Accounting Profession: Oversight, Auditor Independence, and
Financial Reporting Issues (03-MAY-02, GAO-02-742R).
The accounting system's self-regulatory system for auditors,
which largely depends on voluntary contributions from the
accounting industry, is plagued by fragmentation, lack of
coordination, poor communication, and conflicts of interest. In
GAO's view, the current self-regulatory system is broken, and
oversight by the Securities and Exchange Commission (SEC) has
fallen short in protecting the public interest. Because of the
important role played by independent auditors, GAO believes that
direct government intervention is needed to create a new body to
oversee the auditing of public companies by the accounting
profession. Concerns about the timeliness, relevancy, and
transparency of the financial reporting model could be addressed
by closer cooperation between SEC and the Financial Accounting
Standards Board (FASB), adequate and independent funding for FASB
operations, and periodic reporting to Congress on FASB matters.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-02-742R
ACCNO: A03328
TITLE: Accounting Profession: Oversight, Auditor Independence,
and Financial Reporting Issues
DATE: 05/03/2002
SUBJECT: Accounting procedures
Auditing procedures
Financial management
Financial statements
Self-regulatory organizations
Accounts
Accounting standards
Auditing standards
Reporting requirements
******************************************************************
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GAO-02-742R
GAO- 02- 742R Accounting Profession Issues
United States General Accounting Office Washington, DC 20548
Comptroller General of the United States
May 3, 2002 The Honorable Paul S. Sarbanes Chairman, Committee on Banking,
Housing, and Urban Affairs United States Senate
Subject: Accounting Profession: Oversight, Auditor Independence, and
Financial Reporting Issues
Dear Mr. Chairman: This letter responds to your recent request that we
provide our views regarding what steps the Congress should consider taking
to strengthen oversight of the accounting profession, auditor independence,
and selected financial reporting matters. The sudden and largely unexpected
bankruptcy of the Enron Corporation (Enron) and other large corporations?
financial reporting restatements have raised questions about the soundness
of the current self- regulatory and financial reporting systems and resulted
in substantial losses to employees, shareholders, and other investors. These
events have also raised a range of questions regarding how such dramatic and
unexpected events can happen and the role and capacities of various key
players under the existing systems.
The issues surrounding the accounting profession?s current self- regulatory
system for auditors involves many players in a fragmented system that is not
well coordinated, involves certain conflicts of interest, lacks effective
communication, has a funding mechanism that is dependent upon voluntary
contributions from the accounting profession, and has a discipline system
that is largely perceived as being ineffective. (Enclosure 1 serves to
illustrate the complexity of the current system of regulation and oversight
and the stakeholders who rely on the system.)
Simply stated, the current self- regulatory system is broken and oversight
of the selfregulatory system by the Securities and Exchange Commission (SEC)
has not been effective in addressing these issues to adequately protect the
public interest. As a result, given the important role that independent
auditors play and various inherent problems in the current self- regulatory
system, direct government intervention is needed to statutorily create a new
body to oversee the accounting profession?s responsibilities for auditing
public companies. This step is necessary in order to increase the
effectiveness of the audit process and to rebuild public confidence. The new
body should be independent of the accounting profession, have significant
standards- setting, oversight, and disciplinary authority, be adequately
resourced to
GAO- 02- 742R Accounting Profession Issues Page 2 fulfill its
responsibilities, and have sufficient operating flexibility to attract and
retain
quality leadership and supporting staff. On the other hand, the concerns
relating to the timeliness, relevancy and transparency of the financial
reporting model may be best addressed through the SEC working more closely
with the Financial Accounting Standards Board (FASB), assuring that the FASB
has an adequate and independent source of funding for its operations, and
reporting periodically to the Congress in connection with certain FASB
matters. If such an approach is not successful in achieving the expected
improvements in the financial reporting model in a timely and effective
manner, the government can then take further action.
The areas of oversight of the accounting profession, auditor independence,
and financial reporting are important on their own, but they also represent
interrelated keystones to protecting the public?s interest. Failure in any
of these areas can place a strain on the entire system. Consequently,
potential actions should be guided by the fundamental principles of having
the right incentives for the key parties to do the right thing, adequate
transparency to provide reasonable assurance that the right thing will be
done, and full accountability if the right thing is not done. These three
fundamental principles represent a system of controls that should operate in
conjunction with a policy of placing special attention on areas of greatest
risk.
