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We've heard rumblings that since companies are spending so much time on 404, they're neglecting growing their businesses.
I've heard that. I don't think there's a whole lot to it. CFOs and their staffs will undoubtedly be spending a lot of time on 404. But I don't really know any documentable cases in which the strategic future of the company is being adversely affected. I suppose I could waggishly say, "Well then, they ought to spend weekends working on one and the rest of the week working on the other."
How can you be so sure that 404 passes the cost-benefit test?
In getting the right cost-benefit relationship, there is going to be some tugging and pushing between the audit committee and the outside auditor. The audit committee might say, "We really want you to do a lot of testing," and then there's nothing to discuss. On the other hand, the auditor might say, "We need to do this much testing," and the audit committee will say, "We don't really see that." But at the end of the day, the auditor has to say, "[This] is what we have to do to attest." We don't expect the auditor to either run up hours or be difficult. It's a judgment that we expect to be rational.
Some people are concerned that many companies will fail these audits.
I don't think anybody knows that until we get into them. Another thing no one knows is whether there will be cases where the auditor gives a clean opinion on the financial statement, but not on the internal-control assessment. Nor do we know the reaction of the marketplace. Would it be, "Oh my gosh, tank the stock!" or "This is the first year of 404; that's not too surprising"?
Personally, I am a believer in rational markets. I think markets will distinguish [between] cases in which a company just isn't very well managed [and cases in which] a company has work to do, but it will probably get a clean opinion next year. Right now, though, everybody is afraid of the unknown.
What would you say if there were no failures?
[I'd say,] "So what?" If an audit firm could say, "We have done a really thorough job of our attestation work, and each and every issuer gets a clean opinion," then that's OK with me.
There are rumors that quotas will guarantee that some companies fail.
If an audit firm has quotas, I think it's nuts. We certainly don't have any quotas.
Many CFOs also believe that 404 has tipped the scales firmly in favor of the audit firms. Is that your view?
We have made it very clear to the audit firms that 404 is not the way that they can afford to send all of their grandchildren to Harvard. The law establishes new requirements for attestation, which clearly are going to be a new expense for companies. But the amount of work they've done should be reasonable and justified. That is why I expect the audit committee not to roll over dead, but rather to have a meaningful discussion with the outside auditors on how much work is needed. It's like auditing a financial statement: at the end of the day, the auditor has to decide if it gets a clean opinion or not. So while I don't think 404 inappropriately shifts the balance of power to the audit firms, we do not expect auditors to be using it inappropriately to enrich their firms.
As a former CFO yourself, what responsibility do you see finance chiefs now having in the audit process?
The CFO has traditionally been the corporate officer with major responsibility for dealing with the outside auditors. This role will and should continue, but it will also have to change. The audit committee, and particularly the chairman of the audit committee, now has the primary corporate-governance relationship with the outside auditors. I believe the CFO should have as open a relationship as possible with both the chairman of the audit committee and the engagement partner. The goal is to have highly reliable financial statements for the good of investors and the general public. That is also in the clear interest of the issuer.
Finally, what kind of grade would you give the PCAOB at this juncture?
The PCAOB has been in business for just over a year and a half. When I joined on June 11, 2003, I was person number 42 on the rolls. For a start-up with a massive responsibility to the public, I give us as high a grade as one can imagine. With the superb staff we have assembled, I expect to keep meriting that high grade. A colleague once described me as "the most demanding man who ever lived," so I do not give high grades easily.
Audits: How Bad Is Bad?
This month, the Public Company Accounting Oversight Board will publish edited findings of its 2003 limited number of inspections of accounting firms. Those inspections unearthed "significant audit and accounting issues," said PCAOB chairman William J. McDonough, testifying before the House Capital Markets Subcommittee in late June. "We found some situations where their issuing clients...did not appear to follow generally accepted accounting principles."
The Big Four received draft reports outlining the PCAOB's charges and were given 30 days to respond. Any appeals, however, must be made to the Securities and Exchange Commission, "because the SEC is in charge of accounting policy, not the PCAOB," says McDonough. At the same time, the firms are under no obligation to make the infractions public as long as they clean them up during the next 12 months.
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