Transparency: The New Peer Review Watchword

By Robert L. Bunting

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As Austin G. Robertson Jr., the recipient of the 2004 AICPA Public Service Award, has said, the best time to plant a tree is 20 years ago. The accounting profession planted the peer review tree in the early 1980s, and today it is our most important self-regulatory responsibility. Almost 35,000 accounting firms across the United States now rely on the peer review program to demonstrate that their accounting and auditing practices meet the highest of standards.

At various times during the past 30 years, important, fundamental changes to peer review have occurred because of its growing importance to both the public and the profession. The time has come for another change to increase the program’s transparency. If we want to be the trusted profession, we have to be willing to let people know what independent assessments have to say about firms that have taken on the public-interest responsibility of attest functions. Ultimately, the precise amount of transparency will have to be determined within the hearts and minds of individual CPAs, based on how they want the peer review process to be perceived.

A Little History

This is not the first time peer review has acted as a litmus test for the accounting profession. Peer review began in the early 1960s, when large firms used it to monitor their accounting and auditing practices as a way to make certain their different offices maintained consistent standards. In 1977, the AICPA created a single uniform peer review program with the establishment of the Division for CPA Firms, the result of an agreement with federal regulators after Congressional hearings. Although membership was voluntary, this was the first time that requirements were established to make certain all firms conducting attest functions adhered to a single set of generally accepted auditing standards (GAAS). The most important requirement—peer review every three years—would monitor adherence to those standards.

The Division for CPA Firms had two sections. Accounting firms with clients subject to SEC jurisdiction joined the SEC Practice Section (SECPS). Because firms without SEC clients feared that members of the SECPS would have a competitive advantage, a second unit, the Private Companies Practice Section (PCPS), was created for those firms that audited only privately held clients. The PCPS established similar self-regulatory controls, including peer review. As a practical matter, many firms joined both sections.

The peer review process was an instant success, quickly recognized as a rigorous process that produced tangible results. Yet the argument that this was proof that the accounting profession could effectively police itself was weakened because membership in the Division for CPA Firms, and therefore peer review, was voluntary. It was apparent by the mid-1980s that peer review would have to become mandatory to avoid Congressional action. It was time to require peer review for membership in the AICPA.

Many viewed the AICPA’s “Plan to Restructure” as extremely risky because of its stringent new membership requirements—not only for peer review, but also for education. In 1987, the AICPA membership was asked to ratify a proposal that included the most important recommendations of the Special Committee on Standards of Professional Conduct, commonly known as the Anderson Committee after its chairman, George Anderson. The committee was spurred by the high-profile bank failures and corporate bankruptcies of the late 1970s and early ’80s as Congress, the SEC, and the FTC all once again put enormous pressure on the accounting profession to accept additional self-regulatory responsibilities or be prepared to have the federal government take those responsibilities away from us.

In addition to mandatory peer review and new educational requirements, the referendum included a new code of professional conduct that, according to the Anderson Report, demanded “an unswerving commitment to honorable behavior even at the sacrifice of personal advantage. In discharging their professional responsibilities, members may encounter conflicting pressures from clients, employers, and the public at large. In resolving those conflicts, members should act with integrity, guided by the precept that when members observe their responsibility to the public, clients’ and employers’ interests are best served.”

Many observers, both inside and outside the profession, doubted whether the plan’s most controversial recommendations would pass. Particularly dicey were the new requirements for mandatory peer review and continuing professional education (CPE). At more than one AICPA Council meeting, members expressed the concern that implementing the Anderson Committee’s recommendations could result in a substantial erosion of AICPA membership. People thought members would simply resign from the AICPA rather than pay to meet the new requirements.

Yet regardless of any possible short-term repercussions, the AICPA’s Governing Council and Board of Directors decided it was necessary to raise the stature of AICPA membership and regulate ourselves before someone else did it for us. In preparation for the referendum, an ambitious member education campaign explained the proposed changes.

There was considerable controversy and criticism of the proposed changes. Firms not subject to peer review complained that firms that underwent peer review would have an advantage over those that did not. But that, of course, was precisely the intention: Firms subject to the rigor of the peer review program would be better equipped to perform quality accounting and auditing engagements.

