Mary Poppins vs. the Chamber of Commerce

President Bush calls Public Law 107-204, the Sarbanes-Oxley Act of 2002, “the most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt.”

The U.S. Chamber of Commerce snarls back, “Mary Poppins!”

U.S. Representative Richard Baker, Chair of the House Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises, echoes the President: “It offers more change, breadth of change and significance of change, than any Congressional action since the 1933 and 1934 Securities Acts themselves.”

Yet Senator Phil Gramm, ranking minority member of the Senate Banking Committee, retorts, “We are probably going too far in putting people in positions where they are going to have massive unchecked authority and they have no real expertise in the subject area. … It would help to have people who know what they are doing. I don't buy the idea that people who don't know what they are doing are more moral, other things being the same, than people who do know what they are doing. … It is a dangerous thing when there are people with massive power who do not have any kind of intellectual stake in the application of that power, and it concerns me.”

What is so special about this new law? In what way does it justify the President’s optimism in proclaiming, “This law says to corporate accountants: The high standards of your profession will be enforced without exception; the auditors will be audited; the accountants will be held to account”? And how does it lead Senator Gramm to fear “massive unchecked authority” of those with “no real expertise in the subject area”?

It comes down to one word: “Independence.”

“For the first time, the accounting profession will be regulated by an independent board,” the President said as he signed the Sarbanes-Oxley Act, which establishes a 5-member Public Companies Accounting Oversight Board.

Yet how independent is this new Board, all of whose members are to be appointed by the SEC? Each proposed rule or disciplinary action determined by the Board is subject to amendment or rejection by the Commission. Any or all of the Board’s powers can be taken away by the SEC, and the Commission can completely eliminate the Board if it chooses.

So in what sense is the Public Companies Accounting Oversight Board “independent,” as the President and its legislative sponsors keep proclaiming?

In one way only – 3 of its 5 members will not be accountants. It is “independent” not of government but of the American Institute of Certified Public Accountants, the professional association for the Nation’s 350,000 CPA’s. And to those who hold the CPA credential, this is sacrilege.

U.S. Chamber of Commerce lobbyist R. Bruce Josten expressed the view of many accountants and financial experts when he said, “It seems to us Mary Poppins is incapable of doing any kind of auditing or accounting oversight.”

Yet the history of auditing regulation in this country has not shown self-regulation to be consistent or reliable in promoting public confidence in audits of public companies.

“Private-sector” is perceived as a good thing in America, especially where the economy is concerned. Both conservatives and liberals want accounting standards shielded from congressional whim (except of course for their own). So Sarbanes-Oxley is carefully crafted to present the appearance of private-sector regulation even though every Board action is subject to SEC approval or modification.

In January 2002, the members of the Public Oversight Board (an AICPA body in charge of various aspects of auditor self-regulation) voted to abolish itself this spring because the SEC, AICPA, and Big 5 accounting firms had developed a proposed new regulatory structure without even consulting the POB. This self-regulatory body found itself ignored by the power players in accounting and decided to fade away. (The SEC and AICPA developed a Transition Oversight Staff to ensure some continuity while a new system was established.)

Similarly, the Independence Standards Board that had been established in 1997 by agreement between the AICPA and SEC was abolished in July 2001, after the SEC, concerned about the slow pace of ISB activities, issued its own independence rules in November 2000.

So in a sense, self-regulation of auditors on independence issues died along with the ISB in July 2001, precisely a year before the President signed P.L. 107-204, the Sarbanes-Oxley legislation. The suicide of the Public Oversight Board this spring, transferring its auditor regulatory authority back to the SEC, marked the final end of auditor self-regulation.

Much auditor regulation will pass under the bill to the private-sector Public Company Accounting Oversight Board. But this private board will not, unlike the ISB or the POB, be part of the AICPA, and only 2 of its 5 members can be accountants. This does not make the audit industry happy.

The key question (apart from whom the SEC will appoint to the board) is whether the SEC will defer, as it has to the FASB on accounting standards, to the Public Company Accounting Oversight Board on auditing and independence standards, sanctions, and policies.

I am optimistic that it will, at least under current SEC leadership. Even without the new legislation, SEC Chairman Harvey Pitt was proceeding with regulatory proposals that would have reclaimed from the AICPA the authority to set generally accepted auditing standards for those companies that sell stock on U.S. exchanges. SEC Chief Accountant Robert Herdman remarked in June that “it is apparent that the AICPA’s system of peer reviews, overseen by a Public Oversight Board that lacks the power to direct the conduct of those reviews or to discipline accountants for misconduct noted during those reviews, has not produced a credible result.”

The Public Companies Accounting Oversight Board established under Sarbanes-Oxley bears a close resemblance to the Pitt-Herdman proposals of June for one or more Public Accountability Boards. Both called for independent funding, a majority of non-accountant members, the authority and responsibilities to conduct quality control reviews of audit firms, standard setting authority over audits and auditor independence, and disciplinary powers.

Am I emulating Mary Poppins when I support the President’s belief that an audit regulation board independent of the AICPA and with a plurality of non-accountants could help restore the public confidence so essential to our economic well-being? Perhaps – but were the Chamber of Commerce and Senator Gramm peering like Alice through the looking-glass in their hope that audit regulation could once more be left to the auditors?

Ironically, one of the most heated debates in the auditing field regards the extent to which auditing firms should be “independent” of the companies they audit – not dependent on consulting revenues from their audit clients. Sarbanes-Oxley prohibits auditors from performing 9 specific consulting functions for their audit clients, to protect the auditing firms’ independence from financial pressures.

But what about independence from the heavy hand of government? The PCOAB is entirely dependent on the SEC for its members, approval of its rules or sanctions, and even its continued existence. Self-restraint by the SEC will be essential to a successful PCOAB.

The good news is that, even before Congress acted, the SEC developed parallel proposals for a strong external auditing regulatory board dominated by non-accountants. Now that the President has signed Sarbanes-Oxley into law, should we nominate Mary Poppins for chairwoman?

Craig Polhemus is not an accountant. He has served as an Economist at the Bureau of Labor Statistics, as an Editor of the Monthly Labor Review and the Georgetown Law Journal, and as Chief Financial Officer for a $300 million statewide services delivery network. As a Legislative Counsel in the U.S. Senate, he helped revise the Employee Retirement Income Security Act and then worked for two decades in the fields of labor and gerontology on behalf of the workers and retirees who own much of the nation’s stocks and bonds either directly or through pension funds. He is a Certified Government Financial Manager and, as former Executive Director of the American Accounting Association, he distributed thousands of multimedia toolkits about auditor independence prior to the enactment of Sarbanes-Oxley, offering accounting and business educators nationwide the tools to explain, diagnose, and educate students and the public on the ethical, regulatory, and business crises related to auditor independence.