SEC’s Hewitt: Indemnify the Big Four

The SEC's chief accountant calls for auditor protection, and putting the "P" back in GAAP.
Stephen TaubJanuary 26, 2007

The chief accountant of the Securities and Exchange Commission wants the major accounting firms to be shielded from legal liability if their audit clients become embroiled in accounting-related scandals. Speaking at a Northwestern University legal conference in San Diego on Thursday, SEC chief accountant Conrad Hewitt said he is concerned about potential auditor liability because there are only four major accounting firms operating, according to Dow Jones.

“It’s a concern to us if something should happen to any of the four firms,” Hewitt told the audience, according to the wire service. “Something can be done, and should be done, for the accounting profession” to limit exposure to lawsuits, he added. In his speech, Hewitt recommended that accountants consider asking Congress for new protections, the wire service noted.

Asking for liability shields for auditors is not unprecedented. Hewitt told the audience that several European countries already limit auditors’ liability, while Great Britain is considering adding certain caps on damages.

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Meanwhile, the Big Four are mounting their own effort to limit liability. In November, the firms — PricewaterhouseCoopers, Ernst & Young, Deloitte & Touche, and KPMG — issued a report on the benefits of real-time financial reporting that also promoted limiting auditor liability. Then in December, the Big Four announced that they aimed to minimize exposure to liability lawsuits by requiring companies they audit to limit their right to sue. The auditor-independence rules of the SEC currently prohibit companies from indemnifying their auditors in civil suits; however, the rule does not specifically address waivers.

Critics of the waiver effort spoke out against the Big Four, saying that making accountants less liable will also make them less vigilant. At the time, five U.S. banking agencies were preparing to bar large banks from agreeing to these clauses. In addition, by January, the Committee on Capital Markets Regulation called on Congress to look carefully at “the case for caps on liability or safe harbors to prevent the failure of another auditing firm” like Arthur Andersen.

Parts of the auditor liability debate focus on the role that complex U.S. accounting standards play in audit opinions. Indeed, many audit firms argue that when they use professional judgment to interpret complex standards, it opens them up to lawsuits. Hewitt addressed the complexity issue earlier this week when he talked about working with accounting industry groups to begin a project “to eliminate unnecessary complexity in financial reporting.”

In a speech delivered in Washington, D.C., Hewitt said he was hoping to get input from several organizations, including the Financial Accounting Standards Board, the Public Company Accounting Oversight Board, the American Institute of Certified Public Accountants, and the Financial Executives Institute. “The more I am involved with our accounting standards, the more I am convinced that we need to eliminate standards that are overly complex, difficult for issuers to implement without extensive outside assistance, and that are difficult for the average investor to understand,” he added.

Hewitt said he also would like to see an independent body headed by a prominent person launch the project. “The study should probably focus on what created the need, if any, for our complex financial reporting standards and on solutions to the underlying issues that create those complexities,” he asserted. Currently FASB is involved in a similar effort to simplify accounting standards and financial-statement presentation.

Regarding the standard-setting process, Hewitt suggested that the project task force should create guidelines that would result in more understandable and transparent information for users, while balancing the costs involved and time needed to implement standards. “Maybe we should get back to the ‘P’ in GAAP, instead of using rules for our standards,” he stated, referring to U.S. generally accepted accounting principles, the guidelines used by American companies. “As you know, there is no ‘R’ in GAAP.”