Mr. Volcker, the accounting profession looks to be in a credibility crisis.
... Would you agree with that? Where do you see the accounting
... I made a speech to the assembled chief financial officers of the United
States in October, I guess. Enron was beginning to be a problem, but it hadn't
exploded. I said, in my judgment, the accounting profession is in a state of
crisis. I used precisely that word.
Why? What was the crisis?
The crisis was ... so far as auditing is concerned, a relaxation of standards.
But it's not as simple as that. It reflected the pressures on finance and
business generally to deal with the complexities of modern finance. ...
What about just plain right and wrong? In the last three years of the 1990s,
there were 464 American corporations that had to significantly restate their
earnings, which have been approved by auditors. What does that say to us, who
are sitting out here, counting on the scorekeepers -- the auditors -- to audit
Well, it's not a happy picture. The profession needs reform, and that's what
I've been occupied with myself from several directions. ...
But how did it get here? What I don't understand is -- you talk about
complexity. But it seems to me it isn't just complexity. If you look inside an
Andersen, it wasn't so complicated that Carl Bass [in the Professional
Standards Group] couldn't say to David Duncan [the Houston partner in charge of
the Enron account], "You shouldn't be approving those things." It wasn't
complexity. There was a disagreement about whether or not you went against the
Well, there were obviously disagreements. But there are matters of
interpretation, about how to interpret standards which are themselves complex.
I am told that the standard for derivatives -- which is a relatively modern
development, in all their complexity -- runs to something like 650 pages.
Is Enron unique?
No. It may unique in complexity, but you mentioned, what -- 460 restatements of
earnings -- whatever it is. I don't know what the number is. There are two that
are discussed in the paper yesterday and today. Nothing to do with Andersen and
not as dramatic, but there they are in the paper today. Next week, I suspect
there'll be some more, and that's been the picture.
The insiders seem to understand the game. But if you're an ordinary retail
investor ... we don't know what to trust. I don't know whether or not you
agree, but Arthur Levitt said to us it's the trust in the
marketplace that's at stake here, and that's been put at risk.
The trust in the marketplace is what's at issue. I don't want to exaggerate it.
Most companies have fair reports. Most audits are fair audits. In general, I
think our system is still the best in the world, as we say. It's not as good as
we brag about, and that's why we've got to make it better. But by and large, we
have done a reasonable job, given all the pressures and complexities. But we've
got to do a better job. ...
You've made a major issue out of the importance of separating the auditing
function from the consulting function.
Because I think that's one of the pressure points that tends to create pressure
on the auditor itself to not be as disciplined as it might otherwise be with
the client -- when he knows that there's a lot at stake in terms of consulting
fees, as well as auditing fees.
Now there is a basic conflict and a problem, because the audit itself, of
course, is paid. The auditor is hired by the company; the company pays the
auditor. So there's a relationship there that can create pressure. But that is
increased, it's multiplied, if there are large other fees at stake.
I don't think there's any question that, as these firms have become
conglomerates, so to speak, an auditor is aware that a lot is at stake in terms
of fees from other activities outside the auditing itself. They may even be
rewarded themselves in terms of whether their clients use other services of the
To be specific, is David Duncan, the Houston partner for Arthur Andersen,
looking at Enron's books thinking, "We're making $27 million a year from
consulting services and $25 million a year from auditing services. I don't want
to displease this client?"
I don't know anything about David Duncan and his mind. All I know is that there
is an appearance there -- whether it's in Enron or anyplace else -- that the
audit may be subconsciously affected by his knowledge that a lot of revenue is
at stake in his judgments.
Will that affect his independence of judgment? You hope not. But I think that
we're better off by removing that appearance, that possibility -- that reality,
in some cases. That's why I think it's a good idea to keep them separate -- so
that suspicion doesn't arise, that pressure doesn't arise. ...
The 1934 securities law said, essentially, through the SEC, that auditors
were going to work for the public; essentially keep the books straight. Level
playing field, right? It looks to somebody from the outside as though,
essentially, auditors -- particularly those working in the firms -- were
working for management. They weren't working for the public.
