WALL STREET REFORM

August 2002
		How can the Bush administration and Congress clean up Wall Street and restore investor confidence in the wake of corporate scandals?

Forum Introduction Do stock options act as invitations for corporate fraud and misleading financial statements? Did Enron's trading of energy futures on the Commodity Futures Exchange enable it to mislead investors? How much should people with mutual funds worry about corporate corruption and accounting scandals? What is the role of a corporate board of directors? Will the conviction of corporate executives have any real influence on the markets? What would have happened if legislation to privatize a portion of Social Security had been approved? What happened to all the money that people lost -- was it ever 'real'? Why not limit the amount of time an accounting firm can serve as a company's independent auditors?

Serge Perreault of Montreal, Canada asks: ________________________________ Regarding the policing of the accounting profession: Why not limit the amount of time that an accounting firm can serve as the independent auditors for a public company? Why wouldn't the SEC, FASB or Congress set a mandate that auditors of a public company cannot serve beyond a certain amount of time? The audit firm of a public company should not also provide consulting work for that company or its affiliates. How can that be anything but a conflict of interest? It would seem obvious that the public company and their auditors would come to share interests, as with Enron and Arthur Andersen. Ronald Berenbeim responds: ________________________________ I have talked to accountants, and they say that it has been tried in Italy and neither the companies nor the accountants like it. As soon as learning curve problems have been solved, it is time for the accountants to move on. Of course, the fact that Italian companies and accountants don't like it doesn't make it a bad idea. In regards to your last question -- concerning the conflict of interest -- the future is on your side. Consulting and auditing are going to be separated. But the answer is not a simple one. It seems reasonable that auditors should be allowed to provide consulting services related to the audit [e.g., accounting safeguards and procedures]. In the Enron case, early stories said that 70 percent of Andersen's revenues came from consulting and 30 percent from the audit. Later information said that if you accounted for audit related consulting it was a 50-50 split. Accounting firms didn't like auditing because it wasn't interesting work and it didn't pay well. Now they are unlikely to have either of these complaints. But there is likely to be a period of testing to determine what kind of audit-related consulting is allowed and it makes sense that bona fide work of this kind should be permitted. Frank Torres responds: ________________________________ The Sarbanes-Oxley bill passed in July stops short of requiring the rotation of audit firms. Instead, the bill says that those having primary responsibility for the audit within the audit firm must be rotated every five years. The bill does call for a study of mandatory rotation of accounting firms. Many consumer and investor advocates believe that requiring rotation of audit firms would increase the independence of an audit by preventing some of the conflicts that often exist when there is a long-term relationship between the audit firm and their corporate clients. There have also been recent cases where new auditors, called in to verify the corporate books, have found errors resulting in the need to restate company earnings. Rotating auditors on a regular basis could bring discrepancies to light earlier or cause a more careful audit to be conducted in the first place. Some in Congress were reluctant to make such a reform as unnecessary or too disruptive, particularly to smaller businesses. Two years ago, then-SEC Chairman Arthur Levitt attempted to ban auditors from providing non-audit services to their audit clients. His attempts at meaningful reform were beaten back by a strong accounting lobby and members of Congress. The Sarbanes-Oxley bill, while not going as far as the Levitt proposal, does ban auditors from conducting a prescribed list of consulting services for their audit clients. Olivia Kirtley responds: ________________________________ Mandatory audit firm rotation after a limited number of years has a lot of "curb appeal", but a rigid rule on this is not in the best interest of shareholders. There are a number of studies that indicate that mandatory auditor rotation would actually heighten the risk of audit failure in the first couple of years after a change. In fact, several European countries have put in this requirement in some form and subsequently dropped it because it did not achieve their public policy goals. Mandatory firm rotation can also create unwarranted restrictions on the freedom of boards to select auditors in the best interest of stakeholders (knowledge and expertise of industry, capabilities of people within firms for specific issues, etc.) A forced change would not in the best interest of the company or its investors in many, many cases. The new Sarbanes-Oxley Act of 2002 does requires rotation of the lead audit partner and the review partner every 5 years. It also requires the audit committee of the Board, rather than management, to be directly responsible for the appointment, compensation and oversight of the work of the audit firm. I think an added requirement of mandatory firm rotation would be a bad idea. However, the Sarbanes-Oxley Act of 2002 directs the GAO to do a study on the potential effects of requiring the mandatory rotation of audit firms, so this will be subject to future discussion and analysis.