Consumer Federation of America

KEY IMPROVEMENTS THAT MUST BE MADE TO SENATE ACCOUNTING REFORM LEGISLATION (S. 2673)

1) Guarantee the independence of the auditor oversight board. The independence of the governing board is in serious doubt under the terms of the bill. Unless it is fixed, the bill could end up replacing what appears to be a fairly independent board that lacked funding and authority (the Public Oversight Board) with a well-funded, powerful puppet of the industry. This is because the bill now requires that two of the five board members be accountants (the first version of this bill merely allowed two of the members to be accountants.) Moreover, the bill doesn’t require that “public” members of the board be truly independent from the accounting industry. Thus, Harvey Pitt—who is not an accountant but has worked for accounting interests for a number of years--would qualify as a public member, as would non-accountant employees of accounting firms and trade associations. Even without an appointee who has such blatant ties to industry, all it would take for the accounting industry to control the board would be the appointment of one pro-business, anti-regulation public member and two accounting members loyal to the industry. Initially, there would probably be enormous pressure to appoint a board with real credibility, but it is all but inevitable that the accounting industry would gain dominance over the board in time.

Improvement: Remove the requirement that two of the board members be accountants, prohibit accountants from voting on disciplinary actions and sanctions and from serving as chair or vice-chair of the board. Establish independence standards for public members (similar to those the New York Stock Exchange has proposed for independent members of corporate boards) and enlarge the board to ensure that a super-majority are public members.

2) Make the ban on non-audit services meaningful. Don’t leave it in the hands of the SEC. The effectiveness of the bill’s prohibition on non-audit services relies entirely on how the SEC would interpret these vague restrictions. There is nothing in the bill to prevent the SEC from declaring that it codifies weak existing definitions for those services that are covered by current rules. (That is exactly what the bill passed by the house, H.R. 3763, does.) S. 2673 does still go somewhat beyond the House bill, because it bans expert services and a few other non-audit services that the House bill doesn’t cover. But again, the SEC will be free to define those terms in the most restrictive way possible.

Improvement: Incorporate definitions on scope of prohibited non-audit services referenced in original version of S. 2673, as well as principles to be used by the SEC when reviewing permitted non-audit services to determine whether they undermine independence. 3) Require rotation of audit firms. The bill requires the rotation of audit partners, but does not require rotation of firms, which is a key factor in ensuring the independence of the audit and the veracity of audit statements. It is irrefutable that KPMG’s assumption of the audit function this year at WorldCom made it more willing to expose the accounting violations that led to WorldCom's $3.8 billion restatement than it would have been had it been responsible for signing off on the relevant financial statements.

Improvement: Require rotation of audit firms every seven years, as required S. 2056, by Senators Nelson and Carnahan.

4) Improve transparency of disciplinary actions and sanctions. The confidentiality provisions in the bill virtually ensure that board disciplinary actions and sanctions would be kept from the public view until the statute of limitations has run.

Improvement: Eliminate restrictions on public disclosure that were placed in S. 2673 in committee mark-up.