VideoInvestors have already been attempting to reduce the ties between public companies and their auditors this proxy season, says Ann Yerger, a director of research at the Council of Institutional Investors. A handful of shareholder proposals to eliminate all nonaudit service contracts with auditors made it onto corporate proxies this spring. Several were withdrawn after discussions with management yielded a compromise, but a few, including proposals at Walt Disney and Motorola, drew shareholder support in the range of 40 percent.
At Motorola, the Sheet Metal Workers National Pension Fund proposed that the company sever all nonaudit service contracts with its auditor, KPMG. Last year, Motorola paid the firm $19 million — only $4.1 million of which was for audit work. Thanks to a large IT implementation, the audit fees paid to KPMG in 2000 were only $3.9 million of a total bill of $62.3 million. Motorola spokesman Scott Wyman says the company had already committed to discontinuing IT consulting, internal audit, and financial transaction-structuring contracts with its auditor prior to the March 29 shareholder vote. It may have to further curtail its business with KPMG in the coming year.
Many companies are paying extra attention to their relationships with auditors these days. Beth Farbacher, senior vice president and general auditor for Pittsburgh-based health insurer Highmark, says that all internal proposals to use the company's auditor, PricewaterhouseCoopers, for nonaudit work have to be cleared with her first. "I'm sensitive to any engagement that presents a conflict of interest in fact or appearance — particularly in the financials or systems area," says Farbacher, who reports directly to the audit committee of Highmark's board of directors. In some cases — actuarial services, for example — Farbacher says the auditor has a base of knowledge that gives it an advantage over other providers. "It puts them in a position to make better assumptions or to poke holes in our assumptions," she says. The new restrictions in the reform bill, however, will likely force Farbacher to find another firm to perform Highmark's actuarial work.
Joe Martin, CFO of Fairchild Semiconductor, has to choose a new provider of internal audit services for his South Portland, Maine-based company. His auditor, KPMG, has performed the function up until now. "I have no problem with the new rules. We've seen it coming for a couple of years," says Martin, who has also hired KPMG for such other services as human resources management and appraisal work. He has recently been interviewing alternative providers. "It's been convenient to do one-stop shopping [with KPMG]," says Martin. "Now it's just going to be a little less convenient."
A notable exception to the new service restrictions is tax work — the assumption being that issues of tax are so intertwined with accounting and financial reporting that separating the two could jeopardize the quality of audits. Other nonaudit services, however, are also essential to the audit work, says PricewaterhouseCoopers global CEO Samuel DiPiazza Jr. "To perform good audits, we need more skills than just forensic accounting," he asserts. Specifically, DiPiazza suggests that general accounting skills, tax planning, risk management, and security analysis are all vital competencies for auditors to possess. "All these elements are embedded in the financial statements. If we legislate against providing these services, we could end up with poorer audits," he warns.
The new restrictions on the provision of nonaudit services don't resolve all conflicts of interest. The fact that clients foot the bill for their audits and can readily take their business elsewhere creates a basic conflict to begin with. But the new ground rules will at least reduce the appearance of conflicts of interest. "If we're going to rebuild trust in financial reporting, these things are needed," says Professor Mulford.
Bringing the Watchdogs to Heel
When Congress gave the task of setting accounting standards to the newly created SEC in 1934, it left the job of overseeing auditing standards and individual firms to the accounting profession. For the past 65 years, the job has been performed by the AICPA and its predecessor organization.
Industry self-regulation, however, has often meant no regulation. The recently dissolved Public Oversight Board, established by the AICPA to monitor the conduct of auditors and funded by the industry, had little power to enforce standards and discipline wayward audit firms. When it did examine audit failures and factors that may have compromised auditor independence, the industry simply threatened to cut off its funding. "The profession has resisted meaningful self-regulation for decades," says Sutton.
The successor to the old POB, the Public Company Accounting Oversight Board will be funded by mandatory fees from public companies and will operate under the oversight of the SEC. It is charged with establishing audit, independence, and ethical standards for auditors; investigating auditor conduct; and imposing penalties.
Formerly, auditors under investigation by the AICPA oversight board could simply refuse to participate. The new board will have the same subpoena powers as the SEC to bring auditors to the table. But its effectiveness will depend largely on the aggressiveness of the members chosen by the SEC to serve on it. Of the five members, only two can be current or former accountants.
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