Paper_Walker11-2002_acpro122.txt

INTEGRITY: Restoring Trust in American Business and the
Accounting Profession
(This document was written by David M. Walker, CPA, Comptroller
General of the United States, based on a speech he gave to the
American Institute of Certified Public Accountants' leadership
conference in November 2002)
November 26, 2002
Our profession, the performance and accountability profession,
currently faces a "crisis of confidence" that must be addressed not
only for the good of our profession but also for the good of our
country and the nation's capital markets. We are not, however, the
only ones who are under the microscope as recent events in the
private sector have made clear. Restoring public trust and
confidence in a manner that can be sustained over the long-term
will require concerted actions by a various parties in order to
address some very real systemic weaknesses plaguing our current
corporate governance, accountability, and related systems.


RECENT ACCOUNTABILITY BREAKDOWNS:
Recent accountability breakdowns in the private sector have come
in a variety of forms and bear many names, including Enron,
WorldCom, Qwest, Tyco, Adelphia, Global Crossing, Waste Management,
Micro Strategy, Superior Federal Savings Bank and Xerox, just to
name a few. A recent U.S. General Accounting Office (GAO) report
highlighted the increasing frequency and changing nature of
corporate earnings restatements. Furthermore, the rapid decline and
fall of Arthur Andersen LLP has served as a dramatic lesson that
will no doubt be the subject of many books and business school case
studies.
Clearly, some of these breakdowns are more complex and harder to
understand than others. The WorldCom failure appears to be a simple
matter of not following basic accounting principles in connection
with capitalizing versus expensing certain items. Although all the
facts are not known, it is perplexing how such a basic error
involving billions of dollars could go undetected by the auditors.
On the other hand, the Enron situation involved complex
transactions with a number of parties and a now apparent weakness
in current generally accepted accounting principles. Others
involved simple matters of greed by corporate executives and
inadequate oversight and accountability actions by boards of
directors.


ARTHUR ANDERSEN LLP:
Although there are many dimensions to the current challenge,
let's start with one of our own: Arthur Andersen LLP (Andersen).
Andersen may have been the auditor for more than its fair share of
the entities associated with the most recent accountability
failures, but it was not the auditor for all of them. In fact, U.S.
Securities and Exchange Commission (SEC) data disclosed that until
2001, Andersen generally had a lower rate of earnings restatements
for its public company audit clients than did other major
accounting firms. In addition, while Andersen had certain unusual
audit related policies and practices that were not widely known by
its partners and may not be shared by many other firms, it was
hardly a rogue firm in the profession and any assertions to the
contrary are not only inaccurate but also inappropriate. Such
assertions serve to disparage the reputations of the thousands of
Andersen professionals who did their job right every day and to the
very end. Such assertions also serve as an attempt to discount the
need for meaningful reform to help prevent future accountability
failures.
The Andersen story illustrates how a few people can do the wrong
thing with catastrophic consequences for many innocent parties. It
was not long ago that Arthur Andersen was viewed by many as the
premier professional services firm in the world. For years,
Andersen had the reputation of "thinking straight and talking
straight" and doing what it felt was right in connection with
challenging accounting and reporting issues - even if the client
didn't like the answer. From global gold standard to GONE in less
than two years! What happened?
As a former Andersen partner who severed all ties with the firm
in 1998, I believe that Andersen got caught up with a never-ending
quest to grow the top line, grow the bottom line and grow the
income of it partners. Stated differently, it was primarily focused
on maximizing earnings and not enough on managing risk, including
risk relating to its hardearned and priceless reputation. I
observed some of these tendencies during the later stages of my
almost 10-year tenure with the firm. These tendencies had not yet
reached a critical level and the firm had not experienced a major
public accountability failure when I left to return to public
service as Comptroller General of the United States in 1998.
Evidently these trends became much more pronounced after I left the
firm.
During the later part of my tenure with Andersen, I expressed my
concerns publicly in several partner meetings and privately to
various internal players; however, as someone who had not "grown
up" with the firm, I found that my actions to speak up - -
especially when my views were not consistent with Arthur Andersen
business unit leadership's preferences - - were somewhat
counter-cultural. This was most apparent when I expressed my
support for George Shaheen, the ex-Managing Partner of the Andersen
Consulting business unit (now known as Accenture), to succeed Larry
Weinbach as the Managing Partner of Andersen Worldwide, rather than
Arthur Andersen management's choice of Jim Wadia, Managing Partner
of the Arthur Andersen business unit in the United Kingdom.
Ironically, it was George Shaheen rather than Jim Wadia who
publicly stated his support for modernizing the attest and
assurance model for the 21st century! This, along with his
leadership skills, had a lot to do with my support for his
candidacy.
