Major changes must be made in accounting practices if public credibility in independent audits is to be maintained, two academic experts yesterday told a congressional oversight subcommittee investigating conflict of interest and other shortcomings in the industry.
Declaring that the system was incapable of self reform, Robert Chatov, associate professor of managerial economics and policy at the State University of New York at Buffalo, proposed that the Securities and Exchange Commission assign and rotate auditors among corporations. Auditors would be paid out of tax revenue, rather than by the client. He also called for standardization of fees and elimination of other business contacts between the auditor and the audited.
Abraham J. Briloff, professor of accountancy at the Bernard M. Baruch College, City University of New York, decried what he termed ineffective peer review and lax SEC enforcement. He suggested that accounting firms be barred from offering other services such as management consulting to clients whose books they audit, although he would allow them to offer them to non-audit clients. He also urged that outside auditors prepare rather than just examine and certify work done by management.
The hearing was the first in an extensive series planned this year by the House subcommittee on oversight and investigations, chaired by Rep. John D. Dingell (D-Mich.). The last oversight hearing was held in 1977 and, as the scholars noted, few lasting changes resulted.
In recent years, accounting firms have been sued by shareholders because a rash of banks and financial companies ran into trouble shortly after being given a clean bill of health by auditors. Yesterday, Dingell recited a long list of problem cases -- Penn Square National Bank, Continental Illinois National Bank, United American Bank, Financial Corp. of America, Drysdale Government Securities and Baldwin-United.
Critics complain that accounting firms underprice for audits in the expectation of performing supplemental, more lucrative services for corporations, and question how auditors can remain independent when, in effect, they are reviewing their own work.
Several witnesses quoted Supreme Court Chief Justice Warren Burger, who in a case involving Arthur Young & Co., a Big Eight firm, stated last year: "The independent auditor assumes a public responsibility transcending any employment relationship with the client. This public 'watchdog' function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust."
Auditors come under the authority of the SEC, a fact that fosters public fantasies about reliability and discipline of offenders, Briloff said. In fact, the profession is largely self-regulated.
Dingell berated the commission for delegating rulemaking to selected private organizations and relying upon the large accounting firms to police themselves.
Peer review is not effective, Chatov said, because accountants do not apply severe sanctions to one of their own group. And, Dingell added, "The few direct enforcement actions undertaken by the SEC against large accounting firms appear to result in mere wrist slaps, even when the firm is a repeat offender."
In answer to questions posed by Rep. Ronald Lee Wyden (D-Ore.), Briloff and Chatov agreed that independent auditors should be expected to "blow the whistle" on fraud to the SEC and that liability insurance should not cover gross negligence.
Briloff argued that consent decrees, in which the accounting firm neither admits nor denies guilt, should be abolished. Instead, cases should be adjudicated and firms not allowed to seal records to hide practices. Wyden also pushed for more disclosure of financial information about private accounting firms.
Briloff asked the Financial Accounting Standards Board to implement rules as well as setting them, whereas Chatov wanted more SEC enforcement actions.