too much, and do you expect this burden to diminish somewhat as people become familiar with the process?
McDonough: It certainly should. One of the difficult things with this is the first go-round. But on the other hand, unless you're a company like GE, you don't need the internal controls of GE. But that being said, you certainly should be faulted for not doing it right.
After time, it will probably engender a "How much do we really need?" philosophy, instead of, "I can't take any risk whatsoever in not getting it just right." There is probably a fair amount of wheel spinning we're engaged in. But over time that should stop.
Along those lines, many small firms without publicly traded clients are worried about the so-called "trickle-down" effect of SOX, and that some of the compliance mandates will eventually wend their way down to them. Is that a common complaint?
McDonough: Interestingly, a lot of smaller firms that don't have an SEC practice have registered with us, so I think that shows some degree of interest. Private companies who see the strong internal controls required for public companies are probably thinking that it's good for them too. But we've not heard any heavy breathing from smaller firms.
At a financial conference last year you made a statement to the effect that you preferred not to have auditors treating standards like a detailed checklist. To ensure accuracy, shouldn't standards be more or less like a checklist?
McDonough: That brings up the old rules-versus-principles debate. Principles demand a great deal more judgement, whereas rules are much more detailed. For example, the standard on derivatives runs more than 800 pages long.
But on the other hand, take the simplest of all rules, "Thou shalt not steal." That doesn't take a great deal of moral theology to analyze. And if I didn't get it, my mother made sure I did. I actually prefer standards that leave a fair amount of judgment to the auditor.
What was your reaction to the fact that many accounting firms are obtaining additional engagements (e.g., audits of public companies, Section 404 work and tax engagements) in the Sarbanes-Oxley era? Any concerns?
McDonough: I think by and large that's very healthy. But the firms that are getting the business need to realize that this isn't necessarily manna from heaven, and then they have to ask themselves if this is business they really want and are they capable of handling it? The last thing an auditor needs is a client engaged in inappropriate behavior.
Recently it has come to light that the board is not able to hire staff auditors at the projected rate, and as a result, your organization has slashed its already-approved 2005 budget. Raising salaries has been mentioned as one possible solution. Are there any other plans in the pipeline to get past this hiring hurdle? And how will that void hinder your inspection/compliance efforts?
McDonough: To put it in perspective, I had 500 examiners at the Federal Reserve Bank of New York alone. I think we're now catching up quite quickly. We have a new top recruiting person as part of our plan, and our plan is to end 2005 with a headcount of 450, and I'm confident we'll achieve that.
As far as a head count, I think the final number would probably begin with a five. Now, whether that number will be closer to 600 than 500, I can't say.
When you first assumed the chairmanship, you were reticent to discuss your relationship going forward with the AICPA. Now, almost two years later, how would you describe it?
McDonough: I think now it's outstanding, and I think proof of that is how we solved the issue of auditing standards by adopting their standards. They had a big intellectual property investment in those standards and Barry Melancon and I came to a satisfactory agreement on that. I recently addressed their major firms conference in January, and we've kept an open dialogue.
The board has taken on an ambitious agenda for 2005, especially in the area of standards, where you have laid out a schedule of 11. Some have criticized you for having taken on too much of a "full plate," so to speak. Your thoughts?
McDonough: It is ambitious, and we certainly would like in the course of 2005 to complete it all. But as you go through the year, the relative importance of things tend to change. There's not one of those things that we would cut our wrists if we didn't complete them this year.
Your first round of inspections examined an average of 16 engagements for each of the Big Four firms, and the next round has promised to be more thorough and will include several of the national firms as well.
McDonough: At the end of the day, the major question for us will be how big will our inspections be? We did 99 inspections in 2004, with 91 of those being smaller firms, and looked at 60 to 75 engagements for each firm. That means we have about 500 firms to do over the course of the next two years.
As the board matures, have you seen any difference in the way is goes about its mission statement? Has it become easier?
McDonough: Essentially, the attitude we're taking is similar to what the good banking supervisors take to banks. We will work with the profession and restore the faith of the American people. Had that faith in the accounting profession not been lost, the PCAOB would not exist. We'll help them do the right things, but it has to be made clear we're not a rooting section. When they don't do the right thing, we become very, very difficult.
