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While still early in his first term, Levitt started to hear about what he called "corporate numbers" games. For example, companies would place ordinary expenses into the category of one-time or nonrecurring costs (WorldCom would play a similar game when it treated expenses as capital expenditures). As time went on, Levitt and Turner started to see more and more companies restate their earnings. From 1997 through 2000, 700 companies were forced to restate earnings due to misrepresentations in their financial statements. In 1981, by contrast, only three companies needed to restate earnings.
It had also become apparent that many companies, with the blessing of their auditors, were just managing to meet their quarterly projections, time and time again. In fact, between 1992 and 1999, the number of companies that beat quarterly earnings projections by one penny quadrupled. And while companies did not have to disclose audit or consulting fees, it was becoming obvious that the global firms, in particular, were focused throughout the 1990s not on balance sheets but on growing their high-flying consulting practices.
To Levitt, the bottom line was that the global accounting firms, and the AICPA along with them, had for all intents and purposes absolved themselves from acting as independent watchdogs of their clients and were also overlooking evidence of fraud in Corporate America.
Recognizing these developments, Levitt became more confrontational toward the profession in the mid-1990s. If its leaders had been paying attention, they would have known then that Levitt was eventually going to offer tough new independence rules.
Levitt Makes His Move In June, 2000, Levitt proposed that the SEC pass new rules barring CPA firms from providing most consulting services, including information technology consulting, to their audit clients. This was by far the most lucrative nonaudit service Levitt wanted to ban, and the one he knew the global firms would go to war over. Levitt's proposal also addressed the increasing tendency of companies to outsource their internal audit functions to their external auditors, basically in the name of efficiency and convenience. The rules also strengthened the Public Oversight Board, particularly from a funding point of view.
In the 75-day "comment period" between when Levitt's tough new rules were announced and when the SEC held public hearings, Levitt tried to live by the maxim "Keep your friends close, but your enemies closer." He spoke and met with Congressional opponents, in particular, nearly every day.
During the hearings, the leaders of the global accounting firms testified time and time again that the "information age" required a "real-time reporting" so that "intangible value could be captured." In fact, one of the problems from which the accounting profession suffered in the late 1990s -- which was evident at the hearings -- was that it had bought into New Economy jargon. The fault with that reasoning, however, is that during boom times, like the 1990s, it's very rare for audit negligence or fraud to ever come out, because shoddy audit work often comes to light only after businesses fail.
Another tack that the accounting profession took was to repeat this mantra: There is not a single shred of evidence that any audit had ever been compromised due to consulting services that were performed at the client. "I thought the argument that there is no link was specious," Levitt said. "I didn't really care if they thought there was no evidence. Perception is the ultimate reality. Perception creates confidence, or lack thereof. If there is a very dark cloud hanging over a profession, you have to deal with it."
The Final Negotiations The hearings allowed Levitt to get his message out to the public that auditors were turning a blind eye to their clients' efforts to play games with their financial results. But Levitt also faced mounting threats from Congressional leaders that they would cut SEC funding and effectively defang the commission if he didn't scale back his independence proposals.
In the end, Levitt was forced to abandon the ban on firms providing information technology consulting to audit clients. Instead, he had to settle for the requirement that made companies disclose the dollar amount of the audit and the consulting fees they pay. In addition, audit committees were required to report in the proxy statement if they considered any nonaudit services being provided to be incompatible with the auditor's independence. The rules passed on November 15 by a 4-to-0 vote of the SEC commissioners.
Levitt didn't get his separation of auditing and consulting, and less than two years later, Enron had imploded and Arthur Andersen had ceased to exist. Levitt seemed a bit saddened by the whole affair. "I don't think the developments at Enron totally surprised me," he said. "Over time, I've come to believe that fraud is fraud and deception is deception, and it happens in big companies as well as small companies."
Asked about his take on the state of the accounting profession, Levitt recalled some of its past well-respected leaders and expressed concern that today no one seems to be stepping forward to set an example for the profession. "I think it generally takes time to produce a leader," Levitt said. "And it's not just the accounting profession. You couldn't name five people in business right now you'd call a real leader."
Excerpted from Unaccountable: How the Accounting Profession Forfeited a Public Trust by Mike Brewster. Published by Wiley, April, 2003
Brewster is a New York-based financial writer. He writes BusinessWeek Online's "Flashback" column and recently co-authored, with his wife, BusinessWeek Online Associate Editor Amey Stone, King of Capital, Sandy Weill and the Making of Citigroup (Wiley, 2002)
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