Current Issues in Public Accountancy

New York State Senate Higher Education Committee Public Testimony

Introduction

Good morning Chairman LaValle and other distinguished members of the Senate Higher Education Committee. It is an honor and a pleasure to have the opportunity to speak with you today. Several years ago, this committee and other key Legislators recognized the need to update and modernize the Education Law that governs the licensure and practice of the public accountancy profession in New York. The State Education Department and the State Board for Public Accountancy have recognized this critical need and are pleased that we have been a part of the numerous public hearings and round table discussions that the Senate Higher Education committee and other Legislators have held on the many important issues concerning the practice of public accountancy.

In 1998, prompted by a series of lawsuits initiated by American Express against a number of states, the Education Law was strictly interpreted to confer authority over public accountants only when they performed an audit, but not when they performed non-audit services such as tax, estate planning, and a full range of these "peripheral" services. Accordingly, we immediately asked the legislature to introduce a bill to clarify that public accountants are accountable for the full scope of professional services that they offer the public, and not only for audits. This was particularly important given the evolution of the services offered by CPAs and PAs today. Unfortunately, legislation did not pass, and shortly thereafter our attention was broadened by the major financial disasters that left thousands of Americans unemployed while millions witnessed the impact that corporate bankruptcies had on the value of their pension and profit sharing plans. These financial disasters led to the enactment of the federal Sarbanes-Oxley Act of 2002, the most sweeping federal reform legislation affecting the governance and oversight of auditors of publicly traded companies since 1934. We encourage the legislature to continue to assess how this federal legislation should apply in New York State.

Today's news headlines reflect a different story with a common theme that touches us more than the financial disasters that occurred in Texas, Mississippi and elsewhere. Today, financial scandals within public interest entities, including public authorities, not-for-profit corporations and school districts are in the news. The common theme is conflict of interest for personal gain.

We are not here today to discuss the recent Office of the State Comptroller's audit findings regarding auditor independence and school district audits. We cannot discuss the details of specific investigations underway. However, we can say that we worked closely with the Nassau County District Attorney and the Office of the State Comptroller in the Roslyn School District case. That investigation is based upon the Department's existing authority to investigate cases of substandard audit practice, including audits of school districts. We take our responsibility very seriously and are aggressively investigating this case of alleged misconduct.

We also applaud consideration of the five point plan developed by the Comptroller and the Department, and urge your support of the Department's budget request for funding additional staff in the Office of Audit Services to audit districts on a more frequent basis and review annual school district audits, in close coordination with the Office of the State Comptroller.

New York's Regulatory Structure Over CPA Firms

The New York State legislature has entrusted the Board of Regents with the responsibility for licensure and regulation of the public accountancy profession, through provisions in the Education Law. The Rules of the Board of Regents apply to all New York licensed certified public accountants (CPAs) and public accountants (PAs). Existing Rules relating to the profession of public accountancy make it prosecutable unprofessional conduct for licensees to engage in conflicts of interest while performing professional services within the definition of public accountancy. Specifically, section 29.10(a)(5) states that unprofessional conduct in the practice of public accountancy includes:

"Expressing an independent opinion or knowingly permitting his or her firm to express an opinion on financial statements of an enterprise, whether such enterprise is a for-profit or a not-for-profit enterprise, if the licensee or a partner or employee in the firm is not independent with respect to such enterprise. Independence will be considered to be impaired if the public accountant, or a partner in the firm, owns or is committed to acquire any direct or material indirect financial interest in the enterprise or had a direct or material indirect financial relationship with any officer, director, employee or principal stockholder of the enterprise. Independence will be considered to be impaired if the licensee, a partner in the firm or a member of his or her or the partner's immediate family, is or has been a director or officer of the enterprise, or is or has been involved in any situation creating a conflict of interest, during the period covered by the examination or at the time of issuance of a report."

The Regents and the Department have followed a dual strategy of working with the Legislature to seek legislation to strengthen public accountancy oversight statutorily while simultaneously seeking to expand regulatory oversight provisions within existing law by revising the Rules of the Board of Regents that define the unprofessional conduct of CPAs and PAs. Those efforts led to the following amendments to the Regents Rules to strengthen public accountancy oversight:

Ethics Continuing Education

Recognizing the evolving practice climate, the Regents adopted an amendment to the Commissioner's Regulations that requires all registered accountants to participate in four hours of continuing education focused on ethics during each three-year registration period beginning September 1, 2001. Sustained focus on professional ethics through continuing education supports the objectivity, integrity and independence of the accounting profession, and is highly relevant to preventing the ethical lapses that contributed to several highly publicized corporate failures.

