How the SEC Plans to Police Accountants


When it comes to cleaning up the accounting industry, Harvey L. Pitt is the man in the middle. After a decade of audit failures and financial meltdowns -- capped by the $50 billion bankruptcy of Enron -- the chairman of the Securities & Exchange Commission on Jan. 17 announced plans for a new, independent oversight board. Its mission: to take over monitoring and peer-review duties from the Big Five and other accounting firms that audit public companies, and to exercise new powers to discipline errant auditors.

Fulfilling the mission will require stripping the accountants of their jealously guarded control over the profession and is likely to throw the SEC into a pitched battle with one of Washington's most potent lobbies. At the same time, Pitt faces sniping from critics on Capitol Hill, who think he's too close to the accounting profession. They maintain that any plan drafted by Pitt, who counted all of the Big Five firms and the American Institute of Certified Public Accountants (AICPA) among his clients during a quarter-century of practicing securities law, can't possibly be tough enough (see BW Online, 1/17/01, "Why the Enron Probe Needs Harvey Pitt").

Pitt insists he's going to put accountants in their place: under the thumb of the SEC. "We must make certain that the public interest is the first, middle, and last consideration" in disciplining deviant auditors, the SEC chief told BusinessWeek Online in an exclusive interview before unveiling his plan on Jan. 17. "Discipline and quality monitoring...must be responsive not to the profession, but to the SEC."

"UNPRECEDENTED." That's a big change. In the 100 years since public accounting first emerged, accountants have staunchly insisted on their right to police the profession. Even as doctors and lawyers surrendered self-regulation rights to state boards and the courts, accountants have successfully lobbied the SEC and Congress to keep discipline and peer review in the hands of the AICPA. Pitt's proposal is "unprecedented," the AICPA declared on Jan. 17. "Plenty of teeth are gnashing," says a lobbyist for the group.

The plan faces an uphill battle. Pitt insists the SEC has authority to establish an independent oversight board, at least for the Big Five and the 1,200 other firms that audit publicly traded companies. But if the proposal begins to pinch the accountants, they'll likely demand that Congress sign off on it.

Even if the board is established, it will have to struggle to maintain its independence. "The accounting profession is very creative at taking over every group that has ever tried to rein it in," warns a former top aide to Pitt's predecessor, Arthur Levitt Jr.

How will Pitt safeguard the new group? Details of his plan, which have not previously been reported, offer a blueprint:

The discipline board's funding will be insulated from the accountants, who in the past have threatened to cut off money for such watchdog groups as the Public Oversight Board. A public foundation will stand between the board and its funders -- a mix of accounting firms and users of financial statements, such as stock exchanges, mutual funds, and institutional investors. "To the extent that discipline is necessary for members of the profession, it's important for the profession to bear a significant part" of the cost, Pitt says. Investor groups "are certainly among the beneficiaries from sound financial reporting" and ought to contribute, he says.

Disciplinary cases against accountants will be speedier, and auditors accused of incompetence or ethical breaches may be suspended from practice while their cases are pending. "Nobody would continue to practice and ply his trade, and continue to do mischief" while suspected of wrongdoing, Pitt says.

The SEC will step up civil and criminal actions against accountants accused of financial fraud. There will be "a substantial increase in our involvement in the discipline process," Pitt says.

He intends to shake up the Financial Accounting Standards Board, the Stamford (Conn.) think tank that drafts rules for how companies put together financial statements. The central accounting issue in Enron's collapse -- how to treat "special-purpose entities" like the partnerships Enron used to move debts off its balance sheets -- "has been on the FASB's docket for almost 20 years," Pitt says. He wants the FASB to deliver new accounting rules "in months, not decades."

New rules on auditor independence are likely to focus on how auditors get paid. Critics want to bar accounting firms from selling consulting services to their audit clients. But Pitt believes the focus should be auditors' compensation, particularly bonus plans that reward an audit partner if the firm's book of business with his clients grows. The "optimal level" for regulating auditor independence is the local office: "at the audit level, not the national or global firm level," Pitt says.

Can he succeed? Pitt faces a tough fight ahead, and he's not setting a deadline for action. But he says he's determined: "The SEC has to have the ultimate authority over accounting, and we will exercise it diligently," Pitt told BusinessWeek Online. Accountants beware. By Mike McNamee in Washington


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