NEW BODY NEEDED TO REGULATE AND OVERSEE THE ACCOUNTING PROFESSION
Enron?s failure and a variety of other recent events have brought a direct
focus on the ineffectiveness of the current system of regulation and
oversight of the accounting profession. Independent auditors have a key role
to play in protecting shareholders and the public?s interest in our capital
market system. They hold a public trust and their actions or inactions can
have significant implications on investors, creditors and other users of
financial reports. In this regard, auditors must place additional emphasis
on whether financial statements are ?fairly presented in all material
respects? in addition to their traditional emphasis on whether such
financial statements are prepared ?in accordance with generally accepted
accounting principles.? Fair presentation requires providing reasonable
assurance that major value and risk elements are appropriately reflected in
the financial statements and related notes in an understandable fashion. It
also requires employing an ?economic substance? versus ?transaction form?
approach to important accounting and reporting issues.
Many proposals are before the Congress to establish a new body to regulate
and/ or oversee accounting firms that audit public companies. In our view,
the Congress should consider the following key factors or criteria in
establishing this new body, each of which is critical to its likely
effectiveness.
GAO- 02- 742R Accounting Profession Issues Page 3 Functions of the New Body
The new body should have direct responsibility and authority for certain
critical functions in connection with public accounting firms and their
members who audit public companies. These include:
establishing professional standards (independence standards; quality
control standards, auditing standards, and attestation standards). The new
body should be authorized to issue professional standards. In that respect,
the new body should also be authorized to affirmatively adopt, at its
discretion, professional standards, in whole or in part, promulgated by
another standard- setting body. In the area of new standards, the new body
may choose to require auditor reporting on the effectiveness of internal
control over financial reporting in connection with audits of public
companies, which is currently not required under existing auditing
standards. It may also decide not to affirmatively adopt a standard
developed by another standard- setting body but instead issue a modified
version of the standard.
monitoring public accounting firms for compliance with applicable
professional standards. For efficiency, except for quality reviews of the
largest firms and those firms in which the nature of the audits they perform
pose a higher level of risk as determined by the new body, the new body
should be authorized to use contractors or accounting firms to perform
quality reviews in accordance with standards and processes set by the new
body. However, the new body should have final approval authority in
connection with any quality review engagements performed by any contractors
or accounting firms.
investigating and disciplining public accounting firms and/ or individual
auditors of public accounting firms who do not comply with applicable
professional standards. Investigations and disciplinary actions of the new
body should be in addition to existing investigatory and disciplinary
authority that already exists with the SEC and state boards of accountancy.
establishing various auditor rotation requirements for key public company
audit engagement personnel (i. e., primary and second partners, and
engagement managers). Related to this function, we believe the new body
should undertake a study and report to the Congress on the pros and cons of
any mandatory rotation of accounting firms that audit public companies
before taking any action with regard to establishing requirements for any
mandatory rotation of accounting firms.
Funding for the New Body The new body should have independent sources of
funding by virtue of mandatory, not voluntary, payments. Public accounting
firms and audit partners that audit financial statements, reports, or other
documents of public companies that are required to be filed with the SEC
should be required to register with the new body. The new body should have
the authority to set annual registration fees and fees for
GAO- 02- 742R Accounting Profession Issues Page 4 services such as peer
reviews of public accounting firms. The fees should be set to
recover full costs and sustain the operations of the new body. Reporting
Requirement of the New Body and GAO Access to Records
The new body should report annually to the Congress and the public on the
full range of its activities, including coordination with other standard-
setting bodies whose standards it so chooses to adopt, setting professional
standards, peer reviews of public accounting firms, and related disciplinary
activities. Such reporting also provides the opportunity for the Congress to
conduct oversight of the performance of the new body. The Congress also may
wish to have GAO review and report on the performance of the new body after
the first year of its operations and periodically thereafter. Accordingly,
we suggest that the Congress provide GAO not only access to the records of
the new body, but also access to the records of other entities that the new
body has chosen to rely on, such as other standard- setting bodies, and
contractors or public accounting firms that conduct quality reviews, to the
extent GAO considers necessary to assess the performance of the new body.
