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BASIC SPLIT. Morgan himself -- who knew that a qualified audit would hurt his chances of finding other investors for the railroad -- took his objections to May's superiors. But they backed May and wouldn't change the opinion. Morgan grudgingly acknowledged his respect for the Central Pacific's outside audit team and backed off.
A few years later, May would pen auditing standards on how to treat both depreciation and income for a company with many subsidiaries. Perhaps more important, he deduced from his run-in with Morgan -- and those he had with other august clients -- that auditors would best earn the respect of their clients and the investing public by being completely independent from their clients, both in fact and appearance. Thus the modern notion that auditors shouldn't be performing consulting projects for their audit clients can be traced to May.
By the 1920s, May and his peers at other firms were aggressively developing audit standards for railroads, steel companies, and the other major engines of the U.S. economy. It was the auditors themselves -- not company managements or any outside regulator -- who decided the format of the audits, what information the audit certificates contained, and how far the audit opinion went in saying what was "true" or not. Soon, proliferating securities scandals helped May and several of his contemporaries persuade the stock exchanges -- including the New York Stock Exchange -- to require independent audits. By 1930, more than 70% of public companies were being audited by outside accountants.
ALIEN BUREAUCRACY. The creation of the Securities & Exchange Commission in 1934 was the first major incursion into the field that auditors by then controlled. The SEC had full power from day one of its inception to set auditing standards. May saw the commission as an alien bureaucracy, full of accounting dilettantes who wanted to radically alter the auditing rules that CPAs had been drawing up on their own since the late 1800s. In fact, one of the few things that May and his bitter rival, Arthur Andersen, agreed on over the years was that only working auditors -- who were in the trenches at companies every day, seeing the new, creative ways corporate managers were devising to beat the system -- could successfully design auditing standards.
Joseph P. Kennedy, the SEC's first commissioner, locked horns over auditing rules with the leading accountants of the day -- May included. President Franklin Roosevelt wanted to shore up investor confidence with strong, binding auditing standards that reached across all industries, and it was up to Kennedy to deliver them. Following May's lead, however, the auditing profession persuaded the SEC that mandating a single format for audits across all companies would result in chaos that would bring financial reporting to a standstill.
Their blue-chip clients, who didn't want to be restricted by ironclad standards issued by the SEC, supported the auditors. So in 1939, the SEC, under Chairman William Douglas, abandoned its five-year effort to set auditing standards, voting by a 3-2 margin to leave auditing -- and its standards -- up to the professionals. In a sense, the creation of the PCAOB means that after 70 years, the SEC will finally get the power Roosevelt intended it to have to set auditing standards.
OUTSIDE INFLUENCE. After the SEC's abdication in 1939, auditors continued to oppose the creation of any regulatory agency that could fill the vacuum. The profession fought the creation of the Financial Accounting Standards Board (FASB) in 1973, because it knew that the independent organization, formed not to make audit rules but to define general corporate accounting principles, would inevitably try to influence the way audits are performed.
And despite the audit disasters of the past few years, which have proven that not all accounting firms live by the profession's standards, the AICPA still clings doggedly to the idea that the accounting industry should set auditing standards. In a Mar. 18 press release, the association informed its 360,000 members that the AICPA's Auditing Standards Board "will continue to work closely with the SEC and the PCAOB to finalize these new auditing standards."
SEC Chairman William Donaldson, who on Apr. 15 nominated retiring New York Federal Reserve Bank President William McDonough to lead the PCAOB, didn't let the press release pass unchallenged. He sent a terse letter to the AICPA reminding the organization that the new oversight board has the power to set auditing standards, and that the AICPA leadership shouldn't be misleading its constituency.
The AICPA is only trying to maintain a tradition established by George May, who maintained an office at Price Waterhouse and remained active in various accounting associations until his death in 1961. But the truth is that today's auditing profession doesn't have a leader with May's political and diplomatic skills -- not to mention his moral leadership -- to effectively make its case. If it did, accountants might have avoided ending up in a situation where they, too, need to be regulated.
Brewster is author of the upcoming Unaccountable: How the Accounting Profession Forfeited A Public Trust (April, 2003) and is co-author of King of Capital: Sandy Weill and the Making of Citigroup (June, 2002)
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