Maintaining Public Credibility

Maintaining Public Credibility

An Interview with Charles D. Niemeier

By Robert H. Colson

In Brief

PCAOB Acting Chair on Auditing Core Values

Editor-in-Chief Robert Colson visited the Public Company Accounting Oversight Board (PCAOB) at its headquarters in the former Andersen offices in Washington, D.C., to interview its acting chairman, Charles Niemeier. They met in a sparsely furnished boardroom dominated by a large whiteboard with a timeline counting down the activities necessary to meet Congress’ April 26, 2003, deadline for the board to be operational.

Niemeier covered a wide range of topics dealing with the board’s responsibilities, approach, and philosophy on the purpose and culture of auditing. He also spoke at length about his background at the SEC, where his daily activities provided rare insights into accounting and auditing problems. To illustrate the board’s activities, Niemeier repeatedly turned to an analogy of repairing and maintaining a previously neglected, broken-down car: The Sarbanes-Oxley Act repaired the infrastructure of auditing, and the PCAOB’s mission is to maintain it over time. Niemeier sees audits as a fundamental element for credible corporate financial reporting in an era when average investors seek reassurance about the fairness of the capital market system. His high regard for the profession of auditing and its important role in the corporate reporting infrastructure is difficult to reflect adequately, but was clearly evident in the give-and-take of the interview process.

The CPA Journal: What is your view of the board’s initial responsibilities?
Charles D. Niemeier: Membership on the PCAOB is a tremendous opportunity to address the auditing issues that have come to the attention of the public as a result of the highly publicized recent corporate governance failures and the audits that accompanied them. This is the first time that a group independent of the auditing firms has had the responsibility to grapple with significant issues in the relationship of auditors with their clients, the responsibilities of auditors to the public, and the specific conduct of audits. The board sees the need for a careful, balanced approach to making certain that companies’ published financial information reflects economic reality and that there are realistic expectations about what auditors can accomplish within the scope of their professional responsibilities. The environment is very supportive of significant change and advancement.

CPAJ: Can you elaborate on the supportive environment?
Niemeier: Two things stand out in my mind. First, the Sarbanes-Oxley Act is the most significant federal legislation in the securities area since the 1930s. It reestablishes the board of directors as the dominant force in corporate governance, but the crown jewel of the act is the creation of the Public Company Accounting Oversight Board [PCAOB], which deals with the integrity of the auditing function. Second, Congress had a stroke of genius when it chose to organize the board as an independent not-for-profit organization rather than as a unit of government. The board will be able to offer a compensation structure that will attract highly qualified individuals and offer them a career path that simply is not possible for people in government. One of the problems faced by government agencies is that so many of the professional staff work at them for only a couple of years to build their resumes. Although the board is just now coming into being, we hope to build long-term institutional loyalty to the principles for which the board stands by being able to offer people long-term employment and advancement opportunities.

CPAJ: What steps have you taken so far?
Niemeier: So far we have focused on acquiring office space, setting up a recruitment function, and listening to as many groups as will come and discuss issues with us. We have leased this space on K Street N.W. in Washington, D.C., and we are looking for space in New York City to accommodate inspection teams. We have also determined to maintain internally activities such as standards setting, registration, inspections, and discipline. We are trying to take the time to carefully measure the problems and identify clear-cut paths that will make the situation better. There is a lot of work to be done. We’re concerned first of all to get off on the right foot by taking careful, deliberate steps to make sure what we do improves audit quality.

CPAJ: Do you plan to get input from professional accounting organizations?
Niemeier: Yes. Our preference is to set up our own panels, conferences, education functions, and advisory groups that are independent of existing professional organizations. We have been talking with groups currently involved in the activities that we will take over on April 26, and they have been very helpful in working with us to set up the transition.

Getting the Pulse of the Problem

CPAJ: How did you get interested in accounting and law?
Niemeier: I’m from Texas and went to Baylor University, where I earned an undergraduate degree in accounting. I worked initially for one of the large firms, Arthur Andersen, and then briefly for a small firm before starting my own niche practice in litigation support. I always had an interest in the law and discovered that I had a facility in helping lawyers and CPAs bridge their communication gap. I came to the attention of a Washington, D.C., law firm, Williams & Connelly, and they offered me a job heading up their litigation support group in 1989. During the job interview, I told them that it was not a good idea to have their own support group: No other law firm would hire it and they wouldn’t be able to use it for their own cases because it would be too biased. They hired me, nonetheless! While I was working there I entered the night program at Georgetown Law School. I got a great law school education while working on important accounting litigation issues at a high-profile law firm. It was a wonderful experience for me.

