Regulations and Oversight in the Public Interest
Interview with SEC Chief Accountant Donald T. Nicolaisen
Robert H. Colson
Chairman William H. Donaldson announced the appointment
of Donald T. Nicolaisen, CPA, as the commission’s
chief accountant in August 2003. Nicolaisen oversees the
SEC’s accounting policy initiatives and leads its
efforts with national and international standards setters
on critical accounting and auditing issues. He also works
closely with the Public Company Accounting Oversight Board
(PCAOB) to ensure that auditors adhere to the highest business
and ethical standards.
was previously a senior partner at Pricewaterhouse- Coopers
LLP, where he held a range of management and leadership
positions after joining the firm’s predecessor, Price
Waterhouse, in 1967. From 1988 to 1994, he led Price Waterhouse’s
national office for accounting and SEC services. During
that time, he was also a member of FASB’s Emerging
Issues Task Force (EITF).
met with CPA Journal Editor-in-Chief Robert Colson at the
SEC’s Washington, D.C., office in late 2003.
The Role of the Chief Accountant
CPA Journal: What is the dominant item on your agenda as
the new chief accountant?
Donald T. Nicolaisen: Narrowing it down to
one thing is difficult, but broadly, it’s helping
investors be better informed and restoring investor confidence
through reforms that improve the financial reporting process.
This includes reform in the accounting and auditing profession,
which the Sarbanes-Oxley Act has already catalyzed. The
audit process must be improved, and investors deserve financial
statements that are more transparent and easier to understand.
This starts at the top of the organization and will involve,
in many cases, a cultural change. In addition, there is
an expectation gap between what the auditor is required
to do and what the public expects the auditor to do. This
gap needs to be addressed. Auditors must step up to the
plate and better explain their role.
the OCA [Office of the Chief Accountant] staff comprises
talented people, fully dedicated to quality financial reporting
and investor protection. Together, I am confident that we
will achieve our goals.
How would you characterize the problems you inherited on
entering the chief accountancy?
Nicolaisen: Individual and corporate greed
has strained the system and created excesses and abuses
that have led to unethical and sometimes criminal behavior.
In some cases, excessively detailed accounting rules have
given those who choose to abuse the system a means to achieve
better-looking numbers in financial statements by circumventing
the fundamental principles behind the rules.
SEC staff recently released a study on principles-based
accounting standards. The report supports objectives-oriented
standards, which will provide a better framework in which
to exercise professional judgment and may help facilitate
compliance with the intent of the standards. Such a change,
where judgments are required and appropriately exercised,
will go a long way toward improving the corporate reporting
How do you combat the “parsing the rules” mentality?
Nicolaisen: This is another example of how
our culture has evolved. We have a society of laws and rules,
and people—including business owners—who want
to understand what rules apply to them and how to follow
them, all of which is entirely fair. But problems arise
when the rules are stretched and transactions with little
or no underlying economic substance are entered into simply
to achieve an accounting result. In these cases, people
have crossed the line and have misled investors. Professional
accountants, whether working as preparers or auditors, recognize
that misleading investors is unacceptable, and they have
the ability to contribute to quality financial reporting.
Our challenge, and the accounting profession’s challenge,
is not only to encourage compliance with the rules but also
to inform investors about the underlying transactions and
the resulting financial picture.
area where parsing the rules has been especially troubling
is the use of SPEs [special purpose entities]. I believe
that FASB has identified the right approach in FIN 46 [Consolidation
of Variable Interest Entities, effective October 9,
2003] to address the underlying economics of such entities.
Now it’s up to the business community and accounting
professionals to apply their professional judgment and implement
What is the role of the OCA in bringing about reform?
Nicolaisen: My role is to protect investors
and maintain the integrity of our securities markets. OCA
has a number of resources at its disposal to accomplish
these goals. The bully pulpit is one such vehicle, and I
intend to use it effectively. It’s essential that
registrants and accountants understand that we’re
serious about reform. I want to be very clear: We will enforce
the laws and regulations, and people who violate the letter
or spirit should expect to hear from us.
Has the pattern of registrants or accountants bringing problems
to the OCA changed?
the chief accountant has had an open dialogue with registrants
and accountants on how to account for difficult transactions,
and I intend to continue that tradition. This approach has
worked well for all parties. But we don’t see all
the transactions we’d like to, although we often see
the extremes, sometimes after the fact. In our experience,
trade and industry groups have done an excellent job communicating
their concerns to us.
registrants and auditors to discuss questions with OCA early
in the process, before an issue has escalated into a crisis.
