The Noble Cause of Independence

October 2003

The Noble Cause of Independence

In “Accounting Profession, Heal Thyself: A Matter of Survival” (Personal Viewpoint, August 2003), Professors Mano, Mouritsen, and Swearingen undertake a noble cause but propose solutions that, for the most part, are ineffectual or will have severe adverse unintended consequences.

Specifically:

A standard of “strict independence” such as they propose would raise auditor independence over all other values. This may be desirable, although I doubt it, but to assert it without considering the implications is a disservice to Journal readers. For example, the independence of the auditor might be improved with mandatory annual rotation, as the authors advocate. But how would such rotation affect the quality of auditing? It normally takes a long time to fully understand a company’s business, its systems, and, perhaps most important, the quality and integrity of its people. Would the number of missed material errors in the financial statements—whether intentional or inadvertent—increase or decrease as a result of mandatory auditor rotation? And the old independence rule, that no partner in a firm could own even a single share of the stock of any audit client of the firm, may have marginally improved independence, but even the SEC agreed that it created more problems than it solved, and eventually changed the rule. The authors should at least have researched these questions before advocating such an extreme position.
The subject of separating “fairly presents” from “in accordance with GAAP” is a legitimate one, but again it deserves a more thoughtful analysis. For example, who makes a determination of what fairly presents? Before it was prohibited, would treating a merger as a pooling be unfair? Is historical cost accounting unfair? What about LIFO, or accelerated (or straight-line) depreciation? The authors make no attempt to develop such issues or explain why this separate consideration of “presents fairly” would serve the interest of investors, rather than just provide a new basis for litigation against auditors.
The authors assert that auditors should be required to complete an audit even if they want to resign or have no expectation of being paid. Because auditing depends on a risk analysis and on trust of client personnel, auditors sometimes resign because they view the risk that they will not be able to successfully complete an audit as too great. Unless the authors contemplate requiring a flurry of disclaimers because of inability to conduct a GAAS audit, this proposal is unworkable.

Finally, the idea that auditors should be required to complete an audit even if they have no expectation of being paid is unworthy of further discussion, unless the authors are proposing repealing the Thirteenth Amendment to the U.S. Constitution, which abolished slavery.

I would welcome a thoughtful exposition of these vital issues; this piece fails to provide it.

Arthur Siegel, CPA
Former Executive Director of the Independence Standards Board (ISB)

The Authors Respond

Arthur Siegel comments on three of our six proposed actions for healing the accounting profession.

Regarding the first, strict independence, Siegel has on our behalf advocated “an extreme position” involving mandatory annual rotation of auditors. His position against auditor rotation is interesting and one with which we in fact fully agree, but because we never mention or even indirectly advocate auditor rotation, only strict independence, we question whether Siegel actually read our article. Hence, we need not discuss the issues raised against our view of strict independence except to quote from the ISB’s Framework for Auditor Independence. That framework defines auditor independence as “freedom from those factors that compromise, or can reasonably be expected to compromise, an auditor’s ability to make unbiased audit decisions.” In line with this definition, our view of strict independence means that CPAs should not conduct nonaudit services for their own publicly held audit clients.

On the issue of “fairly presents,” Siegel asks, “who makes a determination of what fairly presents?” As our article stated, we believe in the concept of “criteria.” Therefore, it would be up to the auditor to take full and complete ownership of his opinion. We need auditors who, in their heart of hearts, believe the financial statements “fairly present” before they are willing to so state. Siegel should study the landmark Continental Vending case as well as some more recent cases. The central issue in Continental Vending and more recent cases was fraudulent financial reporting even in cases where GAAP had been strictly applied. The judge in Continental Vending ruled that, “regardless of what the accounting standards say, the profession must be held to a higher standard than GAAP.” That is, the auditor may need to require the client to deviate from GAAP in order to prevent the financial statements from being misleading. Such a concept has existed in the profession for years, as evidenced by the Rule 203 Report (referring to Rule 203 of the AICPA Code of Professional Conduct), which requires the auditor to do just this.

Finally, regarding whether auditors should be required to complete an audit even when there is no prospect of being paid, we do not advocate a return to slavery. To repeat the first point of our article, we must commit to the concept that the public is our client. The monopoly right to audit public companies came from the public and we must serve that master even at the risk of becoming unpaid public servants. And no, we do not believe this is equivalent to a return to slavery.

Regarding whether we contemplate a “flurry of disclaimers” where auditors are unable to “successfully complete an audit,” yes, we do; in fact, we expect adverse opinions to become more common. But aren’t auditors supposed to tell it like it is? And if they cannot complete an audit and issue an opinion, doesn’t the public have a right to know that?

Ronald M. Mano, PhD, CFE, CPA
Matthew L. Mouritsen, PhD
James G. Swearingen, PhD, CPA

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