Andersen is not the only organization to be captured by the
siren's song calling for more money, more money and more money.
During the past few years, certain partners strayed from the core
values of leadership, integrity, service and stewardship that made
Arthur Andersen great and caused me to join the firm in 1989. The
result was that a few partners' actions served to bet the ranch in
connection with the firm's reputation, and they lost the bet!
Although some of Andersen's partners and employees may have
violated the law and should be held accountable, the Justice
Department's indictment of the firm resulted in the "Big Five"
accounting and consulting firms becoming the "Big Four." This
served to further reduce competition in a profession of critical
importance to the public that had already consolidated from eight
to five major global firms. It was more than a little ironic that
the Justice Department that opposed the consolidation of the "Big
Six" into the "Big Five" caused the further consolidation in the
profession. Regardless of the methods and motivations of the
various parties, the deed is done, and Arthur Andersen is
essentially dead.
I am proud to have been a partner with Arthur Andersen in its
glory days, but I'm shocked and saddened by what happened to the
firm during the past few years. Clearly, one of the big lessons
from Andersen's fall is that it may take years to create a
reputation of quality and integrity but that hard-earned reputation
can be lost very quickly if there is a real or perceived breach of
trust. In Andersen's case, it took decades for Andersen to climb to
the top and less than two years for it to decline into extinction.
Hopefully, people will take that lesson to heart.


AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
(AICPA):
Andersen's fall, along with the recent business accountability
breakdowns and other integrity failures, has served to adversely
impact the public's trust and confidence not just in CPAs, but also
in other performance and accountability professionals, corporate
officials and a variety of other parties. They have also served to
adversely affect public confidence in our nation's capital markets.
Many CPAs have also shown increasing concern with recent actions
and inactions of our own professional association, the American
Institute of Certified Public Accountants (AICPA).
What are these concerns? First, the AICPA's actions in
connection with the recent accounting reform legislation and
certain other reform related administrative actions have damaged
its reputation in government and elsewhere. Some of its external
actions may have been designed to serve the economic interests of
some of its members but they were not necessarily consistent with
the broader public interest, especially in connection with audits
involving public companies and public funds. Furthermore, some of
the AICPA's recent internal actions have been questioned by its own
membership. For example, the membership soundly rejected the
Institute's efforts to further stretch the CPA brand name and allow
others to benefit from our profession's hard-earned reputation
through the so-called "XYZ initiative." Other AICPA actions
designed to enhance the value of CPAs to their clients have met
with mixed results. In addition, some of these have not been a
model of transparency or integrity given delayed disclosures and
potential conflicts of interest.
One would expect the AICPA to lead by example in connection with
transparency and conflict issues given the role and nature of the
profession that it represents. In my view, the AICPA and its
leadership must set the standard for professional conduct and be
beyond reproach because they represent all of us and, as a result
their actions, reflect on all of us.
Clearly, the AICPA's value-enhancement and trade-oriented
efforts have dominated its agenda in recent years. Although
value-enhancement to the membership is clearly a legitimate role
for the AICPA, as a professional association it also has a
responsibility to aggressively address a range of professional risk
management issues. In my view, not enough has been done to manage
the current and emerging risks associated with our profession,
especially in connection with modernizing the attest and assurance
model and related auditing standards, including the independence
standard for the 21st century. Yes, some steps have been taken but
not nearly enough or as quickly as is called for, given recent
events and the vital role that CPAs play in our overall
accountability system.
As a result, some are questioning the future role of the AICPA
and whether they should continue to renew their membership. I, for
one, have renewed my membership. Why? Because I believe that it is
better to be an active member who tries to make needed and
constructive changes from the inside rather than voting with my
feet and simply walking away. I hope that most of my fellow members
will agree with me. However, I believe that additional actions by
the board and AICPA management will be needed to restore trust and
confidence in the Institute over the longer-term.


CORPORATE GOVERNANCE:
Outside auditors bear varying degrees of responsibility for
these recent failures, but they don't bear all the responsibility.
Where were the boards of directors (boards) and what was the role
of top corporate management in connection with these business
breakdowns? What involvement did other key players have in
connection with these accountability failures? These and other
questions are worth exploring to determine what changes are needed
on a going-forward basis to minimize the possibility that these
types of events will occur in the future.
In my view, the most critical element that needs to be addressed
to help ensure that these failures do not proliferate in the future
is the overall governance model for public companies in the United
States. Many believe, and I am one of them, that the current
U.S. corporate governance model for public companies is not
adequate to protect the interests of shareholders and other key
stakeholders. Specifically, although most public companies are
required to have a board that is comprised of a majority of
"independent directors" and certain key committees are required to
be comprised solely of outside directors, a closer look reveals
that the independence of many boards may be more a matter of form
than substance.
