A New Vision of Oversight

An Interview with Charles Bowsher

A New Vision of Oversight

The Accounting Credibility Crisis

By Thomas W. Morris

In Brief

The Case for Strong, Independent Leadership

Few in the accounting profession rival Charles Bowsher for breadth and depth of insight and dedication to public service. The highlights of his career include serving as an assistant secretary of the Navy, a partner at Arthur Andersen, 15 years as comptroller general of the United States (1981–96), and chair of the Public Oversight Board (POB).

When Bowsher visited the CPA Journal offices he talked with Editor-in-Chief Robert Colson about the Sarbanes-Oxley Act, the Public Company Accounting Oversight Board (PCAOB), and the POB, which he chaired from 1999 until its members disbanded last year. Bowsher was characteristically frank in both his recollections and his analysis of events, the participants, and in his prognosis for the future.

The CPA Journal: The Sarbanes-Oxley Act is being hailed as the most significant federal legislation affecting the accounting profession in decades. What is your opinion of the Sarbanes-Oxley Act?

Charles Bowsher: On the whole this is a very good piece of legislation. If you read the report of the Senate Banking Committee, where it originated, you’ll see that the best leaders of the accounting profession, both supporters and opponents of reform, testified before the committee and gave input. Also, contrary to popular belief, the bill was not “rushed through” the legislative process. Amendments were added when the bill had already been passed by the Senate, because when President Bush climbed aboard to support the bill he wanted to add substantial criminal penalties.

The main part of the act involves improved governance over the accounting and auditing functions, including audit committees. This is why SEC Commissioner Harvey Goldschmid calls it the most important legislation for the accounting profession since the 1930s. The act establishes the Public Company Accounting Oversight Board [PCAOB] as the key to carrying it out. I had hoped that [former Federal Reserve Chairman] Paul Volcker would be the oversight board’s first chair, and [former TIAA-CREF CEO] John Biggs was another person I thought would be a good chair. Of course, Volcker declined the position, and, while Pitt made a serious overture to Biggs, it was later withdrawn. As we all know, Harvey Pitt appointed former FBI Director William Webster as the first chair. Both Webster and Pitt resigned shortly after it came to light that Webster had chaired the audit committee of U.S. Technologies, a small public company that had major financial problems, and that Pitt had not shared that information with the other commissioners. SEC Chief Accountant Bob Herdman resigned almost immediately after Pitt tendered his own resignation. While Herdman left almost immediately, Pitt stayed on until his successor was named, and presided over an extremely active enforcement agenda at the SEC.

Although we’re still waiting for the SEC’s new chair, William Donaldson, to appoint a new PCAOB chair, the oversight board’s current membership is nearly as first-rate as I had hoped. [See page 6 for an update on the PCAOB chair]. How successful the board will be is difficult to tell because they have an enormous task, but I’m hopeful.

CPAJ: At one point, legislation in the Senate Banking Committee seemed dead. Did it surprise you that the Sarbanes-Oxley Act became the preferred solution rather than the House bill?

Bowsher: Many in the accounting establishment were pretty much opposed to the act up until the end. Some were so sure Senator Sarbanes’ bill wouldn’t pass that they didn’t become involved in time to offer constructive amendments until it was really too late. Those of us who had been pressing hard for accounting reform were able to use what influence we had to make ourselves heard and affect the final content of Senator Sarbanes’ bill.

CPAJ: All of the initial PCAOB members, with the exception of Charles Niemeier [the acting chair], do not have extensive accounting backgrounds. Many expect this group to think more like lawyers than accountants. Is this result related to concerns about cooperation from the “accounting establishment”?

Bowsher: Yes. I think in essence we’ve ended up with a group of lawyers overseeing the accounting profession, although that wasn’t our intention. I think the oversight board might need an advisory group of people with an accounting background. Of course, Niemeier probably knows a great deal because of his SEC experience. The new SEC chair and the new PCAOB chair will be the determining factors in the operation of the oversight board, and the types of advice it receives from accounting professionals.

CPAJ: Are the events of the past few years affecting trends that will reshape the expectations for future SEC chairs?

Bowsher: Very much so. The large number of ordinary Americans now invested in the equity markets through their 401(k) plans has definitely changed the landscape. They expect more transparent and fundamentally sound corporate governance structures. Someone who understands corporate governance will be highly sought as SEC chair. Knowing securities law used to be a more important qualification than I think it is now; it’s important, but less so than corporate governance, an area where recent failures indicate a real problem with performance. Sarbanes-Oxley gives us the legislative basis for stronger requirements, and we need people to implement them. The ideal SEC chairman is someone with a broad-based view of corporate governance, accounting, and securities law. There are so many large, difficult issues now that demand a person with a lot of knowledge and a lot of integrity who won’t repeat past mistakes.