Records Retention

One of the most disconcerting actions reported to have occurred in the Enron-Andersen scandal was the intentional destruction of documents that could serve as critical evidence in subsequent criminal prosecutions and/or professional disciplinary actions. Effective January 3, 2003, an amendment to the Rules of the Board of Regents established uniform standards for work paper documentation and retention for attest and compilation engagements in the practice of public accountancy. The amendment ensures that work papers that support attest and compilation engagements are maintained for a minimum of seven years and that such work papers contain adequate documentation.

Consistent with its statutory authority, the Department and the State Board for Public Accountancy are currently working on a series of regulatory reforms that would allow professional misconduct prosecutions after final federal sanctions following an SEC investigation and rules that would require the reporting of specified events that may trigger an investigation by the Department. The proposed amendments also establish in the regulations standards relating to reports licensees must submit to the State Education Department if convicted of a crime or similar offence and to improve the process for license endorsement as a certified public accountant in New York. The Department and the State Board for Public Accountancy have reached consensus on the provisions contained of the Regents Priority Legislation and the regulatory amendments being considered by the Department. Both the statutory and regulatory reforms are needed to improve oversight of the profession and ensure meaningful public protection.

We have provided the Legislature with the Department's comments and input regarding the many legislative proposals that have been introduced into the Legislature over the past few years. We hope that you will consider a legislative proposal that addresses the many necessary reforms in the public accountancy profession. These legislative and regulatory reforms are outlined and discussed in a recent information item presented to the Board of Regents in December 2004, entitled, "A Reasoned Approach to Reform in Public Accountancy."

During the past several years, we have had numerous conversations with federal and state regulators, consumer groups, professional organizations and licensees to listen and participate in the ongoing dialogues focused on reforming the oversight mechanism for the public accountancy profession. The existing Education Law provides oversight of the core attestation and compilation services but does not address the evolution of the practice and the inherent conflicts of interest. Based on these communications, we again reaffirm that New York's laws will be incomplete and the public is not protected until it is clear that licensed CPAs are accountable for all of the services that they provide, ranging from audits to tax preparation, estate planning, bookkeeping services, and all other peripheral services. These provisions need to be enacted immediately because they are right and are needed now to protect the public and the integrity of the profession.

Additionally, we urge the Legislature to consider the central issues that have contributed to recent audit failures as it contemplates reform legislation affecting the public accountancy profession during this legislative session. Some of these proposals are in S. 302-d, while others should be added. These proposals fall into three areas: conflicts of interest that have undermined auditor independence because of a focus on selling non-audit services to audit clients; reportable events that would better inform the regulatory environment; and, better resources to investigate and prosecute unprofessional conduct. The first two are addressed by the federal legislation and deserve consideration, but adequate resources are a cornerstone of meaningful oversight over the public accountancy profession.

Adequate Investigatory Resources

Oversight in the public accountancy profession is unique in New York because the Regents regulate not only individual licensees, but also the firms through which they practice. The largest firms, known as the "Big 4" are the largest public accounting firms in the world. Three of the four firms maintain their worldwide headquarters in New York City. These firms have thousands of partners and tens of thousands of employees worldwide. Each firm generates in excess of $10 billion in revenue annually. In addition to the Big 4 firms, there are a significant group of mid-size firms that also practice internationally, as well as, national, regional and local practitioners that maintain offices and practice in New York.

The regulation and oversight of the large firms, including individuals employed by those firms, presents considerable challenges due to the extensive, ever-fluctuating investigative and legal resources required to pursue large matters. These impediments are further compounded by the state's procurement process, the need to hire outside expert consultants, the lengthy legal procedural timelines and the significant staff resources required to meet all the requirements of the state's administrative procedures act.

Confirming and proving an audit failure by a large firm is a rigorous undertaking and investigations of complex audit engagements can consume several years and cost millions of dollars. For example, the State of California spent in excess of $1.8 million dollars prosecuting the auditors in the Orange County bankruptcy case and the State of Arizona spent more than $600,000 prosecuting the Baptist Foundation case a few years ago.

