ACAP -The Acronym Tells The Story
On March 13, 2008, the U.S. Treasury Advisory Committee on the Auditing Profession (ACAP), co-chaired by former SEC Chairman Arthur Levitt, Jr. and former SEC Chief Accountant Don Nicolaisen, met to discuss the preliminary recommendations of its subcommittees on human capital, [audit] firm structure and finances, and concentration and competition.
It’s a luxurious collection of information.
I’d like to reprint her summary with my comments in bold and a few more comments about what wasn’t recommended. In particular, take a look at things that didn’t make the list that have been recommended by some great minds on these issues like:
Don Nicolaisen:
“I recognise the office of chief accountant has tremendous authority, and with that goes tremendous responsibility. The number one thing that I have focused on is: ‘Is the investor protected?'”
And he and I agree on this point – …”Mr Nicolaisen insists on a “trade-off” to any reform of auditors’ liability. He says accounting firms must publish annual accounts and provide information about partners’ compensation. Now, they only give revenue figures. He says the firms should embark on corporate governance changes, and have boards that, like public companies, have a majority of independent directors.”
Those that know better are afraid to be the one to push for any change that could be blamed for precipitating the next big firm failure. And another big firm failure is inevitable. A “next tier” firm failure is around the corner.
What is never voiced in this crowd, in public, are the questions my friend Jim Peterson has raised and now others have voiced:
Why in the world do we even need the firms or their stinkin’ audit reports?
What purpose do auditor’s opinions really serve anymore except to provide false confidence in a system that is crumbling before our eyes.
Rome is burning and the Neros are still fiddling on the perimeter.
ACAP. Get it? A Cap (on Liabilities?)
Edith’s summary of the 13 preliminary recommendations contained in ACAP’s March 13 report follows.
Subcommittee on Human Capital
The Subcommittee on Human Capital submits the following preliminary recommendations to the Advisory Committee on the Auditing Profession for its consideration:
(In general, I found these recommendations to be more goal oriented than action oriented. Who is going to do this stuff? “Mom and apple pie” wish lists are not what we need to improve the experience of students in the university and the preparation of students for professional life. But never forget, being an accountant is a job. Our university educational process, especially for accountants , has turned into vocational training, serving only the firms’ needs to save on entry level training and not the student’s needs to get a well rounded, complete, best available higher education that will give them options and choices in the career, not a fast track to a job that is controlled by an oligopoly and to firms that will lay them off in two years if the firm hasn’t forecasted its revenues well enough.)
1. Implement market-driven, dynamic curricula and content for accounting students that continuously evolve to meet the needs of the auditing profession and help prepare new entrants to the profession to perform high quality audits.
a. Regularly update the accounting certification exams to reflect changes in the accountancy profession, its relevant standards, and the skills and knowledge required to serve increasingly global capital markets. (It would be nice if the state requirements for the number of hours necessary to sit for the CPA exam were consistent.)
2. Ensure a sufficiently robust supply of qualified financial accounting, audit, and tax faculty to meet demand for the future and help prepare new entrants to the profession to perform high quality audits.
b. Emphasize the utility and effectiveness of cross-sabbaticals. (Professors in the firms and professionals in the classroom on voluntary sabbaticals? Neat idea in theory, but the danger of co-opting is strong. Why not have firm sponsored or CAQ sponsored free workshops and continuing updates for the professors? Why not have firms pay for their employees via a fund for MBAs and Masters and PhD in Accounting and Taxation on a consistent basis? Right now it’s “catch as catch can.”)
3. Improve the representation and retention of minorities in the auditing profession so as to enrich the pool of human capital in the profession. (Gee, that would be nice. Unfortunately, minorities and “diversity” candidates sometimes come with student visas that need to be turned into H1B or better visas. Maybe make sure firms make a commitment of more than a year to the student who thinks they have joined a world-class organization?