It’s important to understand that we don’t say
“no” to every proposed accounting treatment
brought to our attention. Nonetheless, I would caution that
if the company’s auditor is challenging the accounting,
then we’re also likely to see problems with it. In
short, we’re encouraging a more open dialogue that
begins earlier in the process.
How do you view the change in the corporate accounting culture
from an objective, scorekeeping function to a profit center?
Nicolaisen: Restoring investor confidence
will require a top-to-bottom cultural change for some entities.
Unfortunately, the profit-center culture exists in some
companies where executives place undue pressure on the accounting
function to find ways to add to the bottom line through
accounting entries rather than expecting the accounting
function to serve as the neutral reporter. Of course, many
CEOs run their businesses in the right way—by supporting
appropriate research and development programs, ensuring
quality manufacturing and distribution, and trying to earn
an honest return for their shareholders—and treat
the accounting function as an objective scorekeeper of their
successes and failures. The CEO and CFO certifications that
Sarbanes-Oxley now requires represent a big step forward,
because officers now have to affirmatively certify that
the financial statements provide an accurate picture of
results. The act of signing one’s name on such a certificate
drives home the fact that the CFO or CEO is personally vested
in the financial reporting process.
What are your thoughts about the differences between the
responsibility of officers and directors for financial statements
and that of independent auditors?
Nicolaisen: Quality financial reporting starts
with officers and directors. When public company CEOs, CFOs,
audit committees, and boards set a tone at the top that
respects and supports the integrity of the financial reporting
process, the likelihood of quality communications with investors
increases significantly. That tone at the top, starting
with the CEO managing the business, accepting his or her
stewardship of others’ investments, and the CFO reporting
on the business as a steward of others’ resources,
is vital to the entire process. Section 404 [of the Sarbanes-Oxley
Act] and other certifications will not work unless directors
and officers accept their responsibility and accountability
to investors. CEOs or CFOs who fail in these roles may find
themselves facing SEC enforcement actions. The independent
auditor’s role is to understand and challenge the
accounting and reporting of the company, serving as an objective
evaluator of both compliance and fair presentation.
Does the chief accountant have different responsibilities
for preparers and auditors?
Nicolaisen: I have high expectation of both,
and, although their roles differ, both groups have a duty
to investors and can significantly contribute to quality
financial reporting. OCA is at the hub of lots of activity
within the SEC, much of which includes the preparer community.
We also advance the Commission’s interests with the
Public Company Accounting Oversight Board [PCAOB], FASB,
IASB, and others in the international arena. FASB sets GAAP
for preparers, and the PCAOB standards serve the auditor
PCAOB is a brand-new organization, for which the SEC has
oversight responsibility, as it does for FASB. As a practical
matter, the SEC coordinates its oversight of both organizations
through OCA. The PCAOB, under Chairman Bill McDonough’s
leadership, has it exactly right: It will hold firms and
individuals to the highest level of professional and ethical
standards. Enhancing the audit process and ensuring that
firms are independent in fact and appearance is extremely
SEC is a strong advocate of the PCAOB inspection process,
which compares what firms say to what they do. We also have
experience with how registrants interpret and use accounting
principles, and we share that experience with FASB as it
strives to improve the principles underlying financial reporting.
Also, we work closely with the SEC’s Division of Corporation
Finance [Corpfin] in certain areas as it reviews registrants’
filings and issues comment letters, as well as with the
Enforcement Division on actions concerning both accounting
(preparer) and auditing issues.
CPAs’ ethics require them to follow FASB standards
in financial reporting. Should non-CPA CFOs and controllers
adopt similar ethics?
Nicolaisen: Yes. While Sarbanes-Oxley requires
CFOs to adopt ethical standards, it does not require any
specific standard or SEC approval of such a standard. It
will be interesting to see if CFOs, whether or not they
are CPAs, voluntarily adopt such rigorous standards. I think
it would be a very good thing for associations that represent
financial officers to address this in their codes of ethics,
and I would not anticipate different standards for CPAs
You talked about “tone at the top” at public
companies. What’s the appropriate tone at the top
for accounting firms?