CPAJ: What did you do at the SEC before being named to the PCAOB?
Niemeier: I came to the SEC during Arthur Levitt’s chairmanship and worked in the enforcement division, rising to the position of chief accountant of the enforcement division. During those years, I investigated hundreds of SEC cases of companies with auditing and accounting problems. With that type of exposure, I became attuned to the pulse of many of the problems we have seen in recent years.

CPAJ: How will the board address these problems?
Niemeier: The principal problem we’re going to face is how to provide the support system necessary to assist individual auditors and CPA firms to be stronger gatekeepers of corporate financial statements. Young people do not enter the auditing profession because they want to help a company or a company’s management to commit fraud. Yet, unfortunately, that is exactly what has occurred in some situations. The accounting profession has been unable to discipline itself on standards of professional conduct. The board will bring to the environment the rigorous discipline and enforcement of professional and ethical standards that the accounting profession needs when confronting financial statement fraud. Most accountants want to do the right thing, and they understand that those individuals who do not live up to the standards of the profession hurt the entire profession when they are not disciplined.

Promoting Ethics, Combating Fraud

CPAJ: You place a high value on ethics and discipline. Aspiring CPAs receive cursory ethics training in college and their work environment. How can professional ethics be developed more completely?
Niemeier: It’s sometimes easy to lose sight of ethics and professional values when you’re working hard every day on challenging issues. Certainly, competence in dealing with the challenges of a changing world has been the primary focus of most accounting firms over the past 20 years. Professional values have been left in the distance by comparison. The culture of professional accountancy needs rebooting on this dimension. We all need to maintain our competence in the face of changing conditions, but a profession is founded on its primary values.

Recent audit and accounting failures have not been caused by a lack of competence, or even because of weak audit standards. Their cause has been a lack of integrity. In some cases, the auditors found the misleading financial information but chose the path of complicity. In other cases, the auditors actually helped create the misleading financial information. When such things occur, those auditors cease being instruments for the public and become instruments for those intent on committing fraud.

This problem of losing track of core professional values is not limited to auditors. Attorneys, analysts, investment bankers, government officials, and investors have all shown signs of neglecting their core professional values, when you look at the recent failures. Right now, the accounting profession is well ahead of the pack because it has recognized that there are problems and has begun to address its own responsibilities more thoroughly rather than point fingers at others.

CPAJ: Can you talk more about how otherwise ethical individuals can become compromised in the web of fraud?
Niemeier: There’s a crossover point where the law ends and personal morality begins. The gap between the law and personal morality can be enormous. People get into trouble in that gap. Few people start out by doing something illegal. Rather, the progression usually happens like this: It’s easy to start with a minor twist of a standard, rule, law, or moral principle, or a minor blinking of the eye when someone else violates a principle. The problem that required the twist or blink often does not remain minor, but grows, and one thing leads to another until what was once minor has reached the edge of being illegal, or even crosses that line. Otherwise honest, moral individuals often discover that a minor twist or blink last year committed them to complicity in an illegal act this year. At this point, it becomes difficult for them to reverse course. Then they wish that they had refused to compromise initially.

CPAJ: What is the core professional value for accountants?
Niemeier: The key for accountants is to keep the goal of fair presentation of financial information to an average investor firmly in mind and to make all their decisions from that vantage point. We would not be once again having a debate over accounting rules or accounting principles if the fairness of financial presentation—the economic substance of what is presented in the financial statements—had been at the forefront. Rules became an excuse for getting an answer on an accounting issue that the client liked, even when the answer undercut the fair presentation premise on which accounting is based.

The proponents of a principles-based approach argue that rules provide a blueprint for those that want to circumvent them. Principles would highlight the need to stand by them rather than carefully parsing detailed rules. I must add, however, that several of the most visible problems in recent years were clearly violations of the existing rules as well as totally inconsistent with more general principles.