To meet the growing challenges of pursuing large matters, the Department needs a technically proficient staff of investigative CPAs and access to technical consultants on complex accounting issues. Under the existing budgetary scheme, any large-scale investigation must be supplemented by outside consultants. Existing resource limitations would preclude or severely hamper the Department from actively investigating and prosecuting a large firm case.

Given the complex technical accounting issues that arise in large firm cases, it is critical that the Department's Office of Professional Discipline enforcement staff include a sufficient number of investigative CPAs who are skilled at both accounting and enforcement.

In response to the financial disasters, Congress increased the budget of the U.S. Securities & Exchange Commission by $298 million and added as additional 840 new staff. Congress also created the PCAOB with a staff that is projected to exceed 450 in 2005. Currently, regulators in the State of California have an annual enforcement program budget for complex case matters of $2 million and are seeking legislative authority to obtain funding flexibility to extend its complex case appropriation authority over a 24-month period. The California Board is also seeking the reinstatement of one of its investigative CPA positions and is seeking the creation of three new investigative CPA positions. The California board noted that the three new investigative CPA positions would review new, expanded reportable events information, initiate investigations where determined appropriate, and to liaison with national and federal entities relative to their investigative activities and development of professional standards.

In contrast, the State Education Department needs a unit that includes complex case appropriation authority with investigative CPAs.

To address the core changes to regulating large firms and achieve the full benefit of the reform legislation, the Regents Priority Legislation includes a provision for the establishment of a public accountancy oversight group that would incorporate the resources necessary to appropriately investigate and prosecute large firm cases. The public accountancy oversight group would consist of a prosecutor, investigative team and investigative and board office support staff required to adequately undertake a large firm matter and properly implement the proposed legislative reforms. These positions would be funded entirely through the increased volume of individual and firm registration fees generated by the reform legislation.

How does the profession feel about providing the Department with additional resources? At your February 6, 2002, public hearing, the New York State Society of CPAs stated that it supports enhancing the Department's capacity and resources. According to their written testimony, "The New York State Education Department Office of Professional Discipline is woefully understaffed and needs additional staff and more resources to perform their duties of investigation and discipline. The disciplinary process must reinforce the ethics code of the profession and the laws of New York State and ensure compliance by registrants and providers of continuing professional education standards."

Senate 302-d (2004)

During the last two Legislative sessions, we know that the Senate has worked arduously to update and modernize the public accountancy statute. S. 302-d contains several important reform provisions that respond to the needs of contemporary practice. However, we believe that some important modifications are needed to enhance public protection and the oversight of this profession. Your office has recently shared drafts of a revised bill upon which we look forward to commenting in detail. Today, I will only highlight four major areas in that regard.

Scope of Practice

S. 302-d contains a revised definition of the scope of practice of public accountancy that broadens the definition of services beyond the core attestation and compilation services to include other peripheral services including tax preparation and advisory services, financial planning and advisory services, management consulting services. This is VERY important and we thank you for including this major provision. As drafted, however, the language in S. 302-d references services performed by the licensee only while "holding out" under a professional title and "for compensation received or to be received." Consistent with the Regents Priority Legislative proposal, the Department believes that the references to "holding out" as a licensee and "in consideration of compensation received or to be received" limits the Department's ability to regulate licensees who knowingly choose not to use their "CPA" or "PA" designations when providing professional services or when licensees offer pro bono services to the public.

Many licensees have made strategic business decisions to eliminate the term "public accounting firm" from their firms' name to better reflect the broad array of professional services provided to the public. Many firms have also eliminated the designation "CPA" or "PA" from their employees' business cards. These actions have further complicated the Department's ability to prove that licensees or firms are practicing within the definition of the practice of public accountancy. Similarly, exempting licensees and firms from regulation if they provide services pro bono do not protect the public. Often, it is the entities that receive the pro bono professional services that need the greatest protection.

Investigations and Discipline

Section 7403-a of Senate bill S. 302-d establishes profession-specific "speedy trial" provisions that are problematic because of the limited resources under which the Office of Professional Discipline currently operates. The Department regulates over 675,000 licensees and resolves over 8,000 complaints of professional misconduct annually. Without a massive infusion of resources, including the establishment of a public accountancy oversight group, these provisions, which would serve to protect only public accountants from professional misconduct prosecutions, would create havoc for a discipline system involving 44 professions. We believe that the establishment of a Public Accountancy Oversight Group, including adequate funding, as outlined in the proposed Regents Priority legislation is a prerequisite to enacting "speedy trial" provisions. Otherwise, we would urge consideration of imposing these speedy trial provisions across all of the professions with an investment similar to that made for physicians. Under that system, $20 million is allocated for the discipline of approximately 50,000 physicians annually, as opposed to the Education Department's annual allocation of approximately $34 million for the licensure, regulation, and discipline of over 675,000 licensees.

