Is Breeden Still A Believer?

In addition to Don Nicolaisen, Richard Breeden has been, in the past, an outspoken proponent of major reforms that would affect the accounting profession. (Interestingly, both spent time at Pricewaterhouse/Coopers and Lybrand. Maybe that time provided inspiration and motivation for making things how they should be instead of how they are…..) Some of his suggestions were incorporated into the Sarbanes-Oxley Act of 2002. Some were not.

Here, here Mr. Breeden. Your suggestions are worth repeating.

On February 12, 2002, six months before the passage of SOx and before Arthur Andersen disappeared, he testified before the Senate Banking, Housing and Urban Affairs Committee. This testimony was part of an Oversight Hearing on “Accounting and Investor Protection Issues Raised by Enron and Other Public Companies.”

The Honorable Richard C. Breeden, as you may recall was the Chairman of the US Securities and Exchange Commission from 1989 to 1993.

His testimony, entitled, “Responding to Enron – Strengthening Accounting and Disclosure,” was wide ranging and is worth a read in light of his recent activities. However, one particular section was of great interest to me.

Enhancing Performance and Accountability of Accounting Firms.

Require Audit Firms to have boards of directors with a majority of outside directors.

“Getting to the heart of these problems involves shifting the balance of priorities inside the auditing firms in the direction of greater concern for getting the numbers right, and for creating healthy governance structures that will open up the highly insular big firms.

One way of shifting internal dynamics in favor of the public trust would be to require that, as a condition of satisfying the “independence” requirements, an auditing firm for a public company must have a board of directors with full power to remove management, to determine compensation, and to set overall policy. At least a majority of the members of such a board should be from outside the firm. As with stock exchanges, there should be a minimum number of “non-industry” directors on each board representing the interests of shareholders and users of the markets. Officers of audit clients should not be eligible to sit on such boards.

For historic, licensing and other reasons, the Big Five operate as limited liability partnerships rather than as corporations. They are by far the largest private business organizations that do not have a real board of directors. Internal governance comes from various committees drawn from within the firm, whose members are elected or chosen by the partners or the CEO. They are generally subordinate to the CEO, not independent of him or her. While it is an axiom of good corporate governance to have a majority (and typically much more than a majority) of independent directors who can among other things hold the CEO accountable for performance of the firm, the large accounting firms may not have ANY independent directors to provide a wider public perspective or to have the power to remove the CEO.

A board composed of independent directors (with similar standards for independence as a corporate director is required to have) would go a long way to bringing a more balanced approach to how these firms manage conflicts between their legitimate profit interests and their public responsibilities. Ultimately the CEO of any Big Five firm should be subject to getting replaced if the board does not have confidence in the firm’s ability to deliver on its professionalism. There should be accountability for performance in audit quality, not just profit per partner, and that accountability at the top would be better exercised by a board of directors rather than the government. When Andersen was agonizing over its doubts regarding Enron’s potential accounting fraud in February of 2001, discussing the issues with a board including outside independent directors could certainly have given management a better perspective on the decision they had to make and its potential impact on investors, retirees, and others.

A good precedent for requiring the Big Five and other auditors of publicly traded firms to create boards of directors can be found in the operation of stock markets themselves. Though stock exchanges have generally been mutually-owned institutions with many similarities to partnerships, these organizations have a board of directors, with a 50/50 balance of inside and outside directors. Independent boards is one way we institutionalize a body within each Exchange that is directly concerned with carrying out the exchange’s responsibilities to the public.”