The past few months have pointed up so many weak spots in corporate accounting that it's hard to prioritize what needs fixing the most. Clearly, auditors are not always skeptical enough. Obviously, board audit committees need a kick in the pants. Everyone agrees that rule-making needs to become a lot faster and a lot more effective.
But the deepest problem uncovered by the spate of recent accounting scandals is how easy it has been for all the players involved to pass the buck. The board fingers management, management blames the auditor, the auditor blames the rules. Why isn't it clear who's responsible for what and what the penalties are for doing a bad job?
There are steps that would help restore investor confidence. First, there should be limits put on consulting work done by a company's auditing firm. The audit panel should review all nonaudit engagements to ensure that they don't jeopardize the audit. Auditors should rotate every few years to ensure a "fresh look" by a new firm. There should be more forensic auditing to dig behind the journal entries.
Finally, the proxy statement should clearly delineate which responsibilities fall to the board and which to management. At Enron, the audit committee was charged with reviewing related party transactions. In fact, the committee carried out only cursory reviews. But shareholders had no way of knowing it was even part of their duties. By contrast, Cendant Corp. (CD), in the wake of an accounting fraud in a predecessor company, takes extra care to spell out board responsibilities. For example, it makes clear that the board has reviewed and approved the nonaudit work provided by auditors. But Cendant is the exception.
An expanded auditor statement in the annual report would also help. Instead of just asserting that the financials meet generally accepted accounting principles, the auditors' statement should illuminate just where in the wide range of acceptable practices a particular company falls. As an up-close reviewer of the numbers, the auditor is in a unique position to judge how dependent the financial statements are on assumptions that could prove faulty. They already share this information with the audit committee. Including it in the auditors' statement would give investors access to the same insight.
Finally, a price must be exacted for failure to do the right thing. "We had Sunbeam, Waste Management (WMI), and Cendant--and I don't think anybody has gone to jail yet, and I don't know why," says Philip B. Livingston, president of Financial Executives International, a professional group of finance managers. "When the SEC and the Justice Dept. get their act together and start sending some CFOs and CEOs to jail, you'll see a real wake-up call."