Structure of the New Body The new body should be created by statute and
should be independent of the accounting profession. To facilitate operating
independently, the new body?s board members should be highly qualified and
should have authority to set and approve its operating rules. The new body
should have independent decision- making authority; however, it should
coordinate and communicate its activities with other parties such as the
SEC, the various state boards of accountancy, other standard- setters, and
GAO, as appropriate. The new body should set its own human resource and
other administrative requirements and should be given appropriate
flexibility to provide compensation that is competitive to attract highly
competent board members and supporting staff. The new body should also have
adequate staff to effectively discharge its responsibilities.
Candidates for the new body?s board membership could be identified through a
nominating committee that could include the Chairman of the Federal Reserve,
Chairman of the SEC, the Secretary of the Treasury, and the Comptroller
General of the United States. This approach would help to assure the
qualifications and independence of all board members.
The number of board members could be 5 or 7 and have stated terms, such as 5
years with a limited renewal option, and the members? initial terms should
be staggered to ensure some continuity. Ideally, the members of the board
should be presidential appointees who are confirmed by the Senate (PASs).
However, if the board members are not PASs, the board should be actively
overseen by and accountable to a body that is composed of PASs, such as the
SEC, in order to assure adequate accountability to the Congress and the
public. At a minimum, the chair and vice- chair should serve on a full- time
basis. None of the board members should be active
GAO- 02- 742R Accounting Profession Issues Page 5 accounting profession
practitioners, and a majority of board members should not
have been accounting profession practitioners within the recent past (e. g.,
3 years). There are several alternative structures that the Congress could
choose from in establishing the new body, including creating (1) a new unit
within the SEC, (2) an independent government entity within the SEC, (3) an
independent government agency outside the SEC, or (4) a non- governmental
private- sector entity overseen by the SEC. Each of the above alternative
structures have various pros and cons that should be considered in order to
assure the credibility and effectiveness of the new body in protecting the
public interest. We believe that each of the alternative structures provides
an organizational foundation for managing and operating the new body that
potentially is workable. For the following reasons, we favor alternatives
two and three and believe they have a greater likelihood of success.
Under alternatives one and four, the new body?s functions (e. g.,
establishing professional standards, monitoring, and discipline) would be
subject to SEC approval in order to assure that all actions are in the
public?s interest and appropriate accountability to the Congress and the
public. This, however, would increase the SEC?s responsibility as well as
its workload, for the agency and the Commissioners, both of which are
already overloaded. Also, under alternatives one and four the new body?s
board members would not likely be PASs since under alternative one the SEC
Chair and other Commissioners are PASs, and since alternative four involves
a nongovernmental entity. Therefore, under alternatives one and four, the
new body would have less direct accountability to the Congress and the
public than a body with board members who are PASs. This limitation could be
mitigated to some extent by ensuring that regardless of the structure of the
new body that board members are selected from candidates provided by an
independent and appropriately qualified nominating committee as previously
discussed.
Although a structure that provides direct accountability to the Congress and
the public is important in our view, a more critical question regarding the
structure of alternatives one and four is whether the SEC has the capacity
to effectively take on such an additional workload. Clearly, the SEC has the
culture and potential to perform an active oversight role and this would be
in line with its current mission. But, does it realistically have the
capacity to do so? From a historical perspective, while the SEC has had
authority for over 70 years to regulate the public accounting profession
under the federal securities laws and regulations related to public
companies, it has largely relied on the public accounting profession to
regulate itself. It is now apparent that this model has not adequately
protected the public?s interest. Therefore, the SEC would need to institute
a new function within its organization, as called for in alternative one, or
a new oversight structure for a private- sector entity outside the SEC, as
called for in alternative four, both of which would require additional
resources and a significant increase in priority to more directly regulate
the accounting profession at a time when the SEC is already facing a range
of challenges in fulfilling its current responsibilities. Further, we
believe that the SEC also needs to increase the amount of time and attention
that it allocates to interacting with the FASB, the stock exchanges, and the
investment banking/ analyst community.
