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Investor Protection

To Be or Not To Be?

Mary-Jo Kranacher, MBA, CPA, CFE

Whenever regulators, standards setters, and legislators take steps to protect the investing public, controversy is often close behind. Measures taken in the wake of the last wave of financial scandals continue to be challenged, and reform initiatives inspired by the current crisis are facing political opposition even before they can take shape.

Challenging Regulation

In September 2005, the Public Company Accounting Oversight Board (PCAOB) reported that it was investigating Beckstead and Watts LLP, a small Nevada CPA firm that audits publicly traded companies. According to the report, there were “deficiencies” in eight of the 16 audits conducted by the firm and investigated by the board. The PCAOB has since halted its investigation.

Beckstead and Watts and the Free Enterprise Fund, a nonprofit advocacy organization that champions economic freedom and limited government, filed a lawsuit against the board to prevent it from taking further action against the firm, on the grounds that the creation of the PCAOB violated the separation of powers established in the U.S. Constitution. The crux of their argument rests on the provision in the Sarbanes-Oxley Act of 2002 (SOX) that the five board members are appointed by the SEC, not the president, and they can only be terminated “for cause.” This, they contend, violates the Appointments Clause, which was intended to ensure accountability.

Arguments in the case were heard before the U.S. Supreme Court on December 7, 2009. A successful challenge to the legitimacy of the board, combined with the lack of a severability clause, could potentially bring about the demise of the entire Sarbanes-Oxley Act and the investor protections it sought to establish.

In the firm's response to the inspection report, Beckstead and Watts discussed the impact that SOX has had on the firm's ability to compete:

  • Among other things, SOX has added many layers of additional audit steps and documentation requirements, resulting in increased audit process time and increased audit fees above the levels which many small business issuers can bear. … When the “Big Four” accounting firms double their fees, their multi-national clients absorb the costs; when we double our fees, our clients go out of business. (www.pcaobus.org/Inspections/Public_Reports/2005/Beckstead_and_Watts.pdf, p. 11)

As I read this statement, it reminded me of the variety of issues brought about by our system in which the client directly pays the auditor. In past editorials, I have shared my thoughts on ways to remove the inherent conflict of interest in this system. One possible solution would be to use an intermediary to 1) collect the audit fee from publicly traded companies based on the size and scope of the audit to be conducted, and 2) manage a registry of auditing firms that are qualified to conduct those audits. This could also alleviate auditor concentration in the large public company market. According to a 2008 Government Accountability Office (GAO) report, “The largest accounting firms audit 98 percent of the more than 1,500 largest public companies—those with annual revenues of more than $1 billion.”

Standards Setting

Recently, FASB Chairman Robert H. Herz expressed his belief that standards setting should be “decoupled” from regulators' need to protect the economic wellness of financial institutions. Lest we forget, the primary purpose of standards setting is to provide guidelines by which companies will present relevant, transparent, and unbiased financial reporting information to investors, creditors, and other stakeholders so they can make informed economic decisions. There are other effective mechanisms that regulators can use to improve the stability of our financial system, such as reinstituting the provisions of the Glass-Steagall Act (see “Bring Back Glass Steagall,” by Louis Grumet, The CPA Journal, December 2009) and strengthening the capital requirements for financial institutions.


In December 2009, the House of Representatives passed the Wall Street Reform and Consumer Protection Act. Its publicized intent is to overhaul our nation's financial regulatory system. Its provisions include creating a new federal agency dedicated to consumer protection, establishing a council of regulators to monitor the economic environment for systemic risks, providing for oversight of the derivatives market, and increasing transparency of credit-rating agencies, among other things.

However, what our legislators give with one hand, they take with the other; the bill exempts nonaccelerated filers—those with market values of less than $75 million—from the internal control requirements of SOX section 404(b). It also authorizes the PCAOB to exempt auditors of small broker-dealers from the registration and inspection requirements. Final legislation is far from imminent, though; the Senate has not yet decided on its bill, which will likely differ significantly.

The best intentions of regulators, standards setters, and legislators have been riddled with political pitfalls that threaten to undermine investor protections. Are we prepared to make some difficult, long-overdue choices to protect the investing public? That is the question.

As always, I welcome your comments.

Mary-Jo Kranacher, MBA, CPA, CFE. Editor-in-Chief.

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