In January 1988, AICPA members voted overwhelmingly to adopt a series of seminal changes to the AICPA bylaws, including a new code of professional conduct, a requirement that new members must have at least 150 hours of college-level education, and mandatory peer review and continuing professional education. Taken together, the “Plan to Restructure” represented a radical change for the accounting profession, but it was clear that AICPA members had done the right thing by demonstrating their commitment to the public interest, and after a brief drop-off, membership in the AICPA quickly soared to new heights. Even Congressman John Dingell (D-Mich.), heretofore Congress’ most vocal critic of the profession’s self-regulatory efforts, was impressed, commending the “decisive and timely action, as well as their willingness to work with the subcommittee on further improvements.”

The 1988 vote created two distinct peer review programs. Firms with audit clients underwent on-site reviews that evaluated the firm’s quality-control system. Firms without audit clients (performing only compilation and review services) underwent off-site reviews to evaluate their compliance with professional standards. Each review file included a report, and some included letters of comments, the firms’ responses to such letters, and descriptions of any follow-up action required by the Peer Review Committee.

Time for Change Once Again

Today, peer review faces another crossroad. Peer review was initially designed as an educational and remedial program to strengthen quality control, to prevent recurrences of problems, and to correct deficiencies in the practice of member firms. It was not intended to supplant the enforcement responsibilities of others. From the beginning, the role of peer review in both the SECPS and the PCPS was educational and corrective rather than disciplinary. Members expected, and the program delivered, confidentiality throughout the process.

In today’s world, however, this kind of opacity is no longer tenable. For one thing, the universe of people that rely on peer reviews has exploded and now includes a wider range of credit grantors and other users, in addition to regulators and clients. All of these groups expect greater transparency about the results of peer review, in order to evaluate the firm for their various purposes. In addition, businesses use peer reviews to assess the work of their accounting firms; at the same time, these firms quietly trumpet their positive reviews to clients and others. It has almost become a pass/fail system, with many firms treating a positive report as a badge of honor.

The majority of the approximately 34,500 CPA firms that participate in the peer review program because they engage in audits, reviews, or compilations are headquartered in states that require peer review as a condition of licensure. At the moment, 46 of the 54 states and territories that regulate accountancy either mandate peer review as a condition of licensure, delegate that authority to the state accountancy board, or have announced that they are moving in that direction. Twenty states not only require it as a condition of licensure but also mandate the submission of information related to the peer review.

A member referendum will ultimately decide the specific ways to increase peer review transparency. At its May 2004 meeting, the AICPA’s Governing Council approved a resolution expressing its support for increased transparency. It also directed the Peer Review Board to assist members in complying with state licensing requirements by providing state boards of accountancy access to certain peer review information. Boards can access peer review information if the state requires mandatory peer review and the remittance of peer review information and the firm gives its approval for this access.

The Peer Review Board recently recommended that certain peer review information be made available to the general public. Moreover, NASBA released an exposure draft earlier this year that proposed a rule adjustment to remove confidentiality from peer review with respect to state boards of accountancy. Both changes would have to be ratified by AICPA members.

Education for Change

All these pronouncements, however, represent only the first few steps in an inexorable march toward greater transparency. To prepare for these changes, the Governing Council’s May 2004 resolution also directs the AICPA to initiate a member education program, similar to the one conducted before peer review became mandatory. Its purpose is to inform members about peer review and the related transparency issues, to assess their desire for greater transparency, and to incorporate their feedback into the process of developing a more open peer review program. This process will probably continue into the first part of 2005, at which time member feedback will be assessed and a member referendum considered.

In the meantime, the AICPA will continue to work closely with NASBA, individual state boards, and other regulators to increase transparency to the extent allowable within the guidelines of the AICPA’s current bylaws. As a recent, and temporary, addition to the AICPA’s volunteer leadership, I feel an obligation to give our members a wake-up call so they can come to grips with the new reality of peer review transparency and begin the process of deciding whether they are willing to vote to change the nature of the confidentiality that we agreed to in 1988.

Great professions take responsibility for themselves. One of my primary goals during my term as Chairman of the AICPA is to make certain we take control of our own destiny. In the case of peer review, that means recognizing that the educational and remedial tree we planted almost 20 years ago has been clipped in different ways, transforming it into something else, requiring us once again to embrace fundamental reform. For my part, I’m energized by the opportunity to let the world know that we accept our responsibility to serve the public interest and are intent on “transmitting the light, free from pretense or deceit, so that bodies lying beyond are seen clearly.”

Further information about peer review—including the AICPA Peer Review Board’s revised Standards and Interpretations, effective January 1, 2005, and checklists, questionnaires, and other material used to perform system and report reviews—is available at
www.aicpa.org/centerprp/peer_review.htm.