GAO- 02- 742R Accounting Profession Issues Page 6 As we recently reported, 1
the SEC?s ability to fulfill its mission has become
increasingly strained due, in part, to significant imbalances between the
SEC?s workload (such as filings, complaints, inquiries, investigations,
examinations, and inspections) and staff resources. Although additional
resources could help the SEC do more, additional resources alone would not
help the SEC address its high staff turnover, which continues to be a major
challenge for the agency. About 40 percent of the SEC?s staff left the
agency between 1998 and 2001 and, as a result, the average level of
experience at the SEC has been declining. For example, in 2000, 76 percent
of the SEC?s examiners had been with the agency less than 3 years. However,
we also reported that the SEC has not made effective use of strategic
planning and information technology to leverage its limited resources. In
addition to putting more strain on the SEC?s capacity, alternatives one and
four would also likely be less efficient models for the new body to operate
under by requiring additional time and attention from the SEC.
Alternative two, which calls for the creation of an independent government
entity within the SEC, and alternative three, which calls for the creation
of an independent government agency outside the SEC, do not pose the same
capacity challenges for the SEC, especially at the Commissioner level, as
alternatives one and four. Also, alternatives two and three both meet each
of the critical factors outlined above for the structure of the new body. We
recognize there may be concern over adding more political appointments that
have to be Senate confirmed, as called for under alternatives two and three,
given the recent challenges of filling positions that are PASs. However,
having an independent entity overseen by PASs serves to significantly
enhance the entity?s accountability to the Congress and the public.
Of these two alternatives, we favor alternative two as having a greater
likelihood of success because the new body would be housed within the SEC
and, therefore, could receive administrative support from the SEC, including
human resources, payroll, and other administrative support. More
importantly, this alternative should better facilitate communication and
provide for maximum coordination with the SEC, while also allowing the new
body the independence to design its own policies and procedures and systems
as it deemed appropriate. In addition, alternative two would not require the
Congress to create a separate federal entity. Alternative two would also
facilitate a consolidation of the new entity under the SEC in future years
if such a consolidation was deemed to be both desirable and appropriate.
Therefore, we believe that alternative two has the greatest likelihood of
success in terms of potential effectiveness, efficiency, and accountability
of the new body. However, as previously stated, each of the alternative
structures has merit and can potentially work if properly designed and
implemented.
AUDITOR INDEPENDENCE
For over 70 years, the public accounting profession, through its independent
audit function, has played a critical role in enhancing a financial
reporting process that has
1 SEC Operations: Increased Workload Creates Challenges, (GAO- 02- 302,
March 5, 2002).
GAO- 02- 742R Accounting Profession Issues Page 7 supported the effective
functioning of our domestic capital markets, which are widely
viewed as the best in the world. The public?s confidence in the reliability
of issuers? financial statements, which relies in large part on the role of
independent auditors, serves to encourage investment in securities issued by
public companies. This sense of confidence depends on reasonable investors
perceiving auditors as independent expert professionals who have neither
mutual, nor conflicts of, interests in connection with the entities they are
auditing. Accordingly, investors and other users expect auditors to bring to
the financial reporting process integrity, independence, objectivity, and
technical competence, and to prevent the issuance of misleading financial
statements.
Enron?s failure and certain other recent events have raised questions
concerning whether auditors are living up to the expectations of the
investing public; however, similar questions have been raised over a number
of years due to significant restatements of financial statements and certain
unexpected and costly business failures, such as the savings and loan
crisis. Issues debated over the years continue to focus on auditor
independence concerns and the auditor?s role and responsibilities. Public
accounting firms providing nonaudit services to their audit client is one of
the issues that has again surfaced by Enron?s failure and the large amount
of annual fees collected by Enron?s independent auditor for nonaudit
services.