4. Develop and maintain consistent demographic and higher education program profile data sets.
Subcommittee on Firm Structure and Finances
The Subcommittee on Firm Structure and Finances submits the following preliminary recommendations to the Advisory Committee on the Auditing Profession for its consideration:
1. Urge the creation of a center (preferably under the sponsorship of the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and/or the Center for Audit Quality (CAQ)) for auditing firms and other market participants to share fraud prevention and detection experiences, and further, encourage the auditing firms and other market participants to develop best practices regarding fraud prevention and detection and clarify communications with the public regarding auditor responsibility relating to fraud detection, all in order to strengthen the audit process and improve the likelihood of preventing and detecting fraud.
a. Urge the creation of a center (preferably under the sponsorship of COSO and/or CAQ) to facilitate auditing firms’ and other market participants’ sharing of fraud prevention and detection experiences, practices, and data and innovation in fraud prevention and detection methodologies and technologies, commission research and other fact-finding regarding fraud prevention and detection, and further, have the auditing firms, investors, other financial statement users, public companies, and academics develop, in consultation with the PCAOB, the Securities and Exchange Commission (SEC), international regulators, and the National Association of State Boards of Accountancy (NASBA), best practices regarding fraud prevention and detection.
b. Urge that the PCAOB and the SEC clarify in the auditor’s report the auditor’s role in detecting fraud under current auditing standards and further that the PCAOB review these standards. (The bottom line is the firms do not want to be responsible for detecting fraud, Sarbanes-Oxley or not. Who’s going to make them?)
2. Encourage greater regulatory cooperation and oversight of the public company auditing profession to improve the quality of the audit process and enhance confidence in the auditing profession and financial reporting.
3. Urge the PCAOB and the SEC, in consultation with other federal and state regulators, auditing firms, investors, other financial statement users, and public companies, to analyze, explore, and enable, as appropriate, the possibility and feasibility of firms appointing independent members with full voting power to firm boards and/or advisory boards with meaningful governance responsibilities to improve governance and transparency at auditing firms. (Yea. This one made it. Thanks Arthur, Don and Richard. However, let’s see how this would work in real life. The firms would select a friendly advocate from the list of companies that they can find no independence conflict with [a short list for sure], a company they are not doing significant business with yet but want to grow with. Then they would have a revolving door as independence and other business conflicts conflicted those guys out every other month.
4. Urge the SEC to amend Form 8-K disclosure requirements to characterize appropriately and report every public company auditor change and to require auditing firms to notify the PCAOB of any premature engagement partner changes on public company audit clients. (Yep. Ask Chris Ames. Making sense out of the current SEC noodle soup and getting a real story is next to impossible. )
[The report added:]
“Observation: Further Subcommittee consideration of transparency and liability issues.
Subcommittee on Concentration and Competition
The Subcommittee on Concentration and Competition submits the following preliminary recommendations to the Advisory Committee on the Auditing Profession for its consideration:
1. Promote the growth of smaller auditing firms consistent with the overall policy goal of promoting audit quality. Because smaller firms are likely to become significant competitors in the market for large company audits only in the long term, the Subcommittee recognizes that Recommendation 2 will be a higher priority in the near term.
2. Create a mechanism (??????) for the preservation and rehabilitation (Is that what we want ? To preserve and rehabilitate a corrupt, bankrupt firm? The law firms let them die a natural death.) of troubled larger public company auditing firms.
3. Promote the understanding of and compliance with auditor independence requirements among auditors, investors, public companies, audit committees, and boards of directors, in order to maintain investor confidence in the quality of audit processes and audits.
4. Adopt annual shareholder ratification of public company auditors by all public companies. (Yes. Absolutely. Critical. Get these issues out in the public eye. No more sliding in a firm over and over again, even though they lack independence, for example…)
5. Enhance continuously regulatory collaboration and coordination between the PCAOB and its foreign counterparts, consistent with the PCAOB mission of promoting quality audits of public companies in the United States. (Interesting. How about making the firms take more responsibility for their foreign offices and not be able to hide behind the shield of complex legal entity? Taking money from each other, across international borders, representing themselves as a global enterprise and then disclaiming knowledge of their actions later when someone does something illegal sounds like a RICO issue to me. )
Francine, thanks for citing FEI blog summary of Treasury ACAP mtg.. you have a knack for catching subliminal (probably unintended, but nonetheless interesting) metaphor in the committee’s abbreviated name …. In general, there are often varying points of view on many current topics being discussed in various venues today – I find your analysis of issues of interest given your experience in the industry.
