March 2003

Is Federal Regulation the Remedy?

C. William Thomas’ essay [“Enron and Beyond: What’s the ‘World-Com’ing To?,” News & Views, January 2002] was interesting and informative. In an understandable way he set forth the problems facing the accounting industry. (Note my description of what was once “an honorable profession.”) I am a semi-retired CPA. My firm audits no publicly held companies. I have no ax to grind.

Thomas’ conclusion that the reform measures will restore confidence is, I believe, a forlorn hope. It will not be because it cannot be. For example, recently the leading headline in the New York Times business section stated that a fraud suit named KPMG and partners, including Michael A. Conway, one of the firm’s most senior officials and former chairman of the industry group assuring that accounting firms did quality audits. The article refers to Conway as “one of the most prominent auditors in America” and continues to describe his accomplishments. The balance of the article is rather sad.

Having been an accountant for many years and having learned the influence of greed on our fellow humans, I believe the remedy is in a complete abandonment of self-regulation. I am old enough to recall the pro and con arguments at the inception of the SEC on the question of who would do the auditing. The AICPA won that argument and perhaps the financial community lost. I believe the SEC should be charged with auditing public companies, with the cost assessed against the company audited. The SEC could engage accountants of the caliber claimed for Conway at considerably less cost to the public company. And
the audit would enjoy the cachet of the federal government.
What do you think?

Sidney G. Aron, CPA
Ernest D. Loewenwarter & Co. LLP
Mineola, N.Y.

The Author Responds

I share Mr. Aron’s frustration with the failure of seemingly so many individuals in the larger firms who have succumbed to the pressures of high-stakes engagements, rationalizing their ethical principles in favor of personal gain. In my opinion, however, his suggested solution that the SEC take responsibility for auditing public companies represents an extreme reaction that would make things worse rather than better.

We should not forget that, with all of its warts, the United States still has the most transparent disclosure practices and the most rigorous professional auditing standards in the world. Although the failures were disappointing, the old system, as flawed as it was, still brought the failures to the light of public scrutiny. Unfortunately, in the process the entire profession of accountancy has lost credibility in the eyes of the public, whose interests we are charged to protect. It is important that, under the new system, we get it right.

The reforms established by the Sarbanes-Oxley Act and the New York Stock Exchange represent a balanced plan that relies on cooperation between the private and public sectors for improvement in corporate governance, financial reporting, and auditing. An effective oversight mechanism for audits of public companies must be independently and adequately funded in order to deter fraud and malfeasance. Oversight boards must be staffed with persons of integrity who are courageous enough to take action when warranted. The Public Company Accounting Oversight Board (PCAOB) has potential for being such a body. When fully operational, it will oversee the audits of public companies with not only yearly inspections for many of them, but also the right to issue auditing standards. The PCAOB is serious about exercising its authority as necessary to improve the system and deter wrongdoing. Although no system will totally prevent wrongdoing, the one we have now has certainly raised the “fear factor.”

In my opinion, the problems that have occurred in auditing have not been so much the result of inadequate standards as of the failure of individuals to properly execute them. Unfortunate-ly, recent criticisms of the AICPA in the press, whether deserved or not, may have damaged the organization's reputation as an effective rule-making body. Whether audit standards setting will remain in the hands of the AICPA is still very much open to question. Although it remains to be seen whether the PCAOB will actually take over the issuance of auditing standards, it certainly has, and will, exercise the power to approve the AICPA’s issuance of new standards. Much remains unresolved in this area.

In a free society, individuals must have incentive for personal gain in order to maximize their achievements. The role of government should be oversight rather than outright control. This oversight should be adequately funded and should contain strong disciplinary provisions for violators. Recent reforms provide both. Would the corporate reporting process be more transparent and less plagued with fraud if the audit function were taken over by underpaid government bureaucrats? I don't think so. Let’s give the new system a chance to work. I have faith that it can and will.

C. William Thomas, PhD, CPA
J.E. Bush Professor of Accounting Baylor University, Waco, Texas

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