Commentary: Accounting Watchdog--or Lapdog? Here's How You'll Know

By Mike McNamee

Is this any way to restore public confidence in Corporate America's financial integrity? The Securities & Exchange Commission was supposed to establish a strong, independent board to police accountants and raise the quality of auditing.

Instead, the contentious and politicized process of choosing members for the new Public Company Accounting Oversight Board (PCAOB) has created doubts about the group's credibility and capability. Four of the SEC's five picks--including the board's chairman, William H. Webster, the former FBI and CIA director--have no public track record on accounting.

It's hard not to conclude that this PCAOB was designed to be a weak underling for SEC Chairman Harvey L. Pitt. That's good news for accounting firms: Pitt appears to worry a lot about shielding auditors from their own mistakes.

But investors have plenty to fear. The new oversight board--the centerpiece of Washington's response to a horrible year of corporate scandals--could quickly become captive to the accounting industry. Public attention for the PCAOB is bound to wane, as bewildered investors lose interest in the board's increasingly technical decisions. The Final Four accounting firms, however, aren't going away: Their potent lobby will always be ready to push its views on the board.

How can investors tell whether the PCAOB is working for or against them? A few key issues should signal whether this board intends to be a real watchdog:

-- Staffing and resources. With just six months to get organized, the PCAOB must quickly design an organization from scratch and hire key staff. The accounting lobby will be happy to offer blueprints and candidates--but the board needs to strike out on its own. A tough enforcement chief is vital: The board should set its sights on a former top SEC enforcer, such as William R. McLucas, now with the law firm of Wilmer, Cutler & Pickering. It also should charge companies fees that are high enough to support a robust operation.

-- Inspections. Less visible but just as important is the inspection department--the group that will examine the Final Four firms annually to make sure they have strong quality controls. The accountants will lobby for a small inspection team that contracts out its work--recreating the current system of peer reviews. Yet it was that back-scratching scheme that let Deloitte & Touche give Arthur Andersen high marks--even as Enron, Global Crossing, and other Andersen clients were tanking. Clearly, the oversight board must build its own team of strong, independent inspectors.

-- Audit standards. The biggest fight will be over audit standards, the rules that say how auditors go about verifying companies' books. Now, those rules are set by a committee of the American Institute of Certified Public Accountants (AICPA). The CPAs are fighting to keep control. But even the profession's own panels admit that the current rulebook is full of holes. A 2000 report to the SEC said that auditors should provide much more documentation on how they decide to sign off on a company's books. The CPAs rejected that, fearing that better records will leave a paper trail for shareholder lawyers.

There's only one correct response: The PCAOB should take over audit standards and write tougher rules that protect the public, not CPAs.

The PCAOB is not the only place investors need to watch. At the SEC, Pitt plucked out the Enforcement Div.'s chief accountant, Charles D. Niemeier, to serve on the board. "If Pitt hires a replacement who's friendly to the big firms, it will be disastrous," warns Douglas R. Carmichael, professor of accounting at Baruch College. Enforcement has been one bright spot in the SEC's response to corporate scandal.

And then there's the SEC itself. After a 3-2 party-line vote on Webster, the commission will have a hard time pulling together a consensus as it oversees the accounting board. Pitt got the board he wanted. But the longer he pulls its strings, the less investors will trust it--or the markets it's supposed to heal.

McNamee covers the SEC.

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