Commentary: Pitt's Accounting Fix Leaves a Lot Broke

By Mike McNamee

A powerful regulator vows to crack down on an influential industry. The industry smiles and calls the proposal "constructive" and "welcome"--even in private. What's wrong with this picture? Simple: Securities & Exchange Commission Chairman Harvey L. Pitt's proposal to put "real teeth" into auditor discipline has some big gaps where the gums are showing.

Pitt's proposal--unveiled on Jan. 17 as a work in progress--does take ethics, discipline, and quality control in auditing away from the American Institute of Certified Public Accountants, an industry group that has run accounting's discipline system for the past century. Instead, Pitt proposes to give those powers to a disciplinary board of as-yet-undetermined size. A majority of the members will not be accountants, and it will have a professional staff of investigators. The Big Five and other accountants that audit public companies would be required to comply with the board's requests for evidence and would be subject to its discipline. The result, says Pitt: "a tough, no-nonsense, fully transparent discipline system."

Would that it were. In fact, the new board will lack the critical powers it needs to ensure its independence and effectiveness. In the wake of the Enron collapse, Congress and investors are demanding vigorous oversight for auditors. By failing to stake out a tough opening position, Pitt is undermining his own credibility on Capitol Hill--especially since he counts the AICPA and the Big Five among his past clients. And he's worsening chances of real reform.

What does the new board need? For starters, delegates from the AICPA should be banned. That's the view of Charles S. Bowsher, formerly Uncle Sam's chief auditor and now chairman of the Public Oversight Board, a group of five prominent retired businesspeople currently charged with reviewing the Big Five's audits. The POB voted on Jan. 20 to disband itself in protest of Pitt's decision to replace it with a board that includes CPAs, arguing in part that the move will weaken rather than strengthen independent oversight. The CPAs on the board "will have so many resources, so much legal talent, that the profession will soon be running the system," charges Bowsher. That's damning criticism from a body that has itself been widely criticized for being ineffective at combatting accounting transgressions.

The new board will also need subpoena powers since evidence of failed audits must come from companies as well as accountants. And it must scrap AICPA's practice of deferring discipline until all lawsuits are settled. Other self-regulators, such as the New York Stock Exchange, don't give members that shield.

To win such powers, the disciplinary board should have a clear public mandate--and that requires the backing of Congress. "Three years from now, when nobody is paying attention, a private board can just let things slide," says John C. Coffee, a Columbia University law professor.

But the SEC's top dog seems to think he can work out a new system without legislation. Nor will the new board need subpoena powers, his aides say, because the Big Five's audit contracts can require clients to cough up documents. Deferring discipline is fine, they say, because accused accountants will be suspended while their cases are pending. "We are encouraging the accounting profession to take full responsibility for helping to solve this problem," says Pitt.

But Pitt's insistence on working out the terms with the Big Five first, before meeting with the POB or critics in Congress and elsewhere, is the heart of the problem. Those who know him well--even past foes--don't think Pitt is purposely going easy on ex-clients. Instead, he seems hampered by habits left over from his 25 years as a private securities lawyer. He's practicing the art of the deal--negotiating toward a settlement that takes away the accountants' cherished control over discipline but that doesn't bruise CPAs more than necessary. And he believes so firmly in his own integrity that he can't see how serious people would question his do-it-himself approach.

Now, though, Pitt is in a different role--and he has to grow into it. A tougher line toward the Big Five may be the only way for the SEC to emerge with its credibility intact--and with the auditor discipline system investors deserve.

McNamee covers the SEC from Washington.

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