Restoring Public Confidence

Unprecedented disasters, however, sometimes call for unprecedented actions. We want to make it unmistakably clear that not only does our profession have zero tolerance for any CPA who does not adhere to the rules but, in the wake of the Enron collapse, is prepared for unprecedented change. Our history is marked by a willingness and commitment to respond to key market and economic events and to make the changes required to maintain public confidence in both our profession and the securities markets. Twenty-five years ago the profession created the SEC practice section (SECPS) to improve accounting and auditing practices before the SEC. We also instituted peer review as a means of ensuring the uniform and consistent application of the profession’s high standards to all clients. Most recently in 2000 the Public Oversight Board’s Panel on Audit Effectiveness—more commonly referred to as the “O’Malley Panel”—recognized that the profession and the quality of its audits were fundamentally sound although certain improvements clearly were needed. The panel’s recommendations are currently being implemented.

In 1996 the General Accounting Office issued a comprehensive, two-volume report titled The Accounting Profession—Major Issues: Progress and Concerns. It detailed the actions and progress the accounting profession had made during the previous two decades to improve accounting and auditing standards and the performance of independent audits. The report expressed support for the quality control programs we had implemented to ensure that professional standards were being met and commended the profession for the steps it had taken to strengthen auditor independence, such as the AICPA’s revision of its code of ethics. “Most firms now have effective quality control programs to ensure adherence with professional standards,” it concluded.

That said, we have never been content to rest on our laurels but have always made continuous, incremental improvements. The profession’s self-regulatory framework is now about 25 years old. Although it has been continually enhanced and improved by the profession since its inception, the Enron collapse has made it clear to everyone that a substantial overhaul and modernization are needed. The public’s confidence has clearly been shaken. We know that in order to restore that confidence in the auditing profession, our self-regulatory process must be further strengthened for the future.

We are prepared to do just that. The AICPA is actively engaged in supporting and implementing reforms on a number of fronts in an effort to restore public confidence in the capital markets. Some of our current efforts represent new initiatives. Many more are an acceleration of efforts that have been under way since well before the Enron collapse.

SCOPE OF SERVICE RESTRICTIONS

In some instances the AICPA has embraced reform proposals that it previously had opposed, such as some scope of service restrictions for auditors of public companies. The largest five CPA firms in the United States have recently agreed to impose unprecedented restrictions on the consulting services they offer to their audit clients, and Congress is currently considering federal legislation along these same lines. The AICPA has decided not to oppose these changes as a necessary step toward restoring public trust in CPA firms, despite the fact that it continues to believe that nonaudit consulting services do not compromise a CPA firm’s objectivity or independence as long as the required safeguards imbedded in the Code of Professional Conduct are followed. Studies have continually concluded that providing certain nonaudit services helps both the client and auditor understand the economic realities of the company and lays the groundwork for a better audit.

The POB’s Panel on Audit Effectiveness stated in its August 31, 2000, report that its “reviewers did not identify any instances in which providing nonaudit services had a negative effect on audit effectiveness.” Going even further, the panel stated that “on about a quarter of the engagements in which nonaudit services had been provided, the … reviewers concluded that those services had a positive impact on the effectiveness of the audit.” Study after study conducted by those independent of the profession has expressed the same conclusion. At the same time, however, we recognize that the public and Congress are demanding meaningful change, and this is one area where the profession can act unilaterally to help restore public confidence.

NEW SEC PROPOSALS

While specific details haven’t yet been announced, SEC Chairman Harvey Pitt recently proposed to create two new boards to oversee auditors of publicly held companies. They would operate independently from the AICPA and be made up of a majority of public members.

A disciplinary board would be created to accelerate the investigation of alleged public-company audit failures and to provide more transparency. Additionally, the current program of firm-on-firm triennial peer reviews for the largest CPA firms would be replaced by an annual quality-monitoring process administered by a new organization, again with a majority of public members and again outside the profession’s existing structure. This new body would have expanded authority to monitor compliance with SEC practice standards and to refer instances of noncompliance to the new disciplinary board.

The AICPA is committed to working with both the SEC and Congress to make Chairman Pitt’s proposal a reality. We believe, however, that these new regulatory boards are appropriate only for auditors of financial statements of SEC registrants, not for auditors of the financial statements of privately held companies.

MANY OTHER REFORMS NEEDED

The AICPA also strongly believes there are a number of additional reforms that need to be enacted in order to deter accounting abuses and to help investors make better informed investment decisions. These include

Modernizing our current reporting and financial disclosure model to supplement historical financial statements.

Revising current accounting rules for special purpose entities, such as those Enron used.

Requiring additional disclosures in company filings with the SEC, including management’s discussion and analysis (MD&A).

Requiring reporting on a company’s internal control system to evaluate its effectiveness and making that report available to investors.

Requiring auditors to take additional steps to search for fraud.

Requiring disclosure of nonfinancial information to highlight what will contribute to the future success of the company.

Increasing the frequency of reporting.

Making it illegal for anyone in a publicly held company to lie or withhold material information from their auditor.

IMPROVING THE AUDIT

There will always be the threat of management’s overriding the system and preparing fraudulent and untruthful disclosures. That is why the accounting profession, even before the recent Enron collapse, was working on improving auditing standards and guidance to help auditors better detect fraud. An exposure draft of a new standard has already been issued, with the expectation that a final standard will be issued later this year.

IMPROVED REPORTING MODEL

No reporting model will protect investors from greed and bad judgment. However, an improved reporting model will provide every investor with better quality information and increase the likelihood of better investment decisions. More information and timely disclosures in plain English are required.

The reporting model should also address off-balance-sheet activity, liquidity issues, other risks and uncertainties, forward-looking information, nonfinancial performance indicators, unreported intangibles and other important information. To modernize the model, we must focus on

A broader “bandwidth” of information.

Different distribution channels, namely the Internet.

Increasing the frequency of financial reporting so that the delivery of financial information is eventually in “real time,” rather than only periodically.

The AICPA looks forward to working with Congress, the SEC and the Financial Accounting Standards Board to develop meaningful reforms that we believe are essential to restoring investor confidence in the financial reporting system. I can assure you the CPA profession is committed to taking every necessary step toward that end—and has already begun that process.

JAMES G. CASTELLANO, CPA, became chairman of the AICPA board of directors in October 2001. His acceptance speech, delivered at the Institute’s annual meeting in November, appeared in the February 2002 JofA (see “ Let’s Play to Our Strength ,” page 52).