It’s too bad Paul Volcker declined to chair the PCAOB because his experience is a good match to the requirements. He had a historic opportunity thrust upon him when he became the Federal Reserve chairman in 1979. The country was suffering from major inflation and he took on the big issues and did the job. These times could use a man of Volcker’s stature.

Harvey Pitt had the same type of historic opportunity open to him when he became SEC chair, but his early efforts as SEC chair left people unconvinced that he would seize control of it and do something positive. He kept saying that he’d inherited the problems. Well, that may be true, but he should have focused on the opportunity rather than the past. It made for a difficult time and eventually set the stage for the Sarbanes legislation.

CPAJ: Do you think Harvey Pitt’s own mindset, background, and ideology were too deeply ingrained for him to be able to operate any differently?

Bowsher: Yes. Pitt should have made a conscious, observable effort to operate differently than he had as a top SEC lawyer, because as SEC chair he had a totally different job. But he could never free himself completely from being the lawyer, advocate, and Washington representative of the big accounting firms and the AICPA. Instead of dealing substantively with the public’s concerns for needed reform, he chose to work closely with those constituents who wanted reform in appearance only.

CPAJ: How would you characterize the nature of the accounting establishment’s lobbying effort in Washington?

Bowsher: Traditionally, the accounting establishment’s lobbying effort has worked very much behind the scenes. Personally, I favor more disclosure and openness. And I’m disheartened by how many decisions are made in complete secrecy, without adequate discussion or exposure even within the accounting profession. This level of secrecy has also obstructed the efforts of formal discipline processes to sanction CPAs that violate laws or regulations.

CPAJ: The term “accounting establishment” probably first came into usage around 1984. Do you think it’s an apt description?

Bowsher: I didn’t coin the phrase myself, but the term is apt, and the GAO has used it in its periodic assessments of the accounting establishment for Congress. Back in the 1970s and early ’80s, we had the Big Eight, all firms pretty focused on audit and accounting matters. They were “big” by accounting firm standards, but certainly not “big business.” Recently someone gave me a list of the biggest private companies in the U.S. and all of what we now call the Final Four are in the top 10. They have also begun behaving in Washington more like big businesses than professional firms. The AICPA and the Big Four have become a hardball lobbying coalition with enormous amounts of money. Some of their efforts have come at enormous costs to their prestige, and now, because the results are perceived as contributing to the recent financial disasters of several large, public companies, many in Washington are having second thoughts. In general, when such hardball lobbying ends in mistakes, you make a lot of enemies.

The SEC and the PCAOB

CPAJ: If it’s important now for the SEC to show it represents the average investor, can an accountant, attorney, or banker from a large firm or institution be convincing in the top jobs? Do you have any thoughts about the future of the appointments at the SEC and PCAOB?

Bowsher: If you look at the Federal Reserve, which was created in 1913 with the objective of creating a more stable banking system, it got off to a wobbly start. But recently it’s attracted some outstanding chairs, and both Democratic and Republican presidents recognize that they need to make a good appointment to that post because of the agency’s public image and the potential negative consequences of not having a strong chair.

I think the SEC will eventually reach that same level, and Harvey Pitt’s regrettable early performance will make people realize the importance of that job—especially now, when we’ve had a downturn in the economy and many people have been hurt. Investors were looking to the SEC for protection and help, but the SEC leadership tried to keep reform to a minimum rather than deal with the real issues. Also, some accountants express resentment about the press, but I give the national media high marks for its coverage during the last two years.

CPAJ: Returning to the PCAOB, might they appoint someone as chair who’s already been appointed to the board?

Bowsher: Before William Donaldson was appointed as SEC chair, some people speculated that the SEC commissioners could select a chair from outside or from among the current PCAOB members, but I think the commission and the PCAOB need to establish a credible appointment process first. Therefore, I believe that Chairman Donaldson will put quite a bit of effort into creating a process and appoint a new chair to show that the process works. I believe that the acting chair, Charles Niemeier, has done a good job in these early months.

CPAJ: Is involvement in or a connection with a Big Four firm a plus or minus for a prospective candidate for the oversight board or one of the principal directors?

