SEC soon may get new audit watchdogto focus on regulating financial reports

January 31, 2012

The Securities and Exchange Commission and its chairman are coming down to the wire on a decision that could help determine what investors can expect from Corporate America’s accounting watchdogs.

The SEC is close to naming a new member of the five-person board that Congress created a decade ago to police and regulate the audit firms that are responsible for vetting the financial reports that companies give investors, people familiar with the process said.

The commission has been focusing on two candidates, they said, speaking on condition of anonymity because the decision is playing out behind closed doors.

Joseph V. Carcello, a professor of accounting at the University of Tennessee, has criticized auditors’ standard way of doing business. He has called for accounting firms to give investors more information about potential problems lurking in corporate financial statements, and he has argued that auditors should be held to a higher standard.

Jeanette M. Franzel, a managing director at the U.S. Government Accountability Office (GAO), has called on the regulators at the Public Company Accounting Oversight Board (PCAOB) to exercise restraint. In 2009, she told the oversight board that instead of writing a new rule of its own it should adopt the work of an accounting industry group or international rulemakers.

The appointment comes when the PCAOB under activist chairman James R. Doty is considering steps to transform corporate audits. Those include forcing companies to switch audit firms from time to time so that the accounting gets a fresher look and requiring auditors to write more informative assessments. Doty has faulted the auditors’ performance in the runup to the financial crisis.

The initiatives have generally divided investor and industry groups.

The SEC exercises broad authority over the the PCAOB — known as the “Peekaboo” — and the appointment could tip SEC Chairman Mary L. Schapiro’s hand on the policy and politics of auditing.

Audit firms, which are hired and paid by the companies they audit, are supposed to serve as an important line of defense for investors. They are responsible for vetting the financial reports that companies issue.

But many frauds and financial calamities have unfolded with no public warning from the watchdogs.

Congress created the PCAOB a decade ago after accounting scandals at companies such as Enron and WorldCom shook investors’ faith in corporate balance sheets and profit statements. The oversight board replaced a system in which the accounting industry — including the American Institute of Certified Public Accountants (AICPA) — was largely responsible for writing its own rules and policing itself and was criticized for avoiding accountability.

As a member of a PCAOB advisory group, Carcello has expressed support for at least part of the agenda for change. He co-signed a September 2011 letter to the oversight board saying the current system of boilerplate, pass-or-fail audit reports “fails to meet the legitimate needs of investors.”

The letter also said audit reports “should clearly state that the auditor has a responsibility to obtain reasonable assurance as to whether the financial statements are materially misstated, whether caused by error or fraud.”

Franzel wrote a 2009 letter on an audit standard proposed by the PCAOB, saying “the public interest would be better served” if the oversight board adopted standards set by an international group or by a unit of the AICPA.

“If the Board believes, based on its inspections, that additional requirements or guidance is necessary, the PCAOB should develop clear, incremental standards and explain why they believe such incremental standards are necessary and appropriate” on the issue, she wrote.

Franzel also signed a 2003 GAO report concluding that “mandatory audit firm rotation may not be the most efficient way to strengthen auditor independence and improve audit quality.” The report called for the SEC and the PCAOB to take several years to assess the effects of existing requirements.

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