Auditors have the capability of performing a range of valuable services for
their clients, and providing certain nonaudit services can ultimately be
beneficial to investors and other interested parties. However, in some
circumstances, it is not appropriate for auditors to perform both audit and
certain nonaudit services for the same client. In these circumstances, the
auditor, the client, or both will have to make a choice as to which of these
services the auditor will provide. These concepts, which we strongly believe
are in the public?s interest, are reflected in the revisions to auditor
independence requirements for government audits, 2 which GAO recently issued
as part of Government Auditing Standards. 3 The new independence standard
has gone through an extensive deliberative process over several years,
including extensive public comments and input from my Advisory Council on
Government Auditing Standards. 4 The standard, among other things, toughens
the rules associated with providing nonaudit services and includes a
principle- based approach to addressing this issue, supplemented with
certain safeguards. The two overarching principles in the standard for
nonaudit services are that:
2 Government Auditing Standards: Amendment No. 3, Independence (GAO- 02-
388G, January 2002). 3 Government Auditing Standards was first published in
1972 and is commonly referred to as the ?Yellow Book,? and covers federal
entities and those organizations receiving federal funds. Various laws
require compliance with the standards in connection with audits of federal
entities and funds. Furthermore, many states and local governments and other
entities, both domestically and internationally, have voluntarily adopted
these standards.
4 The Advisory Council includes 20 experts in financial and performance
auditing and reporting drawn from all levels of government, academia,
private enterprise, and public accounting, who advise the Comptroller
General on Government Auditing Standards.
GAO- 02- 742R Accounting Profession Issues Page 8 auditors should not
perform management functions or make management
decisions, and auditors should not audit their own work or provide
nonaudit services in
situations where the amounts or services involved are significant or
material to the subject matter of the audit.
Both of the above principles should be applied using a substance over form
doctrine. Under the revised standard, auditors are allowed to perform
certain nonaudit services provided the services do not violate the above
principles; however, in most circumstances certain additional safeguards
would have to be met. For example, (1) personnel who perform allowable
nonaudit services would be precluded from performing any related audit work,
(2) the auditor?s work could not be reduced beyond the level that would be
appropriate if the nonaudit work were performed by another unrelated party,
and (3) certain documentation and quality assurance requirements must be
met. The new standard includes an express prohibition regarding auditors
providing certain bookkeeping or record keeping services and limits payroll
processing and certain other services, all of which are presently permitted
under current independence rules of the AICPA. However, our new standard
allows the auditor to provide routine advice and technical assistance on an
ongoing basis and without being subject to the additional safeguards.
The focus of these changes to the government auditing standards is to better
serve the public interest and to maintain a high degree of integrity,
objectivity, and independence for audits of government entities and entities
that receive federal funding. However, these standards apply only to audits
of federal entities and those organizations receiving federal funds, and not
to audits of public companies. In the transmittal letter issuing the new
independence standard, we expressed our hope that the AICPA would raise its
independence standards to those contained in this new standard in order to
eliminate any inconsistency between this standard and their current
standards. The AICPA?s recent statement before another congressional
committee that the AICPA will not oppose prohibitions on auditors providing
certain nonaudit services seems to be a step in the right direction. 5
The independence of public accountants is crucial to the credibility of
financial reporting and, in turn, the capital formation process. Auditor
independence standards require that the audit organization and the auditor
be independent both in fact and in appearance. These standards place
responsibility on the auditor and the audit organization to maintain
independence so that opinions, conclusions, judgments, and recommendations
will be impartial and will be viewed as being impartial by knowledgeable
third parties. Because independence standards are fundamental to the
independent audit function, as part of its mission, the new statutorily
created body, which we previously discussed, should be responsible for
setting independence standards for audits of public companies, as well as
have the
5 Testimony of AICPA Chairman before the House Energy and Commerce Committee
(Subcommittee on Communications, Trade and Consumer Protection), February
14, 2002.
GAO- 02- 742R Accounting Profession Issues Page 9 authority to discipline
members of the accounting profession that violate such
standards.
