Public Accountancy

Current Issues in Public Accountancy

Public Oversight Board Testimony

Good morning Chairman O'Malley and other distinguished members of the Panel on Audit Effectiveness. It is an honor and a pleasure to meet with you today. At no other time during its 104-year history as a licensed profession has the accounting profession been faced with as many individually significant issues at one time. Issues that may literally determine the future of the profession as we know it today.

Over the next two days, you will hear the pros and cons of many of the Panel's recommendations and why various proposals are important to the public accountancy profession. You will hear from the largest public accounting firms and the profession's membership organization, all of which focus on increasing revenue and profits. The primary goal of the Board of Regents, the New York State Education Department (SED) and the New York State Board for Public Accountancy, however, is public protection.

My testimony will address the following critical public policy concerns that will have the greatest impact on the public and the integrity of the profession:

• An independent system of governance unified under the POB
• The role of state boards of accountancy
• The impact of non-audit services
• Internal control systems of audit firms and the disciplinary system for the profession, and Audit firm structures

In 1896, New York became the first state to license certified public accountants. Since that time, the New York State Board of Regents, an independent lay board, has been responsible for the oversight of the accounting profession in New York. The Board of Regents acts through the State Education Department. The New York State Board of Accountancy, consisting of 22 voluntary members, advises the Regents and the Department on issues critical to effective regulation of the profession.

Research has confirmed that lay oversight best protects the public, primarily because that system effectively balances the public interest with good professional practice. This supports the Panel's assertion that the Public Oversight Board have a majority of public members whose primary purpose is to serve the public.

Independence, objectivity, and integrity are the traditional core values of the profession. Every CPA knows the value of independence. The profession is built upon it, and it is what ensures the integrity of the profession. Today, certified public accountants commit to high standards of practice by participating in continuing education programs and, in some instances, quality review. The public engages a CPA because they trust that the services will reflect the high standards associated with profession. That trust is also based on the public's knowledge that CPAs are accountable for their professional services.

The profession is also defined by its system of self-regulation. The current self-regulatory structure of the profession evolved primarily from the Securities Act of 1933 and the Securities Exchange Act of 1934. The purpose of creating a self-regulatory system of regulation was to instill public confidence in the reliability and accuracy of financial information provided by independent auditors. This self-regulatory system supports but does not supplant the authority of public (government) regulators. During the last 24 years, numerous studies and committee reports have found the evolution of the self-regulatory structure inadequate.

In 1976, the United States Senate's Metcalf subcommittee issued a report entitled The Accounting Establishment. The report detailed an "alarming lack of independence and lack of public protection" in the accountancy profession. The report identified core weaknesses in the self-regulatory structure that threatened the very backbone of the profession: independence.

Concerns over independence were echoed 20 years later in a report issued by the U.S. Government Accounting Office (GAO). The GAO noted that the accounting profession had made attempts to ensure the integrity of its self-regulatory system, ranging from changes in the structure for setting accounting and auditing standards to instituting a quality control system for audit firms. Nonetheless, the report also stated that "the accounting profession needs to be attentive to the concerns over independence in considering the appropriateness of new services to ensure that independence is not impaired and the auditor's traditional values of being objective and skeptical are not diminished."

When you review the conclusions of the Metcalf report against the realities of the current regulatory structure, you will see that the vast improvements envisioned in 1976 have met with only moderate success. A regulatory mechanism that draws upon independent qualified public members is essential. Just as the judgement and work of the independent auditor must be dedicated to the public interest, so too must the profession's regulatory structure.

We agree with the Panel's recommendation that the auditing profession's system of governance be unified under a strengthened Public Oversight Board charged with the responsibility to oversee standard setting, monitoring, discipline, and special reviews. To be effective, the POB must truly be independent of the firms and membership organizations that it is charged to regulate. Some suggest that the POB be incorporated as a separate non-profit foundation to reduce its dependency on the professional membership organizations and firms that would fall under its jurisdiction. This suggestion has merit. Regulatory bodies serve only one master, the public. Recently, the AICPA's SEC Practice Section suspended funding for the special "independence look back testing program" until an agreement could be reached on the scope, timetable and work plan of the project; this is a prime example of a third party attempting to influence the work of an oversight board. If the POB were reconstituted under the current funding mechanism, it too would lack the appearance of independence, which is critical to public confidence.

The establishment of an independent funding mechanism for the POB is an essential first step. Beyond that, we also believe that staff associated with the Accounting Standards Board, the Independent Standards Board, the SECPS Executive Committee, SECPS Quality Control Inquiry Committee, the SECPS Peer Review Committee, the Professional Issues Task Force and the SEC Regulations Committee must be full time employees of the POB housed in POB offices. Similarly, those chosen to serve in volunteer leadership positions of these committees must do so objectively, free of outside influence and in the public's best interest. This is essential in maintaining the POB's credibility with the public.

