Risk & Compliance

PCAOB Can’t Bark, Suggests Crafty Way to Bite

Board urges managers to put the squeeze on accounting firms. Also: SEC supports principles-based accounting, approves SRO rules; many companies req...
Stephen Taub and Craig SchneiderAugust 4, 2003

Under the Sarbanes-Oxley Act, the Public Company Accounting Oversight Board (PCAOB) cannot publicly reveal problems it uncovers at an accounting firm if the firm fixes the problems within 12 months. To say the least, this is not a popular feature among investors who want to know about sloppy auditing practices or lack of independence from clients, notes The Washington Post.

Now two PCAOB members have suggested a way to circumvent those restrictions. Kayla J. Gillan and Willis D. Gradison Jr. are “urging corporate directors to force accounting firms to turn over their inspection reports in order to win or keep the companies’ business,” reported the paper.

PCAOB chairman William J. McDonough did not comment on the proposal, although he did confirm he had talked to many people about the ban and understood that Congress was trying to create an incentive for the accounting firms to quickly address their deficiencies, according to the Post.

In other business at its most recent meeting, the PCAOB said it is already scrutinizing the four major accounting firms and plans to perform annual reviews of firms that audit more than 100 public companies. It will review smaller firms that audit public companies every three years, according to the report.

The board added that special emergency teams can conduct quick investigations in the event of an audit blowup or corporate scandal.

Under the proposals, auditing firms and accountants who are registered with the oversight board could be punished for breaking securities laws, failing to reasonably supervise other accountants, or refusing to cooperate with an investigation, according to the Post.

Disciplinary proceedings would be private, however, unless both sides consented to opening the proceedings to the public. Auditors and their firms could be suspended or barred from auditing public companies, hit with monetary penalties, forced to submit to independent monitoring, or required to undergo more training.

The PCAOB also said it is currently in discussions with the European Union and with Japanese and Canadian officials, all of whom oppose many of the board’s attempts to extend their regulatory reach overseas, according to Reuters.

For example, a number of months ago the PCAOB voted to require not only U.S.-based auditing firms, but also non-U.S. firms auditing companies listed on U.S. public markets, to register with the board.

“We have very active discussions taking place with the European Commission, with Canada, and with Japan. Very shortly we’ll have them with Australia,” McDonough reportedly told reporters after the board’s meeting. “I have full faith that we will be able to work out with the people outside the United States that we can carry out our responsibilities…without creating international difficulties.”

“None of this applies unless the foreign company is listed on an American exchange,” noted Sen. Paul Sarbanes (D-Md.) last week, according to Reuters. “It’s their act of coming into our capital markets that places them under the umbrella.”

SEC Supports Principles-Based Accounting

The Securities and Exchange Commission has prepared a staff study that supports the adoption of a principles-based accounting system. This approach relies more on broadly applied principles and less on specific, detailed rules.

The SEC staff study, prepared by the Office of the Chief Accountant and the Office of Economic Analysis, was submitted last week to the Senate Committee on Banking, Housing, and Urban Affairs and the House Committee on Financial Services. It recommends that new standards should:

  • Be based on an improved and consistently applied conceptual framework;
  • Clearly state the accounting objective of the standard;
  • Provide sufficient detail and structure so that the standard can be operationalized and applied on a consistent basis;
  • Minimize the use of exceptions from the standard;
  • Avoid use of percentage tests — so-called bright lines — that allow financial engineers to achieve technical compliance with the standard while evading its intent.

The study, ordered under the Sarbanes-Oxley act passed last summer, “endorses an approach to setting accounting standards that should result in investors receiving more transparent information about a company’s financial results and position,” said SEC chairman William Donaldson in a statement.

“Objectives oriented” is the term that the SEC will use for this approach to principles-based standard setting. Standards would clearly establish the objectives and the accounting model for the class of transactions, while also providing management and auditors with a framework that is sufficiently detailed for the standards to be operational, maintains the SEC.

“An objectives-oriented approach should ultimately result in more meaningful and informative financial reporting to investors and also would hold management and auditors responsible for ensuring that financial reporting complies with the objectives of the standards,” adds the commission.

The SEC points out that the Financial Accounting Standards Board has begun the shift to objectives-oriented standard setting and is doing so on a prospective, project-by-project basis. It adds that it expects the FASB will continue to move towards objectives-oriented standard setting on a transitional or evolutionary basis.

(Read more about how U.S. and international standard-setters are trying to get “On the Same Page.”)

SEC Approves SRO Rules

Last week the Securities and Exchange Commission announced the approval of a series of self-regulatory organization research analyst rules with “clear guidelines” to promote the independence and objectivity of research.

The rules, developed with the New York Stock Exchange and the National Association of Securities Dealers, are among a series of regulatory actions taken recently to promote integrity in research. On April 28, 10 of the nation’s largest financial institutions agreed to pay $1.4 billion and implement internal reforms to settle allegations that they wrote positive equity research reports in exchange for investment banking business.

The approved rules include the following:

  • Separation of research analyst compensation from investment banking influence;
  • Prohibiting research analysts from participating in “pitches” or other communications to solicit investment banking business;
  • Extending quiet periods for all firms involved in offerings;
  • Prohibiting “booster shot” research reports in and around lock-up expirations;
  • Added disclosure of compensation arrangements between firms and issuers;
  • Prohibiting retaliation against research analysts who publish reports or makes public comments that may adversely affect investment banking business;
  • Registration, qualification, and continuing education requirements for analysts;
  • Notifying their customers when they end research coverage of a company.

Many Companies Ask for Subcertification, Says a Study

The Sarbanes-Oxley Act requires CFOs and CEOs — and no one else — to certify their company’s financial statements.

That’s the law. The reality, however, is that many companies are asking other financial professionals to vouch for reported information as well, according to a survey by the Association for Financial Professionals. The AFP gathered responses from 425 corporate practitioners and 130 other financial professionals.

About one-third of financial professionals who provide information used in their company SEC filings are asked to “subcertify” the documents by signing an affidavit, the AFP found.

Clearly, these lower-level professionals take the process very seriously and respect the potential legal ramifications of their actions. Of respondents who are asked to sign an affidavit, nearly 80 percent expressed a “high” or “moderate” level of concern about their liability.

Another 21 percent have sought counsel from their company’s attorney and 2 percent from a personal attorney.

“I believe the prevalence of subcertification, while a direct result of Sarbanes-Oxley, reflects the increased level of importance that financial professionals hold within their companies,” said Jim Kaitz, AFP’s president and CEO, in a statement. (For more on the growing influence of one group in particular, read “Command and Controllers.”)

“Greater accuracy in financial reporting and increased accountability will ensure that most companies are honest and report earnings accurately,” added Kaitz. “This knowledge will ultimately lead to a more stable economic environment.”

FASB Finalizes Guidance on VIEs

The Financial Accounting Standards Board has posted five final staff positions on FASB Interpretation No. 46, Consolidation of Variable Interest Entities, or VIEs (which previously were often referred to as special purpose entities, or SPEs). The five staff positions offer guidance on the following:

  • Applicability of Interpretation 46 to entities subject to the AICPA Audit and Accounting Guide, Health Care Organizations;
  • Reporting variable interests in specified assets of variable interest entities as separate variable interest entities;
  • Application of paragraph 5 of Interpretation 46 when variable interests in specified assets of a variable interest entity are not considered interests in the entity under paragraph 12 of the intepretation;
  • Transition requirements for initial application of the interpretation;
  • Calculation of expected losses.

(For more on off-balance-sheet financing, read our special reports on “The Future of SPEs.”)