Nicolaisen: OCA encourages firms to approach
client acceptance and retention with selectivity, retaining
those companies as audit clients that are consistent with
their ethical expectations. Senior management at the firms
sets the standards and values of their respective organizations.
For example, compensation plans are a tangible measure of
a firm’s values. If a firm doesn’t support audit
partners making tough calls and replaces them with partners
who are more accommodating, that practice will damage this
profession and the firm along with it.
director of the Enforcement Division, Steve Cutler, has
made it clear that the SEC considers individual as well
as firm accountability. Having the PCAOB inspection as part
of the process will help immensely in understanding the
tone at the top. The PCAOB’s inspectors are asking
auditors about the level of support they receive from their
firm when they make tough decisions. In cases where appropriate
support has been lacking, you can expect PCAOB action with
the full support of the SEC.
How do you deal with registrants who come to you with accounting
questions? For gray-area questions, would you tell them
specifically what to do? Alternatively, would you explain
your view of what they should consider but leave the decision
Nicolaisen: Our starting point is to consider
what’s best for the investor, and how to make the
economics of the transaction as transparent as possible
to investors. I’d want to understand the economics
of the transaction and whether the proposed accounting is
consistent with the economics. Normally, after considering
the views of the preparer, its audit committee, and the
preparer’s auditor, my staff would express its views
regarding the appropriate treatment.
course, when someone brings in a question that doesn’t
fall in a gray area, the process is shorter because I don’t
hesitate to say “yes” or “no” as
appropriate. For example, transactions that lack economic
substance and that appear to have been entered into only
to achieve an accounting result would lead to a simple “no”
The code of professional conduct positions CPAs as objective
neutrals, without primary allegiance to a specific interest,
such as management, investors, or creditors. Yet the public
expects that CPAs represent third-party users when performing
services where such users are inherent to the engagement.
Should CPAs formally address this in the code of conduct?
Nicolaisen: Without parsing words, it seems
to me that every set of audited financial statements has
a third-party user, either immediately or eventually. Having
a code of conduct that made it clear that CPAs are the users’
watchdog would have certain legal implications, but, nevertheless,
it would be a good thing. Preparers and management have
a tremendous information advantage over users. OCA’s
stance on Management’s Discussion and Analysis of
Financial Condition and Results of Operations [MD&A]
is clear: We want management to share with investors their
views about the business. The auditor can help management
in identifying appropriate disclosures.
any event, our markets work on the underlying assumption
that the auditor’s primary responsibility is to the
investor. Increasing awareness of this perspective would
also make the CPA profession more attractive to young people.
I understand that there is a resurgence of interest on campuses
in accounting precisely because young people are attracted
by the importance of auditors’ work in our capital
markets and by the ethical dimension inherent in being an
How can we increase ethics awareness among CPAs?
Nicolaisen: My experience has been that you
really learn something well when it’s part of your
work responsibilities and especially when you teach it to
someone else. Teaching ethics within the firm, or mentoring
young people in ethics, is one way for senior-level professionals
to retain ethical considerations in the forefront. Evaluating
individuals on their participation in such a mentoring program
would also increase its importance. Firms should reward
partners and staff for taking tough stands and doing the
right thing. Prompt disciplinary action can help as well.
What are your reactions to the concerns that new audit requirements,
such as the forensic tone of SAS 99 [Consideration of Fraud
in a Financial Statement Audit], could work against the
free flow of information between client and auditor?
Nicolaisen: SAS 99 could alter the tone of
the relationship between some auditors and their clients,
but it would be for the better if the result is that the
auditor is more objective, more neutral, and more discerning
about internal control and the risks of financial statement
fraud. In too many cases, auditors failed to respond critically
to inappropriate actions of their clients. The auditor’s
primary job is to remain independent in fact and appearance
and not to get “cozy” with the client. In turn,
I would expect that clients, whether private or public,
want auditors to be as tough as possible on the basics because
toughness gives their financial statements that much more
credibility. The job of the auditor is to be honest, sometimes
brutally honest, with company management. An auditor shouldn’t
be capricious or belligerent; a thoughtful, independent,
critical, and professional auditor, however, is very valuable.