The issues of concern start at the top of the corporate
governance pyramid. The CEO of many major public companies also
serves as chairman of the board of directors. As chairman and CEO,
this one individual has a huge impact on the direction of the
company, the role of the board, and the composition of the board.
All too frequently, such individuals will have significant
influence over who is asked to join the board and who is asked to
leave it. Boards are often comprised primarily of internal
management officials, high-level executives from other companies,
and major service providers to and customers of the company.
Interlocking boards are also fairly common. Under such
arrangements, executives from different companies who know each
other will sit on each other's boards. Although all these
individuals have valuable experience and perspective to bring to
the table, they are not well positioned to address all of the key
roles and responsibilities of an independent board.
What should public company boards be doing? Under modern
governance theory, the board works for the shareholders and the CEO
works for the board. But how can this be if the CEO also serves as
chairman of the board? Boards have at least three roles that they
need to play. First, they should provide strategic advice to
management in order to help maximize shareholder value. Most boards
have historically spent most of their time on this role. Second,
they need to help manage risk, including risk related to attempts
to maximize current value at the expense of mortgaging the future.
Risk management must also consider the interests of key stakeholder
groups, such as employees, customers and the communities in which
the company operates. Finally, boards have a clear responsibility
to hold management accountable for results. This later element is a
major reason why having a board that is both qualified and
independent is so important. Board member qualifications are more
than a matter of education and experience, they are also a matter
of personal attributes of which integrity is number one. Board
independence does not require the elimination of all inside
directors but it would seem to call for ensuring that a
super-majority of board members are truly independent both in fact
and appearance.
Having a qualified and independent board is important but not
enough. Boards need to have adequate resources, including having
access to their own independent attorneys and advisors when they
believe it is appropriate. Board members also must have the time
needed to address their various roles and responsibilities. From a
practical standpoint, this means that active executives should
limit the number of boards they sit on, and all board members need
to be comfortable that they can dedicate the time needed to
properly discharge their fiduciary responsibilities.
Yes, board members have a fiduciary responsibility to the
shareholders that they represent. They must do their best to do the
right thing and not breach their fiduciary duties through either
co-mission or omission. After all, it's not just what you do that
counts, it's also what you fail to do when circumstances dictate
that you should act.


EXECUTIVE COMPENSATION:
Having the right governance structure is of critical importance.
It's also important to consider the nature and reasonableness of
the incentives provided to top management and board members. Much
has been written regarding the meteoric rise of executive
compensation in the United States. Various studies have shown how
the ratio of executive compensation to average employee
compensation has risen to levels of irrationality and levels that
far exceed those of other major industrialized nations.
How much is a single executive worth? After all, unlike
inventors who should be rewarded for innovation resulting from
their personal efforts, leadership of a major public company is a
team effort. Despite the assertions of some CEOs, while one key
player can make a difference, it requires a team of talented
executives to add shareholder value and manage shareholder risk
over time. In some cases, one wonders what some highly compensated
top executives were doing to earn their pay given their public
statements and testimonies subsequent to the decline of their
companies. Certain former Enron and WorldCom executives come to
mind in this regard.
It's not just the total amount of compensation but the form and
structure of executive compensation arrangements that is important
as well. It is well known that the behavior of individuals is
affected by the nature of their compensation arrangements; top
executives are no exception. For example, some executives may be
tempted to accelerate income or expense recognition in ways that
will serve to help them maximize their bonus compensation in the
current or following year, respectively. Boards and auditors need
to be vigilant to ensure that any inappropriate actions are
avoided.
Recently, a significant amount of attention has been focused on
the structure of "stock options" and the related accounting
treatment. Clearly, some amount of stock compensation makes sense
in order to tie the interests of the shareholders with the
interests of top executives; however, the amount and structure are
both important to ensure equity and avoid perverse incentives to
maximize value in the short-term at the expense of the
longer-term.
There is little question that some abuse of stock compensation
has occurred. In a large number of cases, key executives have been
granted additional stock options or their existing options have
been re-priced (i.e., lower strike price) because of a decline in
the market value of their company's stock. Part of the decline may
have been due to general market conditions, but it's doubtful that
all of it was. In fact, some or most of the decline could have been
due to the failure of management to deliver on their promises. The
result is that these executives can make huge sums if the stock
price rebounds.
Although some have argued that stock option re-loads and
re-pricing were necessary to keep their executives, I wonder how
many of these executives wanted to give up options or raise the
strike price of their options when general market conditions were
causing all boats to rise? I don't know of any, but maybe you do!