CPAJ: How is the balance between a firm’s business interest and an employee’s professional responsibilities affecting the current environment?
Niemeier: It can sometimes be easy for an individual to lose sight of professional responsibilities when following a business game plan. Accountants may be especially susceptible to conforming to the business plan of the firm even when it runs counter to professional responsibilities. For auditors, fulfilling the primary professional responsibility often boils down to being extremely diligent about focusing on fraud. Fraud hates the spotlight. If you shine the spotlight on fraud in an organization, it will not necessarily go away, but it will look for a way to move into the shadows.

A professional accountant, like a professional athlete, should always be looking for ways to improve performance. Constantly maintaining the spotlight on as many areas as possible, promoting vigilant awareness of what lies in shadow, and diligently shining the spotlight as the shadows change is part of being a professional auditor. In a profession, no business interest should be set before the integrity of the profession’s core value. Professionals should be rewarded financially for integrity to their core value. The time is near when the value of an auditor’s integrity will determine the credibility of a company’s financial statements in the market. In other words, integrity will be the engine that draws clients.

CPAJ: Do auditing standards place enough emphasis on fraud?
Niemeier: There’s a long history of the accounting professional denying responsibility for fraud. I understand the concerns about litigation and liability, but the denial of responsibility for fraud has undermined the profession’s credibility. The fact is that everyone holds auditors responsible for fraud, whether they accept it or not. If we cannot make clear in our own standards our responsibility for fraud, how can we expect to gain the confidence of the public? SAS 99 is a good starting point, and the board will address the responsibility for fraud forthrightly. There is a point, however, where it just is not reasonable to hold an auditor responsible for spotting every fraud. In our society, we expect professionals to do their best to exercise competence in fulfilling their responsibilities and we treat them fairly if they do their best but do not succeed.

CPAJ: Do you have any views on the current “risk-based” approach to auditing?
Niemeier: The risk-based approach to auditing grew out of a desire to respond to the demands of CFOs and audit committees to reduce the cost of an audit. It also grew out of a concern for efficiency in audits. But the thought process has gone far beyond efficiency in providing a professional audit, to the treatment of auditing as a business and an audit as a commodity that should be produced at the least cost. The risk-based approach has a lot of merit, but the principal goal of an audit cannot be to lower its cost. The first goal has got to be an audit with sufficient competent evidence to support an audit opinion. Providing such an audit in the most efficient manner is only a secondary goal.

CPAJ: Does the Sarbanes-Oxley Act address all these issues adequately?
Niemeier: Sarbanes-Oxley is the foundation for redirecting corporate governance issues and overhauling the auditing culture. Imagine an old car that has been neglected and no longer runs like it should. The Sarbanes-Oxley Act is like a major overhaul on that car to fix it so it runs properly again. The PCAOB is the part of the act that provides maintenance for that car into the future.

Let me give you an example of why constant maintenance is necessary. Currently, there’s an AICPA requirement that the engagement partner on a public company audit rotate every few years. What has actually occurred in numerous circumstances is that an engagement partner was “promoted” to the relationship partner position and a junior partner was named as the engagement partner. The new engagement partner was clearly subordinate in the firm management to the relationship partner. The reason for the partner rotation requirement is to bring an independent, fresh set of eyes to the audit. The arrangement I just described circumvents this principle of a fresh look. Firms are concerned about maintaining their business relationship with the client and reassuring the client of the status quo. This example should illustrate that the issues connected to the balance between professionalism and business interests are not trivial or easy to address. We cannot forget that all firms must succeed as businesses; nevertheless, no profession can exist for long if business interests dominate professional responsibilities.

Forward to the Future

CPAJ: Can you compare our current situation to other times in SEC history?
Niemeier: Many of the fundamental issues we’re dealing with today are similar in nature, although their specifics are quite different, to those at the beginning of the SEC. Early SEC chairmen like Joseph Kennedy and William O. Douglas fought hard issues in difficult times when the business community was pressing for different answers. Both Kennedy and Douglas worked to push through changes and rules that were bitterly contested at the time, but were eventually seen as working out for the improvement of the whole system.