If you’re going to be an auditor of a public company,
you have to place auditing and its culture first in all
things and forgo the role of advocate.
the auditor should bring issues to management and the audit
committee early in the process. An auditor fails in some
sense when management is surprised—often at the last
minute—by breaches of internal control or low-quality
and the PCAOB
What is the most important consideration when considering
Nicolaisen: In my mind, the appearance of
independence is critical. Whenever there is a potential
for a conflict of interest caused by the appearance of a
lack of independence, Sarbanes-Oxley provides a mechanism
for the audit committee to determine whether the service
should be performed or whether the auditor has compromised
his or her independence. Because the appearance of independence
is so important, auditors should disclose and discuss with
the audit committee not only services that management wants
them to perform, but also other relationships that might
arise during the ordinary course of business, such as leases
of office space or purchases of products or services.
is a difficult area, and one that will receive lots of attention
from this office and the PCAOB. Because specific facts vary,
Sarbanes-Oxley calls for full disclosure to the audit committee
and requires the audit committee to reach a conclusion.
What is your response to the SEC’s final rules on
auditors and tax services? Is the identification of permitted
services clear enough to keep auditors from becoming advocates
in this arena?
Nicolaisen: Sarbanes-Oxley permits independent
auditors to provide tax services to their audit clients
if such services are preapproved by the audit committee.
Auditors do need tax expertise, and they need to understand
the tax process in order to adequately audit a company’s
tax liabilities and uncertainties. But there are some services
for which the audit committee should be especially probing.
A recent Senate staff report analyzed several cases where
the auditor sold highly structured, highly complex, and
highly aggressive tax products to companies for significant
fees. Other audit committees have identified similar “products”
being “sold” to executives of the independent
auditor’s client. I believe that these types of services
are not consistent with either Congressional intent embodied
in the act or with the appearance of independence on the
part of the auditor.
example, I think it’s appropriate for auditors that
are also involved in tax-return preparation to explain to
their clients how they will treat certain transactions for
tax purposes, and to suggest legitimate tax strategies,
such as that the client should consider accelerated depreciation
rather than straight-line. But that kind of advice is very
different from the design of complicated, sophisticated
tax shelters that involve attorneys, investment bankers,
and auditors, often at fees significantly above hourly scales.
Auditors, in my view, should not participate in those types
How does the OCA participate in the SEC’s oversight
of PCAOB rule making?
Nicolaisen: The PCAOB discusses with OCA where
it’s headed with a standard before their board votes
to release it, and communication between the PCAOB and OCA
is appropriate. OCA’s experience base provides us
and the PCAOB with a useful perspective on how to achieve
the PCAOB’s goals. Our expectation is that OCA and
the PCAOB staffs’ positions will be reasonably close
before the PCAOB staff takes a proposal to their board.
Of course, their board and staff can always make changes,
but if the process works properly, there won’t be
any occasions when the chief accountant is unable to recommend
that the SEC adopt a PCAOB rule.
date our relationship has worked very well. Under the leadership
of Bill McDonough, the PCAOB has done a tremendous amount
of work on a tight timeframe, including hiring staff, registering
U.S. public accounting firms, promulgating a number of important
standards, and engaging in a limited inspection of the large
Would you explain the process, using the PCAOB’s section
404 attestation proposal as an example?
Nicolaisen: OCA has read the public comment
letters on the proposed rule and discussed the concerns
raised and views expressed with SEC and PCAOB staff. We
consider these comments very carefully, and I encourage
interested parties to participate in this process. In the
end, I believe the PCAOB will produce a standard that appropriately
considers all input and addresses this difficult issue.
The objective of reporting on internal controls has been
discussed as long as I’ve been a member of this profession,
so I’m excited to finally see it become a reality,
and I’m confident that the investor will benefit from
Describe your take on the differences of opinion regarding
the extent of substantive testing as part of the auditor’s
attestation on internal control.
Nicolaisen: The current debate and discussion
on the extent of auditor involvement in internal control
attestations has been healthy and useful. The PCAOB did
an excellent job issuing a proposal that would generate
the appropriate level of discussion regarding their views.
Many comment letters expressed concern with cost, and many
suggestions were offered as to how the independent auditor
might obtain satisfaction in a cost-effective manner. I
agree with the view of the PCAOB that the auditor has to
understand and test the effectiveness of controls, and I
believe the final PCAOB standard will strike an appropriate
What does the SEC plan to do when companies self-assess
as having a material weakness in internal control, and the
Nicolaisen: We’ve been discussing that
issue quite a bit. I believe that the commission will accept
internal control assessments with material weaknesses as
long as the audit opinion on the financial statements is
unqualified. We don’t want a situation where rendering
a negative opinion on internal control would by itself preclude
a company from participating in our markets. The principal
objective is to inform investors. The marketplace will decide
what it means if there is a material weakness in internal
control but the auditor’s opinion on the financial
statements is unqualified.
