The enforcement director of the Securities and Exchange Commission yesterday said that the failure of auditors to protect investors has contributed to the large number of financial blowups in the nation and that the agency should aggressively go after major accounting firms, something it has been reluctant to do in the past.
Stephen M. Cutler said the SEC has the legal authority to pursue such actions against the big accounting firms, but generally has not done so. "It is time to adopt a new enforcement model . . . one that holds an accounting firm responsible for the actions of its partners, one that reverses the current presumption against suing firms for an audit failure," Cutler said in a speech at a meeting of the American Institute of Certified Public Accountants.
Any decision to bring charges against accounting firms would have to be approved by the five-member SEC, which is undergoing a leadership change. William H. Donaldson was nominated by President Bush to replace Harvey L. Pitt, who announced his resignation last month after mounting criticism, including charges he was too close to the accounting industry.
If the commission adopts this shift, it would be a marked departure from how the SEC has handled such cases, according to accounting experts. "That's a huge statement," said Orlan M. Johnson, a professor of securities law at Howard University. "It's letting everyone know that there will be no veil to protect anyone when it comes to searching out wrongdoing." Arthur Andersen LLP imploded as a result of government action, but that was a result of the Justice Department's obstruction-of-justice case against it.
Meanwhile the chairman of the AICPA, which lobbies for the accounting industry, yesterday argued that the group should keep its authority to set auditing standards. A law passed last summer allows, but does not require, a newly created accounting board to set auditing standards, rules that accountants must follow in reviewing the financial statements of a company. One member of the oversight board, Charles D. Niemeier, told the AICPA on Wednesday that the board was considering taking over the standard-setting role.
AICPA Chairman William F. Ezzell said in an interview that that would be a bad idea, comparing it to having a surgeon who hadn't been in an operating room for a decade. "You wouldn't want that person to be operating," said Ezzell, a partner at Deloitte & Touche LLP.
Ezzell also defended the current system in a speech before the AICPA, saying it was working well. Ezzell replaced Pitt as a key speaker after Pitt announced his resignation, which was forced in part because of his handling of the selection of William H. Webster to head the accounting oversight board. Webster also was dropped as a potential speaker after he resigned last month.
The statements by Cutler and Niemeier are the latest indication of the potentially significant regulatory changes facing auditors, after major U.S. companies, including Xerox Corp., WorldCom Inc., Rite Aid Corp., Enron Corp. and Tyco International Ltd. were hit with accounting scandals.
In his speech, Cutler said, "So why didn't the risk of auditors passing on inaccurate financials impel them to hold up those financials instead? Why did they apparently believe they stood a good chance of getting away with it?"
Cutler's speech signaled that the enforcement staff would look more closely at the role of the accounting firm in auditing blowups. He added that auditors have too often been preoccupied with expanding their businesses rather than with ensuring that a company's financial statements accurately depict its financial situation.
Cutler also said that accounting firms, including some of the Big Four, have too often been uncooperative during SEC investigations into the alleged financial misdeeds of their clients.
"Firms often don't respond to anything except subpoenas and threats of subpoena enforcement actions when it comes to providing information, and often take a confrontational approach when dealing with commission staff," Cutler said. "The fact is, there's a perception that firms circle the wagons when questioned about their conduct. That sort of approach should not be rewarded by an exercise of discretion not to sue the firm for an audit failure."
The SEC brought 163 enforcement actions in 2002, compared with 79 in 1999. But the agency rarely went after large accounting firms. The exception was the $7 million fine against Arthur Andersen for its audit of Waste Management Inc.
Cutler said the SEC has generally sued individual auditors instead of their firms. But that may not accurately reflect the firm's responsibilities because audit work "is very much a product of that firm's culture, personnel, systems, training, supervision and procedures," Cutler said.