We are in similar times, as the confrontations a couple of years ago between Chairman Levitt and the accounting profession demonstrated. There have been some fundamental structural changes to the participation in capital markets that have changed the significance of the auditor’s role. The rules that Chairman Levitt championed and that became the backbone for the Sarbanes-Oxley Act will eventually be viewed as improving the system as a whole and creating a new level of confidence in the American capital market system.

CPAJ: What are those fundamental changes?
Niemeier: The most fundamental change is the phenomenal democratization of the capital marketplace that occurred during the 1990s. Average individuals turned to the capital markets in large numbers as a place to invest for their future retirement. The capital markets during the 1990s captivated the interest of average people throughout America who now follow public companies, their securities, and their public information very carefully through news reports, websites, and television. We have to satisfy the average investor—not the investment banker, the corporate executive, or the wealthy investor—that the financial information that companies issue is credible.

If the PCAOB can be instrumental through its standards setting, inspections, and discipline in assuring the average investor that financial information can be relied on, then there will be enormous benefits to registrants and their CPA firms. But the primary focus cannot continue to be on benefiting the CPA firm as a business. The focus has got to be on looking out for the average investor. Benefits to business are outcomes of looking out for the average investor.

CPAJ: Do you anticipate that the impact of the PCAOB could reach beyond SEC registrants?
Niemeier: We are acutely aware of and very sensitive to the effects the board will have outside its narrow scope of jurisdiction. Our mission is to create standards, register and inspect audit firms, and to discipline for audit problems as they relate to SEC registrants and their auditors. Others will undoubtedly look at what we do and believe that our standards and processes should be applied to private companies and other non-SEC registrants. We are aware of this and intend to be very explicit about the problems of unintended consequences if our standards and processes are applied in other contexts. The Sarbanes-Oxley Act explicitly says that its provisions do not address issues related to non-SEC registrants whose size and nature make them different enough to require other approaches. We realize that our work could lead to different sets of audit standards and different peer review systems, and that a two-tier system could eventually evolve. It’s hard to say at this time how all this will eventually be resolved. We are keenly aware of the issues, however, and plan to proceed with care.

CPAJ: Do you anticipate problems arising because some audit firms audit SEC registrants as well as private companies and other entities?
Niemeier: There are concerns, especially as they relate to the edges of the Sarbanes-Oxley mandate to the board. Our recent most visible problems have been with large SEC registrants. Many auditors appear to be getting tougher with their small clients. One reason lies in the interplay in large companies between management’s control over the audit, tax, and consulting business. Sarbanes-Oxley tries to get the audit committee more involved in this relationship to make certain that management does not overwhelm the auditors through outside pressure on tax and consulting fees. There will never be a complete way of dealing with all the risks posed by the underlying economics of the relationship. Nor will there be complete ways of dealing with issues that arise because auditors perform services in different market sectors like public and private companies. The Sarbanes-Oxley Act directs the board to share results of inspections with the states’ regulatory bodies, and we will have to carefully consider how we interact with them.

CPAJ: What kind of cooperation is the board receiving from the accounting profession?
Niemeier: The accounting profession is unique in its ability to forge the path once it gets headed in the right direction. While there was opposition from the firms and the national association to the formation of a board with such broad powers to create standards, register firms, perform inspections, and enforce discipline, most individuals, associations, and firms have been enormously cooperative in working out the transition from the old system to the new. Everyone wants the board to succeed. The accounting profession has passed the stage of denying that problems exist. Now it’s trying to mobilize to provide solutions. There are other groups that continue to deny their problems. They concern me because, even if accountants perform their functions perfectly, in-vestors can still be hurt when other professionals devise complex series of transactions with no economic substance whose only purpose is to manage earnings.

CPAJ: What lesson have you drawn from the events leading up to the formation of the board?
Niemeier: My mentor at Williams & Connelly once told me that he had never lost a case in his own office. The lesson for the accounting profession from the last year is to interact more with the other side. Listen seriously to what the public wants from the accounting profession. Look at audits from the viewpoint of an individual investor. Don’t be satisfied with talking and listening only to people that share your own beliefs. If you don’t hear and understand other sides, you’ll never know the weaknesses in your own case and, in the end, you could lose in the court of public opinion.

CPAJ: Will the board meet the April 26 deadline?
Niemeier: We are confident that we will.