First, thank you for your excellent work on this blog and at Forbes. I am a reader and in Internet lingo, a lurker.
Please take this criticism in the flattering light in which it is written, for I believe you are one of the few experts who will at least understand the point I am trying to make, and the post above is an example of it.
To frame it, let us agree that the financial crisis highlighted just how far off the reservation many of our professional classes have gone. In too many respects, they are merely a regulated transactional tax without significantly adding value. Markets are defined by some very simple rules. One of them is communication. So then we come back to the FASB and government institutions like the SEC, and return to elementals:
1. Financial instruments are no longer readable, even by experts. What is off-Balance sheet? And do not tell me that the issue becomes nuanced. I could take 20 laymen off the street and in a morning explain to them the principles of accounting necessary to make a pronouncement on whether a firm’s financial statements materially reflected reality. And I wager 18 of 20 of them would agree on any example we put in front of them. And I wager that given current FASB rules, 18 of 20 would agree that most large public firm financials are intentionally obfuscatory and materially misleading.
2. Auditing is BS and has been for decades. The examples of failure are everywhere. Let me make my point this way: Let us say that the goal is a true “Opinion” of accuracy and honest representation, without chance of material malfeasance with 95% confidence. If that is a valid goal, then I submit that the whole auditing approach is wrong, audit firm pyramid structure is wrong, and regulation is too concerned with the status quo and sees only the trees instead of the forest. Regulation aside, is the above goal possible without impossible fees? Damn straight it is. That is not the problem. The problem is that most auditors wouldn’t know how to go about it.
So if we begin with these two simple precepts, the auditing profession is bankrupt, both morally and technically. It has failed to accomplish its primary purpose; ensure the sanctity of markets. Even more spectacularly and telling, the larger the entity, the worse it is. The ‘top’ of a profession should be its best, not its worst. We have fallen into the weeds so far that we no longer think rationally. The question is not whether to ‘preserve’ the Big 4, but whether we would all be better off, especially the investor, without them. I submit we can make an argument that they would be, and that is a terrible indictment of the state of the profession.
And so all the propositions in the post above are fiddling, acting as small band-aids to preserve a broken system that asks for even higher contributions from taxpayers for almost no return. Until the profession views say, the Bernie Madoff and Lehman fiascos as serious fundamental signals that we are now staring at a professional corpse, we will get nowhere.
There is now a real argument that we go back to basics, clear all the clap trap away, and begin again. Serious self-reflection, simplification and renewal is a proper and appropriate response to complete failure.
@Jim
Thanks for reading. It’s ok to be a lurker. People contribute in many ways to the discussion. Perhaps yore one who has told others about my work and therefore supported me behind the scenes until now. I’m grateful.
I agree with you wholeheartedly. The point of my post – and I’ve said it many times since – is that the thing the accounting industry wants most is liability caps or a full blown safe-harbor from litigation. Then they can go on and do their work under a government sponsored franchise, making oligopolistic profits, in peace.
It’s time to create a new assurance product that the capital markets and investors need and to deliver that product in a truly independent way.
Thank you for your reply. Until our lawmakers insist on writing laws that protect markets instead of pandering to social classes, I fear new assurance products will not find a solid grip in the market unless they can find a way to do so at less cost. Which is a very high bar.
I long ago gave up on waiting for the fiduciary duty of the FASB.
The story of our times could easily be written through the lens of the erosion of our professional institutions’ sense of propriety, idealism, excellence, fiduciary duty and mea culpa. Even my dentist is selling me now, and I think twice before telling my doctor anything. On the other hand, Mancur Olson would probably say that is how all nations eventually fall.
Keep up your passionate work. I am a great fan and I am heartened to meet your words. Too many professionals give up on the big picture as unalterable. A chorus must rise which can not be politicized or ignored.