FOOL ON THE HILL
SEC to Auditors: You Blew It

In the wake of near-weekly accounting scandals, we seem to have reached critical mass in Washington D.C. -- that point in which the power of individual anger finally surpasses that of the big-money lobbying efforts by corporate interest groups. Last week the SEC, run by a man many thought to be squarely in the lap of the big accounting firms, blasted the accounting industry's failure to regulate itself and protect outside shareholders. Bill Mann's initial cynicism about the proposed changes have morphed into anticipation.

Format for Printing

Format for printing

Request Reprints

Reuse/Reprint

By Bill Mann (TMF Otter)
June 25, 2002

I've got to be honest -- I was a bit cynical about the new Public Accountability Board proposed by the Securities and Exchange Commission (SEC) last week. At first. The more I think about it, the more I think that there is some merit here, and some real substantial tightening of controls on auditors.

But mostly, I like the underlying message the SEC gave to the auditing companies: "You were supposed to serve in the public trust, ensure that outsiders received representative pictures of the financial positions of companies they invested in, and you completely screwed up."

No, Harvey Pitt, the SEC Chairman, didn't just wad up a newspaper and say "bad doggie" to the big accounting companies. He blasted them, much to the surprise of his detractors. The strictures announced by the SEC, the removal of self-regulation by the American Institute of Certified Public Accountants (AICPA), were part of a brutal rebuke to an industry that ought to have had enough reminders by now. After all, this is an industry that is watching one of its own, Arthur Andersen, essentially hounded out of business for its role in the systemic fraud perpetrated at Enron. Incidentally, Pitt has been embattled since the day he entered office due to his past role as outside counsel to several of the Big Five accounting firms -- soon to be, what, the Final Four?

"The era of self-regulation is over," said Pitt. So much for the criticism that he's a lap dog of the industry.

A spokesman for the AICPA, predictably, decried the proposed board, stating that the accounting profession has now been relegated to the sidelines in administering to its own members.

Good. Not just good, but great. And I know that every lobbying firm in Washington is supposed to press its case without blushing, but for heaven's sake, AICPA, do you think that your marginalization is somehow a PROBLEM to most people? Heck, as we've discovered time and time again, it's when you're at the center of things when there seems to be problems. Waste Management (NYSE: WMI). Enron. Tyco (NYSE: TYC). Qwest (NYSE: Q). Global Crossing. Rite Aid (NYSE: RAD). More than 200 material restatements of earnings by companies in 2000, the most in history.

Accountants in on the deception
Accounting firms weren't just laying down on the job of protecting outside shareholders, they were actually participating in some of the worst cases of deception. For company management, it is inexcusable. For auditors, it is downright revolting.

With the new Public Accountability Board, the SEC is taking oversight from the accountants and putting in an entity that has a majority of members coming from outside the industry. Of the nine members of the board, six would be independent from the accounting profession. This new board would report to the SEC and would have a much stronger arsenal of punishments than the current (or I should say just disbanded) system, including the power to discipline auditors with fines, censures, forced removal from clients and suspension from auditing publicly traded companies. None of the three members with accounting company ties would be allowed to vote on disciplinary actions.

It seems that the AICPA's just rolled snake eyes. It has used its power in the past to block regulatory actions it did not like, including former SEC Chairman Arthur Levitt's proposal to force companies to separate accounting and consulting work. Seems Chairman Levitt had a good idea in hindsight -- it is a pretty poor secret that in many cases auditing for public companies is treated as a loss-leader to help the accounting firms gain access to the big-ticket consulting work.

You'd think that the accounting firms would call in some favors among their friends in the legislature. Well, they can try, but there is nothing so powerful in Washington as the need by our politicians to be opposed to the evil of the moment. After scandals galore and stock market losses in the trillions, individual investors -- who also happen to be individual voters -- are convinced that the game was fixed, and that the accounting firms were in on the take. Any Congressional member who sticks his neck out for the AICPA at this point is likely to do so at enormous political cost. There's blood in the water, and right now the accountants are bait.

In fact, both the House and the Senate have legislation in process that in some cases goes further than the regulations proposed by the SEC. The House bill, for example, places criminal sanctions on anyone found to be tampering with the accuracy of a financial audit of a public company. The Senate version proposes that the lead auditor for a company be mandated to rotate every five years, and is studying the feasibility of forcing rotation of whole accounting firms on the same schedule. Further, the Senate bill bars many forms of consulting work by auditors.

And it's their own damn fault.

Now, it needs to be noted once again that the majority of all accountants are more than likely scrupulously honest. Just the same, even though 200 companies had to restate earnings in 2000, that still is less than one out of every 50 public companies. People who are living in fear of a giant, out of control money-sucking machine need to realize that, yes, there are some completely unscrupulous people who have been allowed to run rampant during the greed and insanity of the late 1990s. But all told, the American financial system, accounting, and the stock market work remarkably well.

The changes being proposed by the SEC and Congress are a result of the need to punish the few, not the many. It seems that some in accounting forgot the public trust that was granted them, or worse, took full advantage of that trust. Further, existing mechanisms were neither efficient at identifying nor sanctioning those who would flout their positions of responsibility. For the actions of the few, the entire industry has suffered a big black eye. But it's high time that the AICPA recognizes that its lack of action against rogue elements in its midst mean that it has lost the privilege of self-regulation. And that is that.

Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards

We'll be discussing this topic on the Fool on the Hill discussion board. Be sure to stop by!

One last thing -- Matt Richey and I are hosting an online seminar on Selling Stocks. It's an important topic, and perhaps the most misunderstood, most difficult component of Foolish portfolio management. We've got some great lessons in helping you take profits on your winners and selling your losers. I hope you'll come and join us!

Bill Mann wonders "What is the opposite of pigeon?" He holds no beneficial interest in any of the companies mentioned in this article. Please check his profile for a complete list of holdings. The Fool is investors writing for investors.