By Jeffrey M. Brinn

Analyze this:
Earlier this year, U.S. Securities and Exchange Commission Chairman Harvey Pitt proposed that Judge William Webster become chairman of the new Public Company Accounting Oversight Board (PCAOB) created under the Sarbanes-Oxley Act of 2002. Pitt discussed Webster’s background with SEC Chief Accountant Robert Herdman, including the dismissal of BDO Seidman by U.S. Technologies, an SEC registrant whose audit committee Webster then chaired. The dismissal of Seidman followed the firm’s sending a negative letter to U.S. Technologies’ audit committee regarding internal controls and related matters.

EITHER (1): Herdman, presumably after reading the disclosures in related Form 8-K filings under Item 4, in compliance with Regulation S-K Item 304, did not recognize the significance of this sequence of events, and did not advise Pitt that such action by an audit committee chaired by Webster reasonably disqualified him from serving in the post Pitt was considering him for.

OR (2): Herdman did in fact advise Pitt, but the chairman did not inform the other SEC commissioners, who then voted three to two to appoint Webster—action later followed by the disclosure of the nondisclosure by Pitt. This led to Pitt basically investigating himself, followed a few days later by his election-night resignation.

THEN (3): Webster declared that he considered himself fit for the task for which he had been selected.

NEXT (4): A few days later Herdman resigned.

FINALLY (5): Webster resigned and Pitt, still serving as a lame duck chairman, proclaimed the judge nevertheless well qualified for the post he had just resigned.

WEBSTERGATE: What an extraordinary chain of events, despite the precise order not being clearly known. Of course the Emerging Issues Task Force would not consider these events extraordinary under Accounting Principles Board Opinion No. 30, probably because there were five of them and, therefore, they were not unusual.

Question: Where does this leave the SEC and the PCAOB, both now without chairmen, and the latter of which is facing the Congressionally imposed “required sufficiency date” of April 26, 2003?

What effect will this vacuum at the top have on the various target dates for implementing different aspects of the Sarbanes-Oxley Act? Will the SEC be declared in contempt of Congress or will Congress amend the act and effectively give the SEC and the PCAOB an extension?

What happened? How did the most “trusted profession” become a highly regulated industry?

Clearly it was an accumulation of sins, not just limited to Andersen clients: Sunbeam, Waste Management, Enron and, finally, WorldCom, ultimately the biggest fraud in history, approaching or exceeding $10,000,000,000 (that’s ten billion dollars), with nationwide investor losses from all the accounting scandals and related investor mistrust measured in the trillions.

Who is to blame? Who was asleep at the switch? Who failed to live up to the sacred trust given to them by Congress through the SEC almost seven decades ago? It was the auditor, the last line of defense!

It was a pervasive culture of what was euphemistically called “accommodations,” or favors that were granted to clients for basically continuing to be clients. Rather than use our years of training to propose and require adjustments to accounts that were misstated, many of us learned we were to use our knowledge and our skills to justify not requiring adjustments to financial statements that we were certifying. Often this was done under the guise of such misstatements not being material, certainly not material to the income statement, particularly when we considered the effect of adjustments waived in the prior period, which would have reversed in the current year.

When auditors who had reached management level in the audit firms they worked for left those firms and went to publicly held clients, they knew the accommodations were there to be had. Every executive wanted his share. This phenomenon was fueled by the instantaneous worldwide dissemination of information, the power ceded by the registrants to the analysts, the obsession with attaining or exceeding estimated earnings forecasts, and the riches derived from risk-free stock options, which certainly did not align the interests of management with stockholders, but, rather, caused top executives to fixate entirely on the short term.

Our ethical precepts had one overriding rule. Forget the problem with auditing one’s own work, making too many journal entries, combining the trial balance accounts into financial statement captions or writing footnotes. CPAs are taught to hold one thing above all else: When in the practice of public accountancy, never subordinate our judgment to that of another!

Now the Financial Accounting Standards Board is considering whether it should move to a “principles-based” system of accounting rather than the “rules-based” system that has evolved. Certainly FASB has not put itself in the best possible light when a pronouncement such as Statement 125 allows nonconsolidation of a 97-percent-owned entity. But to blame the profession’s problems on FASB is as shortsighted as the former Big Five were last New Year’s Eve day when they circulated a petition to the SEC, presented on mock SEC stationery, requesting that the SEC issue rules requiring greater disclosure when there is nonconsolidation of off-balance sheet entities, and also requiring more transparent disclosure of transactions with other than clearly independent parties. Any reader of the MD&A requirements in Item 303 of Regulation S-K, or Regulation S-B, for that matter, knows that those matters already were required for discussion.

The problem lies not in accounting or disclosure requirements, but in compliance with auditing standards. At a recent New York State Society of CPAs’ committee meeting, several experienced audit practitioners expressed doubt about moving to a principles-based accounting system, fearing that those who prepare financial statements could have too much leeway in selecting and applying measurement standards, with auditors lacking the power to ensure a fair presentation in accordance with generally accepted accounting principles. But auditors have always had that power, because it is their signature that certifies the financial statements. A third of a century ago, Leonard Spacek, the accountant widely credited with bringing Arthur Andersen into the modern age, made this cogent point while testifying at open hearings regarding the use of “discovery value” accounting in the petroleum industry, when he said that fairness of presentation is the most important consideration.

Finally, in trying to turn the CPA profession into a supermarket of financial services, the American Institute of CPAs neglected the true auditing franchise, and stood idly by while the auditing profession lost the public’s trust. Those of us who continue to practice as auditors must reclaim that trust.

Analyze that!

The 2003 SEC/FASB Conference will be held on Jan. 28, 2003, at the Sheraton New York Hotel in Manhattan, and will feature several experts on the Sarbanes-Oxley Act of 2002, critical recent FASB statements, and SEC reporting initiatives, as well as SEC Corporation Finance Chief Accountant Carol Stacey and others.