SEC Chairman Harvey L. Pitt
Over the last decade or so, this Country’s vaunted system of disclosure, financial reporting, corporate governance and accounting practices has shown serious signs of failing to keep up with the needs of today’s investors, our economy, and new technology that makes rapid communications not only possible but essential. The latest example – a most tragic and unprecedented one – is the failure of Enron.
There are two distinct facets to the “Enron situation.” The first is finding out who did, or who failed to do, what, and who bears responsibility for the horrendous losses imposed on Enron’s investors and employees.
As I have said before, the commission is actively and aggressively investigating these circumstances. Our investigation will be thorough, and will deal effectively with any wrongdoing that may have occurred. The second facet of Enron is to see what lessons we can begin to learn about how to prevent failures like this from recurring.
Our disclosure and financial reporting system is still the best in the world, but it has long needed improvement. Its inadequacies are more visible after Enron’s failure, and the need for change cannot be ignored any longer. This is not a problem that arose overnight. Investors here and abroad are entitled to rely upon our system as the finest in the world. We intend to fulfill that responsibility.
There are many aspects of this problem. Our system of periodic disclosure, for example, is old and not good enough. Today, disclosures are made not to inform, but to avoid liability. We need to move to a system of “current” disclosure.
The present system, which has been in effect for 67 years, doesn’t provide for “current disclosure.”Financial disclosures are dense, impenetrable. We have called for plain English financial statements.
Corporate governance issues and the role of Audit Committees are also in need of review. We recently alerted companies and their Audit Committees of the need for transparent disclosure of key accounting principles and policies in annual reports. Very shortly, we intend to issue a statement on MD&A disclosure that seeks to promote greater consideration of the intent of MD&A, which is to give investors a view of the company through the eyes of management, on critical financial issues.
We need more prompt action by the FASB, the nation’s accounting standard setter. And, we at the SEC need to improve the way we oversee our disclosure and financial reporting system.
Finally, there is a need for reform of the regulation of our accounting profession. We cannot afford a system, like the present one, that facilitates failure rather than success.
Accounting firms have important public responsibilities. We have had far too many financial and accounting failures. The commission cannot, and in any event will not, tolerate this pattern of growing restatements, audit failures, corporate failures and investor losses. Somehow, we must put a stop to a vicious cycle that has been in evidence for far too many years.
In addressing this myriad of issues, we will be creative and expeditious in exploring and pursuing private, regulatory and legislative avenues of action.
To return to the accounting and auditing system, while there are many facets of our system that need repair, the potential loss of confidence in our accounting firms and the audit process is a burden our capital markets cannot and should not bear. Given that we are now in the process of year-end audits, and given the enormous – and appropriate – attention being focused on the role of accountants in some of these corporate failures over the last decade, we have taken the initiative to begin the process of restructuring the regulatory system that governs the accounting profession.
Toward that end, even before Enron’s collapse, we called upon the accounting profession to work with us to resolve its vulnerabilities and weaknesses. The commission, not the profession, must take a leading role in protecting the public interest; this effort requires a reordering of perspectives and priorities within the profession. The profession has shown great willingness to work with us to produce a better regulatory system.
In our vision, this system must at heart be a tough, no-nonsense, fully transparent disciplinary system, subject to independent leadership and governance. In addition, there must be regular monitoring of the ways in which accounting firms perform their responsibilities, and the areas in which either individual firms or the profession as a whole, can improve.
The system we envision must be thoroughly vetted with all major constituencies, and we have advised the relevant congressional committees that oversee our efforts that we will work closely with them to ensure that the framework we ultimately propose meets their notion of what is appropriate in the interests of investors.
There have been public reports of some of the components included in the system we are examining. In brief, here are some of the components we believe should be a part of this process. We initially envision a new body dominated by public members, with two primary components – discipline and quality control.
Let me speak to those two elements.
The system should be subject to a new body that is dominated by public membership.
The SEC should decide whether conduct should be pursued as violations of law (in which case the SEC would handle it), or pursued as violations of ethical and/or competence standards (in which case they would be handled by the private sector regulatory body).
The body should be empowered to perform investigations, bring disciplinary proceedings, publicize results, restrict individuals and firms from auditing public companies.
The disciplinary proceedings should proceed expeditiously. Disciplinary actions should be subject to SEC oversight.
Quality control reforms
There should be a reform of the current peer review process that avoids firm-on-firm review. The new process should replace the current triennial firm-on-firm peer review with more frequent monitoring of audit quality and competence designed to produce better audits in the future.
There should be a permanent Quality Control staff, composed of knowledgeable people unaffiliated with any accounting firm. The staff should be deployed and overseen by the new publicly dominated body and its staff We are at the early stages of this proposal, and many details remain to be worked out. The SEC will carefully review this and other proposals regarding a system of public sector regulation to ensure that it addresses our concerns with the current system.
A strong accounting profession is key to our capital system, and we are firmly committed to assuring that it functions properly, expeditiously and in the public interest. Significant work remains to be done, but we are confident that with input from all sectors we can erect a system that will restore public confidence in the integrity of the accounting profession.