Bowsher: Definitely a minus. Everyone thinks one of the problems with Harvey Pitt and Bob Herdman was that they were too close to the accounting establishment, where the Big Four has disproportionate influence. If you look at some of the things they tried to do, it looks bad, and the result included very negative media coverage of the accounting “industry” that was reminiscent of the S&L crisis of the 1980s. The accounting profession will need to get its house back in order and rebuild its credibility.

CPAJ: Can the Big Four accomplish this?

Bowsher: It’s possible but not assured. It will require great leadership because at this point in time the Big Four have dug themselves a huge hole where public credibility is concerned. The leaders at the Big Four that I’ve dealt with over the last five years cause me concern for the accounting profession. They’re more business-development types and not that focused on building the accounting and auditing profession. The public, the capital markets—everyone—needs the financial information system straightened out and working well. The United States looks foolish to the extent that other countries are challenging our leadership in the area of auditing standards and financial reporting, and challenging whether they need many of the things the United States has been saying they need. The United States has a big job to rebuild credibility both at home and abroad.

CPAJ: What was your reaction when you learned that the SEC and AICPA were discussing a new oversight board without including the POB, which you headed?

Bowsher: The POB felt, as expressed in our testimony before Senator Sarbanes’ committee and in our white paper (which we prepared with the assistance of our counsel, Alan Levenson of Fulbright & Jaworski and former head of the SEC’s division of corporate finance), that we’d had a series of very frustrating encounters with the leaders of the big firms, starting in May 2000. At that time they cut off the funding for the POB’s review of their independence issues, which the SEC had asked us to do after PricewaterhouseCoopers’ independence problems came to light. That was followed by a prolonged and frustrating ordeal in getting the POB’s charter approved. The AICPA leadership dragged that out in a very bureaucratic way. Then, of course, when Enron hit in October 2001, the POB recognized immediately this was a major development in the history of corporate governance, the capital markets, and financial accounting. We wanted to have some real reform efforts.

In December 2001 the AICPA issued press releases that promised vague reforms but were really only public relations. Then, at a SECPS meeting, the AICPA inadvertently disclosed that it was working on its own plans to reorganize oversight of the profession, without the POB’s knowledge or involvement. The Big Four, the AICPA, and the SEC chair basically bypassed the POB, and Harvey Pitt announced plans for reforming the oversight of public company auditing at a press conference without conferring with the POB. Although they all subsequently denied that they had secretly conspired to end the POB, and although Harvey Pitt will claim he acted on his own, I am certain Pitt was working closely with the accounting establishment in that development. I’m convinced that a task force of the AICPA and members of the big firms had given Pitt a plan to create a new board over which they would have more influence than they’d had over the POB, which was always composed of independent members. We at the POB (myself, Norm Augustine, John Biggs, and Aulana Peters) didn’t hesitate to resign. Harvey Pitt told me on more than one occasion that he was upset when I publicly called their plan a sham because its origins were in the AICPA and the big firms, and that he knowingly went along with it.

CPAJ: In your opinion, what motivated Pitt to act as if he were the advocate for the accounting establishment?

Bowsher: I think he’s very intelligent, which he demonstrated when he was in school, in private law practice, and at the SEC. But when you get to the top position in an agency like the SEC that is so much in the public eye, judgment becomes a big factor, outweighing intelligence. From my perspective, Pitt struggled to arrive publicly at careful decisions about important issues. He always thought he could keep things quiet without explaining his actions or plans. The Webster appointment was the last example: He thought, “We’ll make the decision. We don’t have to explain it.”

Over the years I’ve learned that intelligence does not always equal good judgment, especially when you have to handle tough issues. People like Paul Volcker and Melvin Laird are intelligent and have good judgment. They can explain the basis for their decisions. They also know how to move and manage in a way that keeps those involved adequately informed.

More than one person advised me and the other POB members to remain on an interim basis while the SEC proposed board was formed rather than resigning, but we came to the conclusion that doing so would give the wrong impression to the public. We did not want to appear to participate in what we regarded as an AICPA, Big Four, and Harvey Pitt plan to marginalize the independence of the oversight role. I said in our Senate testimony and white paper that we came to our conclusions as an auditor should: If you can’t convince your client to do the right thing, you should resign; and that’s what we did.

Standards Setting

CPAJ: What is your assessment of the AICPA’s role in the past few years?