How would an auditor evaluate the audit committee on internal
Nicolaisen: I think for the auditor to grade
an audit committee, using A, B, or C, would be a bad idea
and would place the auditor in an awkward position. But
in implementing Sarbanes-Oxley and in considering the important
role of the audit committee, it’s hard to envision
how an evaluation of internal control would be complete
without considering the audit committee’s activities,
objectivity, and performance. There are many strong audit
committees, and I am confident that they will continue to
improve over time, in part because they will feel increasing
pressure to represent shareholders’ interests, which
include the need for complete and accurate reporting.
What’s your take on the future of the accounting profession?
Nicolaisen: In light of the recent financial
scandals, no one could claim that the auditor is irrelevant,
and the investing public and Congress have made it clear
that they value good financial reporting and high-quality
audits. To me, that translates into an expectation that
accounting and auditing should have a bright future. Many
changes under way will affect CPAs and the profession, and
that is especially true at the audit firm level.
audit firms’ near-term adjustments to the challenges
of finding the right people and developing the right expertise
to perform financial statement audits and internal control
attestations as envisioned by Sarbanes-Oxley will determine
whether accounting will be an exciting, growth profession.
From what I see now, the road may be a little bumpy, but
I am confident that the accounting and auditing profession
will emerge stronger, more independent, and that it will
offer a more rewarding career to young people who are considering
entering the profession.
What’s the role of the AICPA in the world after Sarbanes-Oxley?
Nicolaisen: The AICPA’s role has changed,
but it is a strong organization with tremendous talent and
resources. I would caution, however, that whatever role
it chooses to take in the future should not be confusing
to the public—the AICPA is no longer a regulator or
a standard setter for public company audits, and self-regulation
of those who audit public companies is a thing of the past.
However, regulation and standards setting for public company
audits aside, the AICPA has a tremendously important role
to play in training, education, supporting its members and
the rest of the profession, and representing the face of
the profession to its many constituencies. Its role with
respect to private companies is significant.
love to see the AICPA do even more in the educational area,
such as creating and distributing material like its recent
Audit Committee Toolkit. Such publications are extremely
valuable, serve the public good, and create positive impressions
of the CPA profession. The AICPA also has an important role
to play in supporting other institutions in the accounting
profession, such as the PCAOB and FASB. Working together,
the future of the accounting profession is bright.
Is the AICPA’s restructuring of the Auditing Standards
Board, to set audit standards for the private sector, helpful?
Nicolaisen: It’s too early to tell,
but I would hope that differences in auditing standards
would be minimal. From my perspective, substantially different
auditing and accounting standards for public and private
companies could be confusing and potentially counterproductive.
The PCAOB process is deliberate, open, and independent;
as a result, I would expect that the marketplace and investors
will gain confidence in their standards and that they will
be the standards most familiar to the investing public.
While the AICPA does set standards for private companies,
every bifurcation of audit standards has the potential to
confuse the public and investors about what CPAs do. Accordingly,
I would encourage cooperation between the AICPA and PCAOB.
Is it time for more consistent regulation of CPAs at the
Nicolaisen: I suspect that what state a CPA’s
license is in makes very little difference to the investing
public. Investors are looking for the assurance of a CPA’s
report on an audit of financial statements. The difference
in licensing requirements across the states does add complications,
and the Uniform Accountancy Act [UAA] hasn’t worked
well enough to encourage licensing authorities to pursue
one hand, it’s in the best interest of the investing
public to have uniform, national qualifications for CPA
licensure; on the other hand, the states clearly have an
interest in licensing professionals who practice within
their borders. Although, at the state level, passage of
a uniform law hasn’t worked, we’re at a unique
juncture in the history of the CPA profession. Thus,
it may be possible that an arrangement could be made that
would preserve the states’ legitimate interest in
licensure while serving the national interest as it relates
to CPAs’ importance to the investing public. This
is a good issue for the NYSSCPA and other state societies
H. Colson, PhD, CPA, is Editor-in-Chief of The CPA