We should not have a heads-I-win and tails-you-lose compensation
structure. This situation could be mitigated if companies had
qualified, independent, and adequately resourced boards; however,
as I noted previously, this is all too often not the case.
Boards have a responsibility to ensure the reasonableness of
overall executive compensation. It's clear that a number of them
are not doing an adequate job in his regard. At the same time, the
federal government bears some responsibility for the movement to
stock-based compensation due to tax changes that limited the
deductibility of certain types and amounts of executive
compensation. These provisions may have to be reexamined as
well.
From a more strategic perspective, there is both a need and an
opportunity to forge a realignment of interests between the board
of directors and auditors in ways that can help to enhance value
and manage risk for shareholders and other key stakeholders. In
theory, auditors work directly for the board of directors and
indirectly for shareholders. Yes, audit committees of the board
interact with and recommend which audit firm to retain for approval
by the shareholders. In the real world, however, top management has
much more influence on and interaction with the outside auditors.
This must change and under the recent Sarbanes-Oxley accounting
reform legislation, some related changes will be required.
Importantly, once additional needed corporate governance reforms
are made to enhance the independence and capacity of the board, the
opportunity to implement the needed realignment will be greatly
enhanced.


ACCOUNTING AND REPORTING MODEL:
What about the current accounting and reporting model? We have
recently seen how current accounting and reporting requirements are
inadequate. For example, the collapse of Enron showed how
accounting and reporting for so-called "special purpose entities"
(SPEs) is hard to understand, much less defend. Does it make sense
for companies to be able to keep significant financial transactions
off their books when unrelated parties provide only 3 percent of
the related capital at risk? I think not! Although Enron may have
violated this 3 percent requirement, the 3-percent level would seem
to be way too low in a environment in which we should be focusing
on economic substance versus legal form in accounting and reporting
as well as attest and assurance matters.
There has also been a considerable amount of discussion and
debate regarding the appropriate accounting and reporting treatment
for stock options. Strong views are held on both sides of this
great debate. From a practical perspective, if stock options aren't
compensation, what are they? In my view, it's not on the issue of
whether they should be recorded as compensation expense; it's more
a matter of how it should be done.
From a broader perspective, I believe that the current
accounting and reporting model is not well suited for our 21st
century knowledge-based economy. Unlike the industrial age in which
tangible assets were of great value and importance, in today's
knowledge-based economy it's intellectual capital that is driving
the market value of many enterprises. Intellectual capital is
created by the efforts of people. As a result, people represent the
most valuable asset in the knowledge age. People are the source of
all process improvement, technological innovation, and
environmental enhancements. If people are our most valuable asset,
then why are people treated primarily as a cost and a liability
under our current accounting and reporting model?
What about historical cost? Although it's nice to know what
something costs, it's arguably more important to know what it is
worth! Furthermore, the days when historical financial statements
were viewed as being of critical importance are gone. It's not that
they aren't important, it's that they aren't as important as they
used to be. Today, it's important to have access to timely and
reliable financial and non-financial performance information. In
addition, it's important to not just know what has happened but
what is likely to happen based on key performance indicators,
projection, information and sensitivity analyses.
We live in an increasingly inter-dependent world. Our markets
are global in nature and no nation, including the United States,
can go it alone. And yet, we still lack a set of global accounting
and reporting standards that reflects the globalization of
economies, enterprises, and markets. We need a set of global
standards, and various interested parties need to work together to
help make this become a reality sooner rather than later.
These new accounting and reporting standards should not just be
global in nature, they should be principle-based rather than
rule-based. Current U.S. accounting and reporting standards have
become much too complex. Too many players are looking for special
treatment and loopholes and are focusing on legal form rather than
economic substance. Furthermore, too many professionals are busy
checking boxes rather than turning on their brains and using their
professional judgment to get to the right answer. We must remember
that as CPAs, we get paid for our judgment, so let's exercise
it.
New principle-based accounting and reporting standards should be
focused on value and risk. Related disclosures should focus more on
key performance indicators along with selected projection
information and sensitivity analyses. In addition, all disclosures
need to be stated as clearly and concisely as possible. Too many
public companies' disclosures are written in legal language and are
way too long. They seem to be designed more to confuse rather than
inform the reader.
Some have recently advocated a three-pronged approach to future
financial and performance reporting. The first prong would
represent basic reporting applicable to all public companies. The
second prong would include key benchmark information based on the
company's industry. The third prong would include supplemental
information on key value and risk elements affecting the company. I
believe that such an approach has conceptual merit and should be
explored along with the other key concepts outlined above.


