SEC Chairman Harvey L. Pitt last Thursday proposed sweeping changes in corporate financial oversight. He said the failure of Enron and its auditor Arthur Andersen clearly exposes the defects in the country’s “vaunted system of disclosure, financial reporting, corporate governance and accounting practices,” and the need to develop an entirely new method of financial regulation “that will restore public confidence in the integrity of the accounting profession.”

“We cannot afford a system, like the present one, that facilitates failure rather than success…,” Pitt said at a Washington, DC, press briefing. “We have had far too many financial and accounting failures… Somehow, we must put a stop to a vicious cycle that has been in evidence for far too many years.”

Enron’s accounting revelations helped drive it into bankruptcy, and Arthur Andersen’s failure to provide early independent assessments of the company and subsequent disclosure that it destroyed Enron-related documents severely damaged the accounting profession’s already tarnished image.

While reiterating that the SEC is aggressively investigating Enron and its auditor and “will deal effectively with any wrongdoing that may have occurred,” Pitt outlined a Securities and Exchange Commission plan to form a new privately funded regulatory entity that would oversee the accounting industry and hopefully handle matters such as these before they reached the critical stage. The new public entity would be empowered to perform investigations, bring disciplinary proceedings, publicize results and restrict individuals and firms from auditing public companies.

Under a revamped system that would include the new regulatory body, the SEC would decide whether conduct should be pursued as violations of law (in which case the SEC would handle it), or pursued as violations of ethical and/or competence standards (in which case they would be handled by the new regulatory body), Pitt said. Disciplinary proceedings governed by the new regulatory entity should proceed expeditiously, he said, and disciplinary actions should be subject to SEC oversight.

“What the SEC chairman is suggesting in terms of enhanced self regulation for the accountants would be, I think — if properly structured — a significant improvement over the current system of non-regulation,” said Barbara Roper, director of investor protection at the Consumer Federation of America. “There are some things that he said that are essential components of a plan of that type: the independent oversight, more frequent inspections. He said a lot of the right things if you believe that self regulation [of the accounting firms] is an answer to this problem.”

However, Roper believes, formation of an independent auditing agency would be a much better idea that would lead to more substantial changes. It should be apparent from the decades of failed audits, said Roper, including the savings and loan disasters and the failures to detect the big securities fraud of the 1980s, that something more significant needs to be done.

“Enron is the latest in a whole series that’s included Waste Management, Microstrategy and Sunbeam and Right Aide, where billions of dollars of investor assets have disappeared overnight when these shoddy accounting procedures have been brought to light,” she said. “I think it raises the fundamental question of whether it isn’t time to make the independent audit independent. This idea that you are going to get an independent evaluation from someone who has an $80 million contract on the line is [crazy]. How would you like to be the audit partner who loses a $52 million Enron account because you were too aggressive in challenging the company’s accounting? The audits simply aren’t independent and as long as the auditor is paid by the auditor’s client they won’t be independent.”

Pitt is proposing the let the big five accounting firms keep doing all the auditing and continue to combine auditing with consulting but with oversight from this new body so that they will be fined in the future if another failure occurs. “There is merit to having the threat of a sanction if you do a shoddy job,” said Roper. “It would at least provide some countervailing incentive to weigh against these huge incentives they have to avoid doing a good job.”

She said setting up an independent auditing agency would require an act of Congress. It would mean the creation of a government-sponsored enterprise similar to Fannie Mae, i.e., a quasi governmental agency that would do nothing but audit companies. Companies still would pay for the audits but they wouldn’t be free to fire their auditor because there would only be one. There also would be more consistency in how audit standards were applied.

But getting Capitol Hill to go for such an idea is unlikely given the huge political influence of the auditing firms. Achieving the more modest changes proposed by Pitt would be much easier but still probably no walk in the park.

In addition to the formation of the new oversight body, Pitt has called for reform of the financial disclosure and reporting system. The inadequacies of the country’s disclosure and financial reporting system are much more visible after Enron’s failure, said Pitt, and the “need for change cannot be ignored any longer. Our system of periodic disclosure, for example, is old and not good enough. Today, disclosures are made not to inform, but to avoid liability. We need to move to a system of ‘current’ disclosure,” he said. “Financial disclosures are dense, impenetrable. We have called for plain English financial statements.”

“Presumably if you made them comprehensible to the general public maybe the auditors would start to understand them, too,” Roper quipped.

She said these are all very good ideas but it will take some time before any of these changes actually are put into practice.

“We are at the early stages of this proposal, and many details remain to be worked out,” said Pitt. “The SEC will carefully review this and other proposals regarding a system of public sector regulation to ensure that it addresses our concerns with the current system.” He said he would work with Congress to craft any necessary legislation and added that all stakeholders would be consulted prior to any formal regulations.

“I don’t think this is going to happen quickly,” said Roper, “because the accountants are extraordinarily powerful politically. Their influence on the Hill, in the area that I work in, is unrivaled. But there’s nothing like a little document shredding to undercut your credibility.

“Some of the people who are being most aggressive right are the ones who have gotten a lot of money from the accountants. Billy Tauzin (R-LA), for example, has gotten a lot of money from them over the years, Arthur Andersen in particular, and he’s not alone in that. I think there may be a sense in which they feel the need to prove that they can still be tough, and that could actually work in our favor.”

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