The Panel's report briefly discusses the role of the state boards of accountancy in the public regulation of CPAs and accounting firms. We believe that it is important to highlight the role that the state boards play within all regulatory structures of the accountancy profession. State boards of public accountancy are the only entities empowered by state law to license public accountants. Similarly, state boards are the only entities that can discipline licensees for practicing public accountancy with gross incompetence or gross negligence with the ultimate penalty being the revocation of a professional license. Yet, the current system of regulation fails to link the self-regulatory structure with public regulators. We strongly believe that state boards of accountancy must serve in an ex officio capacity, similar to the SEC, in the revised self-regulatory structure. In addition, state boards of accountancy must be involved in any dialog to revise the profession's independence rules.

While the Panel focused on the needs of publicly traded companies, the proposed structure must recognize that professional oversight can not be limited to those that service these companies. The mechanism established to secure the independence of the audit firm must also consider the impact those changes will have on the entire auditing profession. We suggest that the POB consider an expanded role that encompasses auditors of both publicly traded companies and closely held businesses either within the self-regulatory framework or in partnership with the state boards of public accountancy.

The number and types of professional services offered by accounting firms have increased dramatically during just this decade. While the Panel could not reach a consensus on the effects on auditor independence of non-audit services, we believe that the movement into investment banking, legal, and other services conflicts with auditor independence and therefore, does not serve the public interest.

There are two problems with the trend toward increased non-audit services and multidisciplinary practices. First, the audit partner is placed in the position of "selling" the firm's highly lucrative consulting services. Second, auditors are engaged to perform an independent audit for the benefit of the investing public. Management advisory services, on the other hand, are provided for the benefit of management. Will the auditor's independence be impaired if she/he is placed in the position of auditing the firm's consulting work? At the very least, is appearance of a lack of independence sufficient justification to prohibit such services to audit clients? We believe the answer is yes because even the appearance of impropriety denigrates the profession and over time could destroy the profession. We strongly support the tenants of the U.S. Securities & Exchange Commission's proposal to establish independence rules that promote public confidence in the reliability and integrity of audited financial statements.

It is also time to reassess the effectiveness of the internal control systems of audit firms. This action will ultimately improve the quality of independent audits and maintain the confidence of the investing public. The current peer review system is flawed because it is performance based, focusing on the audit firm's quality control structure. It does not consider the conduct of the individuals employed by the audit firm. It is interesting that just three years after the issuance of the GAO report we have witnessed multiple violations of the profession's independence rules and the inadequacy of the audit firm's quality control structure at one major multinational accounting firm's. The failure of quality control systems undermines the public's trust in the entire public accountancy profession as well. We suggest that any revisions made to the existing peer review structure consider the auditor's personal conduct as well as the quality of the firm's audit practice.

It is also time to revise the disciplinary system for the profession. The current system of enforcement lacks an effective process for providing licensing jurisdictions with timely information on investigations. Due to member confidentiality issues, the current disciplinary mechanism impairs the timely resolution of matters that impact the primary users of audited financial statements - the public. An improved mandatory reporting system that provides necessary information to the SEC and state boards of accountancy would enhance public protection and the integrity of the profession.

While the Panel did not explore the move toward non-licensee ownership of accounting firms, we believe that trend also bears close examination. The growth of jurisdictions permitting non-licensee ownership is occurring at a time when serious questions have been raised about audit firms' quality control systems and auditor independence. Proponents of non-licensee ownership of professional accounting firms suggest that there is a need to provide one-stop shopping to clients and a need to keep the best and brightest non-licensees in-house to provide new product lines to clients. We have seen little evidence that the public craves one stop shopping or multi-disciplinary accounting firms. We are concerned that an ever-expanding menu of services offered by audit firms of all sizes, coupled with non-licensee ownership of accounting firms, benefits the firm's "bottom line" but not the public interest.

On April 21, 1999, the New York State Board for Public Accountancy voted to recommend the continued prohibition of non-CPA ownership of accounting firms. The Department opposes non-licensee ownership because of the strong potential to undermine professional judgment of CPA's and their independence within a firm.

As for arguments that this places firms at a competitive disadvantage, I note that the New York Board of Regents addressed the need for CPA firms to hire and reward non-licensee consultants in 1987 by adding Section 29.10(b) to the Rules of the Board of Regents. This section of the Rules provides a mechanism that permits a CPA firm to share up to 35% of its annual net income with non-licensees. This broadens a firm's ability to attract and retain talent in today's multifaceted firm. Many issues must be explored when considering non-licensee ownership. We believe that the POB could provide the appropriate forum to explore this important issue.

In summary, we support an independent system of governance unified under the POB that recognizes the role of state boards of public accountancy. It is essential that a reconstituted POB closely monitor those professional services and audit firm structures that impair the independence of the auditor, in fact or in appearance. The POB must develop a disciplinary system that links the self-regulatory structure to the state board of public accountancy. This is critical for the public trust and is in the public interest. I thank you for the time you have given us to share our perspective on these important issues.