Mandatory Continuing Education

S. 302-d amends existing Education Law to require all licensees, including those employed in private industry, government and academia, to participate in mandatory continuing education. The Department agrees with this provision, believing that all licensees should participate in mandatory continuing education as part of their continuum of learning during their professional careers. Current demographics in the public accountancy profession indicate that approximately 50% of all licensees are employed in private industry, government or academia and are currently eligible to claim an exemption from mandatory continuing education. S. 302-d, however, contains an additional provision that eliminates the 24-hour concentrated learning option available to licensees who participate in continuing education. In 1987, the Legislature funded a $675,000 study of continuing education in public accountancy. Among other things, the study concluded that individuals participating in concentrated learning in excess of 24 hours did not retain significantly more information than those participating in 24 hours of continuing education. No other profession licensed and regulated by the Regents participates in as many hours of mandatory continuing education as does the public accountancy profession. Licensees must participate in a minimum of 24 hours per year or 72 hours every registration period (three years). In contrast, the profession with the next highest continuing education requirement is podiatry with a 50-hour requirement every three years.

The quality of the education programs, not the quantity of hours will result in better public protection. Each month, the staff of the state board for public accountancy performs audits of licensees and registered continuing education sponsors to determine compliance with the Education Law and the Regulations of the Commissioner of Education to maintain a consistent quality of continuing education learning.

While requiring each of these licensees to take 40 or more hours of continuing education each year would be beneficial to registered continuing education sponsors, the Legislatively funded study concludes there is no benefit to this requirement. The cost of requiring 40 hours of mandatory continuing education per year could have significant economic burden on the public, licensees employed in government or private industry, and small firm practitioners. For example, one credit of continuing education coursework could cost in excess of $46 per hour or more than $735 annually. Over a three-year registration period, a licensee could expect to pay more than $2,200 if the 40-hours of general studies is the only continuing education option.

Recently, one continuing education provider that would benefit from a 67% increase in mandatory hours noted that they disagreed with the findings of the Education Department study; however, they offered no reasonable explanation for their conclusion. Drawing from the recent financial disasters in Texas and Mississippi, where 120 hours of continuing education are required, one can see that there is no correlation between number of hours of continuing education and the quality of one's practice.

Mandatory Peer Review

S. 302-d includes participation in mandatory peer review as an additional oversight mechanism. We believe that a quality review of registered firms is a necessary element of public protection, but several revisions are necessary to enhance this proposal. Among other things, the bill stipulates that a reviewer selected from a roster of qualified peer reviewers established by a statewide or national professional accounting organization will conduct a peer review. The bill also contains a provision that an inspection conducted by the Public Company Accounting Oversight Board (PCAOB) shall be deemed to comply with the mandatory peer review requirement contained in S. 302-d.

In 1988, the American Institute of Certified Public Accountants amended its bylaws to require all AICPA members engaged in the practice of public accounting to practice with a firm that is enrolled in an approved practice-monitoring program. This program was established and conducted in cooperation with the state CPA societies and was focused on education of its membership in an attempt to enhance the quality of audit engagements.

An outcome of the Enron disaster was a determination that the AICPA peer review model provided insufficient public protection and Congress, as part of the Sarbanes-Oxley Act of 2002, established the PCAOB to conduct inspections of auditors of publicly traded companies. As part of its regulatory responsibility, the PCAOB determined that its inspection of registered firms was not the same as a peer review conducted in accordance with AICPA standards. Based on this conclusion, we believe that the provision providing that a PCAOB inspection shall be deemed to comply with the mandatory peer review requirement be removed from S. 302-d. Instead, we believe that a clear distinction must be drawn between a peer review program conducted for the benefit of a membership organization and a quality review program. Designed to ensure enhanced public protection, these quality reviews would have reviewers approved by the Department conduct reviews and report substandard practice to the Department.

We thank you for the opportunity to continue to discuss these provisions and others with your office as the drafting process continues.