Bowsher: I’m not sure if the AICPA is leading the Big Four or the other way around. The morale of all CPAs about their profession has sunk so low over the last two years, and to a great extent it’s because the leaders of the big firms and the AICPA have undertaken initiatives that turned out to be disastrous. The AICPA has become a big public relations and lobbying machine. It does a good job with some of its education programming, but its involvement with auditing and professional standards setting has become deemphasized.

CPAJ: How would you change the auditing standards-setting process? Where would you start?

Bowsher: I’d start by taking standards setting out of the AICPA and setting it up under an independent control board, which is what the Sarbanes-Oxley Act did by establishing the PCAOB. It would be a disaster if the PCAOB does only what [AICPA President/CEO] Barry Melancon wants it to achieve, which is to delegate auditing standards back to the AICPA. The intention of Sarbanes-Oxley was to set up a real auditing standards board.

CPAJ: How did the processes and outcomes of the O’Malley Panel, which created by the POB, affect your thinking about the auditing standards-setting process?

Bowsher: The O’Malley Panel clearly thought that auditing standards needed a lot of work when it issued its final report and recommendations in 2000. But in hindsight they fell into the trap of thinking the AICPA would be willing to invest more resources and work more cooperatively than was actually the case. That’s further evidence that the AICPA’s leadership isn’t paying attention, and that it’s important for auditing standards to be taken out of the AICPA and managed independently.

CPAJ: How about the Yellow Book standards for auditing governments and government agencies?

Bowsher: When my predecessor at the GAO, Elmer Staats, created the Yellow Book standards, his modest hope was to establish some auditing standards that would help state and local governments. Now it’s a worldwide doctrine. I developed an international set of auditing standards that is based on the Yellow Book. So the Yellow Book has had great influence, including being translated into other languages, including Spanish and Chinese.

CPAJ: What motivated the new GAO independence standards that Comptroller General David Walker has issued?

Bowsher: I think Walker saw what the SEC and POB were trying to accomplish as the world was changing in the late 1990s, and he’s faced up to some difficult issues and taken the Yellow Book a step further in ensuring independence.

A Need for Leadership

CPAJ: Do you think things will get better?

Bowsher: Yes, I do. But I think the accounting profession needs to improve auditing first, because otherwise there will be lots of problems. For one thing, we can’t get down to much fewer than four big firms because the regulatory and legislative community—and the rest of the world—won’t accept it. Let me make an analogy to the automotive industry. There used to be many auto manufacturers. After they consolidated into three—Chrysler, Ford, and GM—American-made cars weren’t very good.

I think our big auditing firms have put themselves in the same position. You can’t continue to have that many big audit failures that are tied to big business failures because either the civil liabilities will be huge or the government will step in and take action. So this is a very sensitive period, but one that could be very successful and a good opportunity for strong leadership. That’s why the PCAOB is so important. People who think the PCAOB should be made of moderates who get along with everybody don’t understand the risk they’re taking. We are in a critical time.

CPAJ: Can the leadership you envision come from the private sector?

Bowsher: We at the POB concluded that, in order to be effective, any oversight board needs to be legislatively based and receptive to public pressure to make the needed reforms. We didn’t see pressure for real reform coming from the firms. After the stock market crash of 1929, we had congressional hearings to implement reforms in business and we had no big corporate failures until Penn Central Railroad went bankrupt in 1970. At that time we had the Moss and Metcalf hearings, which I attended and which were productive because many, although not all, firms were sincerely motivated to move toward independent oversight and peer review. The firms that opposed those reforms found that it wasn’t the end of the world.

In the 1990s, firms were evolving from auditing firms to professional service firms, deemphasizing auditing. When we ran into problems we realized we needed great private-sector leadership but we didn’t get it. [Former Secretary of the Treasury] Paul O’Neill was a member of the first POB, and when he saw resistance on the part of CPA firms to the POB’s independence reviews, he said, “These guys are asking for government oversight,” which is what has happened. But the big firms never saw it coming because they were so sure their big contributions and lobbying power could handle it. Then we had Enron, WorldCom, and Adelphia. I have no doubt there may be others out there.

I think the leadership that the profession needs won’t come from the AICPA unless there’s a change there. The Big Four could bring about reform in the profession and the AICPA if they want to, but I’m not sure that will happen. If it doesn’t, the real question is what the consequences will be for the next few years, because we’re skating on thin ice.

I’m reminded of the American Medical Association (AMA), which used to wield immense power but entered a period of weak leadership that made the wrong moves. Today the AMA has limited influence. Less than half the doctors in the country belong to it. I hope that doesn’t happen to the accounting profession and its major national organization.