New Pressure on the Number-Crunchers

Cases of fraud and schemes that inflate earnings are on the rise, leading Congress to promise a close look at accounting-industry standards

The nation's accountants have had a rough time in the past few years. In 1998, they came under fire as Arthur Levitt Jr., then chairman of the Securities & Exchange Commission, began to criticize the accounting games some companies play to boost their reported earnings. Then in 2000, Levitt fought a brutal battle with the profession over what he saw as a blatant conflict between the traditional role of auditing and the accounting firms' growing practice of consulting.

In the end, some new regulations were adopted, but accountants managed to avoid getting hung out to dry. But Congress may be growing weary of what accountants do to help their clients' financial results look as strong as possible. On June 7, the ranking Democrat on the House Financial Services Committee blasted the profession for its complicity in a growing number of financial scandals that have cost investors tens of billions of dollars.

"Regrettably, there is increasing and disturbing evidence that the problem is widespread," said New York Representative John J. LaFalce at a subcommittee hearing called to discuss international accounting issues. "What may look like an ice cube is much more likely to be the tip of an iceberg, [and] I suspect that iceberg may be gigantic."


  Not exactly the kind of public thumping an industry likes to get. But with half of American households now owning stock, LaFalce's remarks underscore that audit and accounting quality have effectively become mainstream issues. Stock prices lean heavily on the corporate financial statements that accountants prepare and audit, and the number of cases of fraud and earnings restatements has been soaring. Typically, as problems are announced, stock prices tumble -- and the ripples are felt in portfolios across the nation.

As stock ownership has been growing, Americans have become more dependent on these funds -- chiefly because many of the investments they hold are in retirement-savings accounts that replace traditional, fixed-benefit pension plans.

Accountants and auditors are under fire for two basic reasons. One is their part in creating or facilitating accounting methods that allow what has been called the earnings "numbers game," which helps companies massage their quarterly results to match expectations. The second is their failure to detect outright fraud by company management.


  In 2000, a high-profile, blue-ribbon panel said the accounting industry needs to "vigorously" address fraudulent financial reporting, including questionable schemes to pump up earnings. The profession, while supporting antifraud efforts, has resisted specific standards or benchmarks, saying flexibility in professional judgment should be preserved.

Robert K. Elliott, immediate past chairman of the American Institute of Certified Public Accountants (AICPA), the industry's key trade group, isn't happy with LaFalce's upbraiding. In his view, the problems are overstated. "The fact is that the vast, vast majority of all [financial] filings are of high quality," he says. "Audits are doing an outstanding job." It has actually been SEC regulators who have resisted efforts to bring more modern measurements to the accounting field, Elliott claims.

Despite such protests, LaFalce vows to aggressively pursue the question of whether accounting lapses are affecting the integrity of U.S. financial markets. He might have trouble making much progress in the GOP-controlled House of Representatives, but the flip in Senate control to Democrats may improve the visibility of the issue, if the Dems hold public hearings.


  And any attention is good, says Paul B.W. Miller, a University of Colorado accounting professor who has studied the intersection of politics and accounting. "We're in dire need of reform," he says. The industry needs prodding because it is "intent on protecting the status quo and the image that accounting standards are unassailable," says Miller.

Congressional pressure has contributed to shakeups in the accounting field before. The profession's standard-setting group, the Financial Accounting Standards Board, grew out of concern in the early 1970s that auditors' ties to company management jeopardized self-policing. Later hearings also lead to a revision in the structure of the AICPA.

Beyond LaFalce's criticism, the House has recently shown more inclination to challenge the industry and Wall Street. On June 14, the capital-markets subcommittee of the financial-services panel will hold a hearing on examining conflicts of interests among Wall Street stock analysts. The analyst community -- notorious for continued buy recommendations even after stocks have tanked -- has drawn growing criticism for blurring the line between research and sales.


  In an effort to head off possible regulation, the securities industry has compiled a voluntary code of ethics and professional standards for analysts. But that may not be enough to satisfy lawmakers. Subcommittee Chairman Representative Richard Baker (D-La.), says the hearing will be only the "minor beginning" of his look at the issue.

So, between LaFalce and Baker, what had been a haven on Capitol Hill for Wall Street and its accountants doesn't look quite as friendly anymore.

By Christopher H. Schmitt in Washington

Edited by Beth Belton

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