Regents Priority Legislative Reform Proposals

The Department and the State Board for Public Accountancy have been working on a public accountancy reform bill since the late 1990's. This bill broadens the definition of the scope of practice of public accountancy and updates the practice provisions contained in Education Law. In 2003, recognizing the significance of these issues to the public and the profession, the Regents elevated the legislative proposal to a Regents Priority Legislative proposal.

The Regents Priority Legislative proposal:>

• Revises the scope of practice for certified public accountants/public accountants (CPA/PA) to reflect the realities of modern practice. Oversight of CPAs would be extended to cover all professional services rendered by a licensee, including tax preparation, advisory services, financial planning and other services that go unregulated under existing Education Law. Further, unlike other proposed definitions of the scope of practice of public accountancy, the Regents Priority Legislation clarifies that licensees would be regulated whether or not they hold out to the public as CPAs or PAs and if they performed pro bono services for the public.
  
  
• Requires all firm types to register with the Department. The proposed bill updates Education Law to require sole proprietorships or any other form of organization that is lawfully engaged in the practice of public accountancy to register with the Department.
  
  
• Allows for practice through substantial equivalency. A CPA licensed by and in good standing in another jurisdiction may be granted the right to practice public accountancy in New York, if his/her state of licensure is deemed by the Department to have licensure requirements substantially equivalent to New York. As part of the notification process, the licensee must acknowledge that s/he may be subject to Regents disciplinary action for unprofessional conduct while practicing in New York.
  
  
• Mandates participation in mandatory continuing education for all CPAs, even if employed in private industry, government or academia and broadens the areas of concentrated learning. The proposed bill would require all licensees, with limited exceptions, to participate in mandatory continuing education. Consistent with the conclusions of a 1987-1990 Legislatively funded study; CPAs and PAs would have the ability to choose to participate in 40 hours of general studies or 24 hours of concentrated learning each year.
  
  
• Requires all accounting firms that provide financial statement services to undergo an independent quality review at least every 3 years. The quality review process enables licensees, independent of the firm undergoing quality review, to review, assess and report on the firm's quality control process and professional work product. Substandard work found during a quality review would be reported to the Department for investigation and possible disciplinary action by the Regents.
  
  
• Establishes profession specific penalties for professional misconduct since public accountancy may be the only profession in which national or multi-national firms with thousands of partners practice the profession. Public Accountancy is unique among the professions licensed and regulated by the Board of Regents in that it is the only profession that includes firms with thousands of owners with national and international operations generating billions of dollars in revenue each year. The current disciplinary system fails to acknowledge the complexity of the existing practice environment. We believe the disciplinary structure must be adapted to be consistent with the evolution of the accountancy profession.
  
  
• Establishes a Public Accountancy Oversight Group consisting of CPA investigators, prosecutors and support staff to accomplish the proposed new provisions of the bill. The proposed legislation also includes a funding mechanism. The oversight group will be funded entirely by dedicating a portion of public accountancy registration fees and disciplinary fines and penalties. This funding mechanism will not require new State General Fund dollars. This proposal recognizes the complexities of the public accountancy profession and provides the necessary resources to augment the additional responsibilities contained in the proposed legislation.

Conclusion

An individual becomes licensed as a certified public accountant by meeting rigorous education, examination and experience requirements. The public engages a CPA because they trust that the services provided will meet the high standards of the profession. That trust is based on the public's knowledge that licensees are held accountable for the services the licensee provides.

The dramatic expansion of services provided to the public requires an amendment to Education Law to clarify the scope of practice definition and give the State jurisdiction over all services provided to the public by CPAs and PAs. The New York State Board of Regents, the State Education Department and the State Board for Public Accountancy have long supported the tenants of the accountancy profession and continue to do so in pursuit of our mission to protect the citizens of New York State and the integrity of the public accountancy profession. The authority granted to the Regents is not taken lightly. The Regents, the Department, and the State Board for Public Accountancy have diligently worked to maintain New York's practice standards.

The legislature recognized as early as the 1800's that Public Accountants needed to be licensed professionals since the work they do is so important to the health, safety and welfare of our State and it's citizens. Never before has that been so clear, as today, while we are all affected by the audit failures that are becoming common place in the media. Thank you for continuing your relentless pursuit of reform efforts to bring the relevance of New York's regulatory framework into the 21st Century.

Thank you for the opportunity to meet with you today and participate in this most important discussion. We look forward to continuing our work with you and your colleagues in the Legislature to enhance the oversight of this vital profession in New York, the financial capital of the world.