ATTEST AND ASSURANCE STANDARDS:
Although the accounting and reporting model needs to be updated,
in my view, the current attest and assurance model is also out of
date. The current model relies heavily on an auditor's expression
of an opinion on historical cost-based financial statements after
year-end. For public companies, audited financial statements
generally are required to be filed with the SEC within three months
of the company's fiscal year-end. This report has some value but it
is not as valuable as it once was.
More needs to done to enhance the scope and improve the
timeliness of various attest and assurance services and related
reporting. More also needs to be done to address the continuing
"expectations gap" regarding what auditors are doing in connection
with the detection of fraud and internal controls, and to audit
through electronic information systems rather than around them. In
this regard, Texas A&M University has recently formed a new
Center for Continuous Auditing involving a consortium of over 12
leading universities and others to help address these issues.
Currently, outside auditor reports are not required to provide
any level of assurance with regard to key internal controls. Such
controls are critical to determining the reliability of interim
reporting and various ongoing assertions by the company throughout
the year. Importantly, opinion level of reporting on internal
controls over financial reporting will be required by the
Sarbanes-Oxley accounting reform legislation that was passed in
July 2002. It is designed, among other things, to enhance oversight
of public company auditors in light of recent accountability
failures.
However, the current audit-reporting model does not provide any
level of assurance regarding key risk and value-based performance
and projection information that are important to a wide range of
stakeholders. We also need to take steps to do so in conjunction
with the needed enhancements to the current accounting and
reporting model.
It's important to enhance the scope and timing of any related
audit reports, but it's also important to ensure that firms are
both qualified and independent to perform such audits. Contrary to
assertions by some, independence is more than a state of mind.
Auditors must be independent both in fact and appearance in order
to be credible. In my view, current AICPA independence standards do
not adequately ensure the independence of auditors who provide
certain non-audit or consulting services to their audit clients. As
a result, the GAO issued new independence standards applicable to
audits of federal departments and agencies and entities that
receive federal funds, and the Sarbanes-Oxley legislation limited
the ability of auditors of public companies to perform certain
non-audit services for their audit clients.
The Sarbanes-Oxley provisions were based in large part on GAO's
new independence standards. Importantly, GAO saw the need for a
change in his area and we began the process to make related changes
long before Enron and other recent business failures came to light.
Although GAO took a lot of heat in being out front on this
controversial issue, in part due to recent events, we're getting a
lot of accolades now!
During the past decade the AICPA and many accounting firms put
too much emphasis on how they could grow their top line, bottom
line, and earnings through pushing non-audit/consulting services
and not enough time modernizing attest and assurance services that
represent the franchise for CPAs on which the public relies. This
must change, and recent events are likely to force both the
accounting profession and the firms to place much more emphasis on
their core services. At the same time, many major accounting firms
are spinning off the portions of their consulting practices that
pose the greatest potential independence problems.
In my view, auditors should able to provide some consulting
services to their audit clients, but there are certain services
that would clearly be inappropriate for them to provide.
Specifically, under the GAO's new independence standards auditors
must not violate two basic principles. First, auditors should not
perform management functions or make management decisions. Second,
auditors should not audit their own work when the work involved is
material to the subject matter of the audit. These principles are
simple, straightforward, and timeless in nature. We also need to
take this type of approach in connection with key
accounting/reporting and audit issues.
As I noted earlier, the board and the auditors should have a
strategic alignment of interests. Furthermore, for any system to
function effectively, there must be incentives for parties to do
the right thing, adequate transparency to provide reasonable
assurance that people will do the right thing, and appropriate
accountability when people do not do the right thing. This
strategic realignment and convergence of interests between the
board and the outside auditors would help to achieve these
objectives.


LEGAL, FINANCIAL AND OTHER ADVISORS:
A variety of outside players other than auditors have been
involved in and bear differing degrees of responsibility for some
of the recent business failures. Attorneys, investment bankers,
consultants and other advisors have played major roles in
structuring or engineering business transactions in order to
achieve not just a desired business result but also a desired
accounting and reporting result. In some cases, this has resulted
in changing the form of certain arrangements in order to meet the
minimum technical requirements of any related accounting and
reporting requirements while coming close to the line of what is
legal. Some might call this aiding and abetting.
Many advisors try to help their clients meet a short-term
value-oriented objective. However, in doing so they must remember
that short-term gain can come at a huge longterm cost if the
transaction unravels or otherwise comes under close regulatory
review or public scrutiny. Such was clearly the case in connection
with certain recent business failures.
Several companies have used such aggressive approaches to deal
with a variety of tax issues and other matters. For example, a
number of major multi-national companies based in the United States
are trying to have their legal headquarters located in another
country for tax reasons. Typically, companies and their advisors
try to minimize the visibility of such techniques in order to avoid
public criticism. Sometimes they succeed, and sometimes they
don't.