FINANCIAL REPORTING
Business financial reporting is critical in promoting an effective
allocation of capital among companies. Financial statements, which are at
the center of present- day business reporting, must be timely, relevant, and
reliable to be useful for decisionmaking. In our 1996 report on the
accounting profession, 6 we reported that the current financial reporting
model does not fully meet users? needs. More recently, we have noted that
the current reporting model is not well suited to identify and report on key
value and risk elements inherent in our 21 st Century knowledge- based
economy. The SEC is the primary federal agency currently involved in
accounting and auditing requirements for publicly traded companies but has
traditionally relied on the private sector for setting standards for
financial reporting and independent audits, retaining a largely oversight
role. Accordingly, the SEC has accepted rules set by the FASB- generally
accepted accounting principles (GAAP)- as the primary standard for
preparation of financial statements in the private sector.
We found that despite the continuing efforts of FASB and the SEC to enhance
financial reporting, changes in the business environment, such as the growth
in information technology, new types of relationships between companies, and
the increasing use of complex business transactions and financial
instruments, constantly threaten the relevance of financial statements and
pose a formidable challenge for standard setters. A basic limitation of the
model is that financial statements present the business entity?s financial
position and results of its operations largely on the basis of historical
costs, which do not fully meet the broad range of user needs for financial
information. 7 Enron?s failure and the inquiries that have followed have
raised many of the same issues about the adequacy of the current financial
reporting model, such as the need for additional transparency, clarity, more
timely information, and risk- oriented financial reporting.
Among other actions to address the Enron- specific accounting issues, the
SEC has requested that the FASB address the specific accounting rules
related to Enron?s special purpose entities and related party disclosures.
In addition, the SEC Chief Accountant has also raised concerns that the
current standard- setting process is too cumbersome and slow and that much
of the FASB?s guidance is rule- based and too
6 The Accounting Profession: Major Issues: Progress and Concerns (GAO/ AIMD-
96- 98, September 24, 1996). 7 The accounting and reporting model under
generally accepted accounting principles is actually a mixed- attribute
model. Although most transactions and balances are measured on the basis of
historical cost, which is the amount of cash or its equivalent originally
paid to acquire an asset, certain assets and liabilities are reported at
current values either in the financial statements or related notes. For
example, certain investments in debt and equity securities are currently
reported at fair value, receivables are reported at net realizable value,
and inventories are reported at the lower of cost or market value. Further,
certain industries such as brokerage houses and mutual funds prepare
financial statements on a fair value basis.
GAO- 02- 742R Accounting Profession Issues Page 10 complex. He believes that
(1) a principle- based standards will yield a less complex
financial reporting paradigm that is more responsive to emerging issues, (2)
the FASB needs to be more responsive to accounting standards problems
identified by the SEC, and (3) the SEC needs to give the FASB freedom to
address the problems, but the SEC needs to monitor projects on an ongoing
basis and, if they are languishing, determine why.
We generally agree with the SEC Chief Accountant?s assessment. We also
believe that the issues surrounding the financial reporting model can be
effectively addressed by the SEC, in conjunction with the FASB, without
statutorily changing the standardsetting process. However, we do believe
that a more active and ongoing interaction between the SEC and the FASB is
needed to facilitate a mutual understanding of priorities for standard-
setting, realistic goals for achieving expectations, and timely actions to
address issues that arise when expectations are not likely to be met. In
that regard, the SEC could be directed to:
reach agreement with the FASB on its standard- setting agenda, approach to
resolving accounting issues, and timing for completion of projects;
monitor the FASB?s progress on projects, including taking appropriate
actions to resolve issues when projects are not meeting expectations; and
report annually to the Congress on the FASB?s progress in setting
standards, along with any recommendations, and the FASB?s response to the
SEC?s recommendations.
The Congress may wish to have GAO evaluate and report to it one year after
enactment of legislation and periodically thereafter on the SEC?s
performance in working with the FASB to improve the timeliness and
effectiveness of the accounting standard- setting process. Accordingly, we
suggest that the Congress provide GAO access to the records of the FASB that
GAO considers necessary for it to evaluate the SEC?s performance in working
with the FASB.
The FASB receives about two- thirds of its funding from the sale of
publications with the remainder of its funding coming voluntarily from the
accounting profession, industry sources, and others. One of the
responsibilities of the FASB?s parent organization, the Financial Accounting
Foundation, is to raise funds for the FASB and its standard- setting process
to supplement the funding that comes from the FASB?s sale of publications.
