Accounting Profession Likely To See Changes

June 7, 2002
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GRAND RAPIDS — The Enron debacle is a classic example of how the actions of a few can taint the reputation of an entire profession.

As Douglas Van Der Aa, a local CPA and lawyer, quips: “I never thought I’d see the day when I was more embarrassed to tell people I’m an accountant than I was to tell them I’m an attorney.”

Where’s the accounting industry headed now? At least for the time being, probably not down the same road it was pre -Enron, said Van Der Aa, of Hungerford, Aldrin, Nichols & Carter, PC.

Enron has put a burden on the profession to do things right, observes Joe Godwin, professor of accounting at Grand Valley State University’s Seidman School of Business.

“There are a lot of people who do things right every day. I think a lot of those people work for Arthur Andersen,” said Godwin, who served a yearlong academic fellowship in the office of the chief accountant of the Securities and Exchange Commission between 1998 and 1999.

“I think Enron gives corporate boards of directors more backbone. The market is just skittish; at the first sign of an accounting problem, the market is really punishing a company. I think companies are saying, ‘We can’t get caught in that mess; we’ll take our consulting services somewhere else.’”

Many accounting firms are looking for ways to spin off or divest of their consulting operations, and there is significant pressure on several fronts for them to do so. One of those applying pressure is the SEC.

Former SEC chairman Arthur Levitt pressed for reform two years ago, proposing a regulation that would have severely limited the amount of non-audit consulting that accounting firms could do for the public companies they audited.

Concerns about auditor independence had been raised regarding certain non-audit services provided to audit clients. Of concern was both the fact and the appearance of auditor independence, and subsequently, the quality of audits.

The final outcome was a less restrictive version of the proposal in which audit firms were allowed to continue consulting but with limits on certain services, particularly information technology and internal audit services, that they could provide to their audit clients without impairing their independence.

Godwin believes the SEC felt it was a good decision and about as far as it could press things at the time, because the accounting profession, in general, was lobbying Congress to slow down the SEC’s efforts to restrict consulting.

When talk of reform was brewing a couple of years ago, Ernst & Young sold off its consulting services.

“Talk about market timing,” Godwin remarked. “They picked the right time to sell and they got good money for the consulting side.”

Earlier this year, in what appeared to be a response to Enron’s collapse, some of the largest accounting firms began announcing their intention to stop providing any internal audit or certain information technology services to their audit clients.

For audit firms, part of the process in doing an audit is setting up a system of internal controls that, if working properly, automatically detect when there’s a problem, Godwin explained. Large corporations have a relatively complex set of controls.

There have been cases in which it appeared there was a conflict of interest. But a conflict of interest is difficult to prove, because the SEC can’t get inside a person’s mind to determine whether he’s making a decision to be lenient on an audit because it’s the right thing to do or because he has $20 million in fees coming in every year over on the consulting side, Godwin explained.

“I think that provides some opportunity sometimes to go a little softer on making the decision about whether an accounting practice is acceptable or not. That was what the SEC was after — trying to remove that temptation from the process.”

Godwin said the training for accounting is very consistent with doing a lot of legal advisory and valuation work, among other things.

“But where they run into trouble is when they start doing them for their auditing clients, they get very near either auditing their own work, or very near having a lot of temptation to overlook problems they might find — or maybe even not look too hard.”

Large accounting firms have several internal policing systems, such as second partner reviews and “quality control for independence” units that select, monitor and review audits from throughout the company.

They’re also peer reviewed by other audit firms, a practice that began in the late 1970s, under the auspices of the now defunct Public Oversight Board, a former watchdog group for the profession.

The triennial firm-on-firm peer review process has come to be viewed as ineffective as either a diagnostic or remedial tool, according to the POB.

“More important, the process has lost credibility because it is perceived as being ‘clubby’ and not sufficiently rigorous,” the group stated in a report released March 19, called “The Road To Reform.”

Godwin agrees. “I think the peer review process has largely been a back-slapping exercise. I don’t know that a problem has ever been identified by that process.”

But changes are coming in the wake of Enron.

Several proposals for a new self-regulatory structure are now under consideration on Capitol Hill. Godwin suspects it will be next year before anything actually materializes.

He also thinks there are some leadership problems with the American Institute of Certified Public Accountants, in that it has shifted its tone from being one of a professional organization to one of a trade organization.

The institute spent millions trying to promote the idea of CPAs as professional services advisers rather than public accountants, pressing for a new international business credential — the “cognitor” designation.

“It put a little bit of different spin on what CPAs are about,” Godwin said. “It made it appear that many of us were after something perhaps different than what we ought to be after — protecting the public interest. The leadership of that organization has really compromised the profession’s ability to be respected.”

The goal was for CPAs to become broader-based consultants — strategic business providers, as Van Der Aa puts it. He, too, thinks the institute’s efforts were misdirected.

“They had all kinds of broad talk about what this thing was to be and do, but they never really specified how you got to be one, what knowledge or skills one had to demonstrate and what it was going to mean to anybody else.”

Sixty percent of the AICPA’s membership voted against the change in designation last year.

Then came Enron.

“We really had our eye off the ball in terms of the profession,” Van Der Aa said. “So now to what extent are we all going to be consultants? I don’t know. Many of the Big Five were already spinning off their technology and consulting practices.”

Before Enron, the accounting practice was on its way to becoming a multidisciplinary practice, moving toward a closer alignment with, or overlapping with, professional services firms, where a firm might have under its roof accountants, attorneys, insurance people, doctors, nurses, psychologists and so forth.

It looked like there were going to be big consulting firms with subsidiaries or boutiques that would do the audit work and legal work separately, and then everybody else — the tax people, the technology people and the process people — were going to be the high-powered consultants in the parent company.

Internationally the Big Five CPA firms were already the world’s largest law firms, considering the number of lawyers they employed, Van Der Aa noted.

And the multidisciplinary practice made a lot of sense to a lot of clients in a one-stop-shopping sort of way.

But there were problems with differing professional rules of ethics among professions. A couple of the accounting profession’s and the legal profession’s core values were in conflict, such as the duty of confidentiality and the rule against sharing legal fees with non-lawyers.

So the profession hadn’t quite figured it out up to that point, Van Der Aa said.

“Thanks to our friends at Arthur Andersen, all of that is now on hold,” he added.  “Nobody knows if they really want to be in a multidisciplinary practice with the auditors, because we’ve seen how their problems and exposures can suck the entire firm down the black hole.”

Furthermore, the profitability of consulting isn’t what it was two or three years ago. The high tech and dot-com work that consultants were getting paid big bucks for has dried up, Van Der Aa said.

Paul Volcker, former chairman of the Independent Oversight Board for Arthur Andersen LLPhad a rescue plan: Andersen would retrench and restructure itself as kind of an audit boutique. The Andersen partners didn’t go for it.

“Is that what the model of the profession is going to be in the future? Are we going to get over this and go back toward multidisciplinary practices? Are we going to continue to be dominated by consulting firms? I don’t know,” Van Der Aa said.           

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