In my view, too many people today are trying to structure
transactions and other business dealings so they are technically
acceptable rather than doing what is right. It is time for people
to realize that things like the law and accounting and reporting
standards represent the floor of acceptable behavior and not the
ceiling! Values like integrity, morality, compassion and
stewardship represent higher callings that more people should
strive to achieve. In the end, we all need to be more responsible
for our actions and inactions. The simple rule is, if in doubt
about what to do, then check it out both from a technical and value
oriented perspective. If still in doubt, don't do it! It's not
worth betting your reputation or the reputation of your
organization. Just ask the former partners and employees of Arthur
Andersen.
Wall Street firms are subject to these same tendencies. They
also have certain conflicts in connection with their investment
banking and brokerage operations that need to be addressed just as
independent auditors do in connection with their consulting
services. The independence and objectivity of stock analysts
reporting is also a matter of concern. The SEC and several states
are looking into these issues. Hopefully, Wall Street will take
voluntary steps to address these issues before it is forced to
act.
In the final analysis, attorneys and other advisors need to keep
in mind that their actions can have an adverse affect on their
reputations as well as the public. Given the lessons from Arthur
Andersen's fall, they need to keep this in the forefront rather
than the back of their minds.


FEDERAL REGULATION AND ENFORCEMENT:
The primary federal regulator in connection with financial
accounting and reporting for public companies is the Securities and
Exchange Commission (SEC). The SEC promulgates and enforces the
registration requirements dealing with public companies. The SEC
has vast responsibilities and finite resources. As a result, they
need to constantly look for process improvements and technological
enhancements to leverage their finite resources to maximize their
effectiveness. In light of recent events, a consensus has emerged
that the SEC needs significant additional resources to help ensure
that it can do its job properly.
Although the SEC has the authority to issue certain
accounting/reporting and auditing standards for public companies,
it has historically relied to a great extent on certain
selfregulatory bodies to help maintain trust and confidence in our
nation's capital markets. For example, it has historically relied
on the Financial Accounting Standards Board (FASB) to set generally
accepted accounting principles and the AICPA's Auditing Standards
Board (ASB) to set generally accepted auditing standards. In
addition, other parties such as the major stock exchanges play a
role by imposing various requirements for companies to attain and
maintain their listings.
While self-regulatory approaches can and have worked in various
situations, there are certain instances in which it is unrealistic
for them to work as effectively as needed in order to adequately
protect the public interest. One example of this is in connection
with what type of non-audit or consulting services that outside
audit firms can provide to their audit clients and still maintain
their independence. History has shown that the present
self-regulatory structure has not been adequate in this regard.
There is too much of a tendency for self-regulatory structures to
rationalize how the provision of a broad range of services can add
value to the client and does not present an independence problem.
This has clearly been the case in connection with the AICPA's
current independence standards.
Another area where the current self-regulatory structure has
proved to be inadequate is in connection with the AICPA's
self-disciplinary function. The process usually takes too long, and
in the final analysis, the most severe sanction the AICPA can
impose is expulsion from the Institute. Since CPAs are not required
to belong to the AICPA in order to conduct public company audits,
the most severe sanction would only serve to save the CPA some dues
without any other practical effect. This is clearly
ineffective!
While the state boards of accountancy have the ability to impose
much stiffer sanctions, including revoking a CPA's license to
practice in a state, these boards have not exercised this sanction
very frequently.
While I believe that it is not always desirable to have the
government intervene, at times it is necessary in order to protect
the public interest, especially when others who could act fail to
do so. Recent examples include actions taken by the Congress, the
SEC and the GAO to address areas of concern that each felt
warranted government action. Hopefully, government intervention can
be minimized in the future; but for that to occur, others must take
steps to address serious public interest issues before they reach
crisis proportions. If they fail to do so, I have little doubt that
government will eventually act.
From an enforcement perspective, the SEC has certain civil
enforcement powers that it can use to address violations of the
nation's securities laws. In some cases its sanctions are adequate,
but not always. Most corporate officials, board members and
professionals are people of ability and integrity who try to do the
right thing. At the same time, every country and sector has "bad
actors" that take short cuts and push the envelope to achieve a
desired result. Many of these players tend to be arrogant and
believe that the end justifies the means. In addition, as we have
seen in the case of various derivatives transactions involving
Enron, Qwest and Global Crossing, sometimes bad actors join forces
to help achieve their goals. To effectively deal with these types
of individuals, civil sanctions must be strong enough and targeted
enough to discourage potential bad actors from doing things that
harm others. Too many existing civil sanctions are imposed directly
or indirectly (through company paid premiums on officers and
directors insurance) on the company and ultimately the
shareholders. In this case, shareholders can pay twice for the sins
of others.