Some have questioned whether this is the best arrangement to ensure the
independence of the standard- setting process. This issue has been raised by
the appropriateness of certain accounting standards related to
consolidations, that the FASB has been working on for some time, applicable
to Enron?s restatement of its financial statements as reported to the SEC by
Enron in its November 8, 2001, Form 8- K filing. However, the issue has
previously been raised when the FASB has addressed other controversial
accounting issues, such as accounting for stock options. We believe that the
FASB should have mandatory sources of funding to remove the appearance of
any independence issues related to funding FASB. Therefore, the Congress may
wish to task the SEC with studying this issue and
GAO- 02- 742R Accounting Profession Issues Page 11 identifying alternative
sources of mandatory funding to supplement the FASB?s sale
of publications, including the possibility of imposing fees on registrants
and/ or firms, and to report to the Congress on its findings and actions
taken to address the funding issue.
CLOSING COMMENTS The United States has the largest and most respected
capital markets in the world. Our capital markets have long enjoyed a
reputation of integrity that promotes investor confidence. This is critical
to our economy and the economies of other nations given the globalization of
commerce. However, this long- standing reputation is now being challenged by
some parties. The effectiveness of systems relating to independent audits
and financial reporting which represent key underpinnings of capital markets
and are critical to protecting the public?s interest, has been called into
question by the failure of Enron and certain other events and practices.
Although the human elements can override any system of controls, it is clear
that there are a range of actions that are critical to the effective
functioning of the system underlying capital markets that require attention.
In addition, a strong enforcement function with appropriate civil and
criminal sanctions is also needed to ensure effective accountability when
key players fail to properly perform their duties and responsibilities.
The accounting profession?s self- regulatory system has not effectively
fulfilled its responsibilities. In addition, the current model whereby the
SEC oversees various self- regulatory organizations in connection with
financial reporting and auditing has not worked well, especially in
connection with audits of public companies. Further, the SEC is not staffed
to take on a more direct role in regulating the accounting profession nor
has the SEC strategically managed its limited resources well. Therefore, we
strongly believe that a new independent body, created by statute to regulate
audits of public companies, is needed in order to better protect the
public?s interest. However, currently we do not believe that it is necessary
or appropriate for the government to assume direct responsibility for
financial reporting. We do, however, believe that the Congress should
provide the SEC with direction to address the issues concerning financial
reporting as we have previously discussed.
In summary, Enron?s recent sudden collapse, coupled with other recent
business failures and certain other activities, pose a range of serious
issues concerning the accounting profession and financial reporting that
should be addressed. The fundamental principles of having the right
incentives, adequate transparency, and full accountability provide a good
sounding board to evaluate proposals that are advanced. In the end, no
matter what improvements are made to strengthen the oversight and
independence of the accounting profession and enhance the relevancy and
transparency of financial reporting, bad actors will do bad things with bad
results. We must, however, strive to take steps to minimize the number of
such situations and to hold any violators of the system fully accountable
for their actions.
GAO- 02- 742R Accounting Profession Issues Page 12 We would be pleased to
meet with you or other members of the committee to answer
any questions that you may have or to provide further assistance. Sincerely
yours,
David M. Walker Comptroller General of the United States
Enclosure
GAO- 02- 742R Accounting Profession Issues Page 13 ENCLOSURE 1 ENCLOSURE 1
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Public regulation
Financial reporting Enforcement
* Boards of directors
Audit committees
Management responsibilities for
- Financial reporting - Internal controls - Compliance with
laws and regulations - Code of ethics Publicly traded
companies Private sector regulation
Financial audits and consulting services Broker dealers
NASDAQ Independence standards for auditors of SEC registrants
Delegated responsibility
FASB Corporate
governance
FAF
Self- regulatory organizations
e. g. NYSE NASD SEC
Public accounting
firms NYSE exchange
Direct Responsibility Delegated Responsibility Oversight
Individual Investors
Institutional Investors Banks and Lenders (creditors) Rating Agencies
Public Interest
Effective Financial and Capital Markets
State boards of accountancy
ASB PEEC SECPS
(Peer review)
AICPA POB
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