While more meaningful and targeted civil penalties can help to
discourage many bad actors, in my view, civil sanctions aren't
enough in some cases. You need to be able to issue a few so-called
"wide-striped suits" to players who violate criminal statutes.
Nothing will focus someone's mind like looking at the world from
the inside of a prison cell. In addition, we need to be sure that
white collar criminals are not merely detained in so-called
"country club" federal prison facilities for relatively short
prison terms. The price for criminal behavior must be high for
these individuals as well.


PENSION AND SAVINGS PLANS:
The recent business failures have also served to harm a number
of innocent parties, including pension and savings plan
participants. A number of defined benefit pension plans lost
significant sums as a result of the decline in the value of their
holdings in Enron, WorldCom, etc. When defined benefit pension
plans lose money the plan sponsor, typically the employer, will
ultimately bear the cost of the loss. However, when defined
contribution plans, like 401(k) plans, incur such losses, the
individual plan participants are directly affected and bear the
losses themselves.
Participants in 401(k) plans can be particularly harmed in
situations where their accounts are heavily invested in employer
stock, either because their employer matches their employee
contributions in the form of such stock or because they themselves
make significant investments in their employer's stock using their
own voluntary contributions. In these cases, participants risk
losing not only their jobs but also a significant portion of their
retirement savings if their company files for bankruptcy. This was
the case in connection with Enron and certain other business
failures. In addition, in the Enron case, plan participants were
not allowed to sell company stock in their 401(k) account when the
stock price was declining rapidly due to a pending change in plan
administrators. At the same time, top Enron executives were free to
exercise their stock options, and some did. This inappropriate and
un-level playing field was addressed in part of the Sarbanes-Oxley
legislation. Some suits are likely in order to attempt to right
alleged fiduciary breaches. Additional legislation has also been
proposed that would, among other things, give employees the ability
to diversify their employer matching contributions out of company
stock more rapidly than they can under current law.


PAST AND FUTURE ACTIONS:
A variety of parties have already taken some steps in light of
these recent business accountability failures. The New York Stock
Exchange is moving to adopt certain changes in its listing
requirements relating to governance matters; boards and audit
committees are taking their related responsibilities much more
seriously; the Financial Accounting Standards Board (FASB) is
exploring a principles-based approach to accounting standards and
is reconsidering the current accounting and reporting treatment for
SPEs and stock options; the AICPA has issued a new fraud detection
audit standard and is beginning to assess the need for other
enhanced attest and assurance standards but it clearly needs to
pick up the pace; the U.S. Congress has passed the Sarbanes-Oxley
legislation which included establishment of the Public Company
Accounting Oversight Board (PCAOB), tougher independence standards
for auditors of public companies, and independent funding sources
for the PCAOB and the FASB; the SEC has taken a number of
regulatory and enforcement actions and made initial appointments to
the PCAOB; various U.S. Attorneys have filed charges against
several key players associated with some of the recent integrity
and accountability failures; the New York State Attorney General
and the SEC are taking steps to address certain conflicts within
the investment banking community, and the GAO has taken a number of
steps as discussed below.
These actions are clearly steps in the right direction. However,
as noted above, additional actions are necessary in order to
address several remaining systemic issues. Hopefully, the
appropriate parties will take steps to address these issues. If
they don't, the government may chose to act again in order to fill
any related voids.


GAO'S ROLE:
The GAO is a professional services organization within the
legislative branch of the federal government. Our job is to help
the Congress discharge its constitutional responsibilities and
improve the performance and assure the accountability of the
federal government for the benefit of the American people. To do
so, we perform a variety of oversight, insight, foresight and
adjudicatory functions spanning everything the federal government
does or is thinking about doing anywhere in the world. Simply
stated, at GAO we speak truth to power. Power comes in many forms,
including the U.S. Congress, various government officials, the
press and ultimately the greatest source of power in our democracy
- the American people. Today, I'm speaking what I believe to be the
truth about how to restore confidence in American business and our
profession to each of you. I will continue to speak out on these
issues in the coming months.
Among other things, GAO serves as the independent auditor of the
largest, most diverse and most important entity on the face of the
earth - the U.S. Government. We conduct financial statement,
performance and compliance audits of federal entities, and
promulgate generally accepted auditing standards for audits of
federal entities, and entities that receive federal funds. We also
help to promulgate generally accepted accounting principles for
federal government entities.
As the leading performance and accountability organization in
the United States and arguably the world, we believe that we have
an obligation to lead by example and practice what we preach. We
take these obligations very seriously with all of our
responsibilities, including those relating to the Congress'
concerns regarding the recent accountability failures in the
private sector. We held a Corporate Governance and Accountability
Forum in February 2002 involving prominent leaders from the public,
private and not-for-profit sectors to discuss the recent
accountability failures in the private sector and what actions may
be necessary to help prevent such failures in the future. This
forum served to help inform the GAO's work and other efforts to
support the Congress, including our efforts that helped lead to the
eventual passage of the Sarbanes-Oxley legislation. We are holding
a follow-up forum on December 9, 2002 to discuss what actions have
been taken by a variety of parties and those that remain in order
to help restore public trust and confidence.
In addition to these actions, GAO has voluntarily decided to
express an opinion on internal controls and key compliance issues
in connection with our audit of the consolidated financial
statements of the U.S. Government and various other federal
entities. We are also advocating enhanced reporting in connection
with key federal performance and projection information. As
previously noted, we published new independence standards dealing
with non-audit/consulting services when the AICPA failed to act. We
are working with others within the federal government, including
the Secretary of the Treasury and the Director of the Office of
Management and Budget, to modernize federal financial management
and promote expanded performance and accountability reporting.
Furthermore, at GAO, we are using the "bully pulpit" and speaking
out to encourage others to do their part to help restore public
trust and confidence and we will continue to do so.


CLOSING:
In the final analysis, for any system to work you need to assure
that the key people have integrity, that the information provided
to key stakeholders is timely and reliable, and that the persons or
entities that are providing assurance as to the reliability of any
financial and non-financial information are qualified and
independent both in fact and appearance. The importance of
integrity can not be overstated, if the key players don't have
integrity, not much else matters. In addition, systems should
incorporate incentives for people to do the right thing, adequate
transparency mechanisms to provide reasonable assurance that people
will do the right thing, and appropriate accountability mechanisms
if people don't do the right thing. These basic principles are
timeless and can be applied to a broad range of professional,
business, government and personal issues, including how to restore
trust and confidence not only in the performance and accountability
profession but also in the broader business community and our
nation's capital markets.
I hope that all key parties will take the necessary steps to
address any real and perceived problems that serve to undercut
public trust and confidence. As recent events illustrate, trust
takes years to gain but can be lost in an instant. The performance
and accountability profession, and in my opinion, our corporate
governance system are at a critical crossroads. As CPAs we must
chose the right path. If we do, we will not only regain any lost
public trust and confidence in our profession but we can position
ourselves to help add value and manage risk in a whole new range of
areas that are both needed and which we are well positioned to
address a whole new range of performance, projection and compliance
issues.
During these challenging times, CPAs must look to what we share
in common and how we can help to create the future of our
profession. I would suggest that all CPAs regardless of what
position they hold or what sector they work in share certain roles,
responsibilities and values. With regard to roles, all CPAs are in
the business of maximizing the performance and assuring the
accountability of their enterprises and areas of responsibility.
With regard to responsibility, all CPAs should be mindful of the
broader public interest in connection with all their activities.
With regard to values, all CPAs share certain basic values such as
integrity, objectivity, competence and professionalism.
In my view, we all need to return to a set of core values and
timeless principles that can help us to do the right thing, at the
right time, all the time. These core values serve as both beliefs
and boundaries; beliefs in the form of positive concepts one can be
committed to, and boundaries in the form of limits that should not
be violated. At GAO our core values are accountability, integrity
and reliability. Accountability describes what we do, integrity
describes how we do our work, and reliability describes how we want
our work to be received. Every world-class organization should have
a set of core values, and so should our profession. I touched on
these earlier.
In addition to core values, we all need to keep certain timeless
principles in mind at al times. First, don't believe what Gordon
Gecko said in the film, Wall Street. Greed is not good - greed is
bad!! Second, remember that the law and other standards set the
floor of acceptable behavior and not the ceiling. Don't lie on the
floor - reach for the ceiling! Don't just do what is acceptable, do
what you think is right! Third, CPAs and other professionals are
paid for their judgment. Turn on your brain rather than checking
boxes in connection with key accounting, reporting and auditing
issues. Fourth, say what you mean, mean what you say, practice what
you preach and lead by example in everything that you do. Finally,
remember that your reputation is priceless. It takes many years to
build a reputation which can be lost very quickly if you breach the
trust that others hold in you. In addition, if you act improperly
or fail to properly discharge your duties, you can harm a number of
innocent parties. As a result, if it doesn't seem right, don't do
it!!
In closing, we all have a stake in the future of our profession
and the reputation of CPAs. I can assure you that GAO and I will do
our part to practice what we preach and lead by example in our
roles, responsibilities and values. I hope that I can count on each
of you and others to do the same. After all, the time to act is
now! Let's do it!!