Well, I think that's overstating it. But I think to the extent the conflict
exists, and the extent to which we can reduce the conflict -- both the reality
and the appearance -- it's a good thing to do. That's why I have been
advocating separating the auditing function from the variety of other services
that these firms are providing. They were on a track where more and more
non-auditing services were being provided. Now, in reality, I think what's
happened is the market itself is pushing back in the other direction now. I
think that's a healthy thing.
How do you mean?
That some of the auditing firms -- most of the auditing firms -- are selling or
disposing of some of the really expensive, complicated consulting --
particularly in the high-tech area and the information technology area. They
have sold off those practices, or are in the process of selling off those
practices. They've stopped selling them in many cases -- most cases -- to their
auditing clients. So changes are under way as we talk.
One of the arguments made by the accounting industry at the moment is, "Let
us do it." Has self-regulation worked, in your opinion?
The people that I have talked to that are much more familiar with accounting
and auditing over a period of time feel very strongly it has not worked. It's
been too weak, and it needs to be strengthened, stiffened, disciplined. I think
we will get legislation in that direction.
So would you favor government oversight or some body with oversight
Yes, I would favor some kind of body with oversight power, with disciplinary
powers, with powers of initiating their own inspection and review of audits.
... To what extent are controls and oversights needed that are independent
from the control of the accounting industry?
I think you need it for the oversight body that we were just discussing to
review the practice of auditing itself. Now, when you get to FASB [the
Financial Accounting Standards Board] ... you have a problem. You can't be
independent of the accounting industry. You need accounting experts. You need
auditing experts to make these rules.
What you want to do is have them independent from political pressures and
independent from particular industry pressures, so that they can arrive at
their judgment on a technical basis: what is good accounting, what is good
accounting rules and programs, which is what they're responsible for.
But you have to have experienced people there. Then you have the little problem
that you don't want them working off in an ivory tower, absorbed with
technicalities and theory without some sense of how their rules affect real
All those arguments are understandable. But part of what happens is that you
get people now who are saying there are always reasons to have the accountants
running it -- their expertise is necessary, their consultations are necessary.
But basically what you get is a myriad and a maze of rules that are so complex
that nobody but an accountant can understand it. In the end, you never get any
judgments, and there seems to be no deterrent to bad behavior in the accounting
Well, look what's going on now. The whole discussion that we are having is a
deterrent to bad behavior. There's no question that what is going on in the
marketplace -- it's not just Enron, [there are] many other cases, with Enron a
spectacular case -- is having a chastening and disciplining effect on the
accounting and auditing profession, and consulting.
But people said that after the savings and loan scandal, and they paid a
billion dollars in stockholder suits. And here we are again, a decade
Exactly why I think we also need some structural reform, so that these
pressures that we feel now and the discipline that we feel now persist. That is
precisely my concern. ... I want to see that oversight body. I want to see a
division between auditing and other services. ...
When you came in [earlier this year], heading the oversight board for Arthur
Andersen, did you find strong leadership? Did you find Mr. Berardino on top of things and knowledgeable and in control?
Mr. Berardino was knowledgeable. But if you say there was a strong, unified
management of Andersen, I do not think that is correct. It partly reflects the
difficulties of managing a huge partnership of that sort. But Andersen in
particular, I think, was going through some effort to decentralize. They may
have overdone that, in retrospect; but there's obviously a tension between
central control and decentralization. ... One of our, the oversight board's,
strong feelings is [that], in an auditing firm, you do need strong, central
control over auditing and accounting interpretations.
To make sure that you have some counter to the natural pressures in the client
relationship, to try to make it possible for the client to do what he wants to
do within the rules. You want to make sure the rules are not bent to permit
that. I think that requires a strong central body, which Andersen,
interestingly enough, used to be famous for in the industry -- by having
strong, central, technical control. I think we've got to restore that.
So are you implying, maybe, that some of Andersen's problems at Sunbeam, at
Waste Management, at Global Crossing, at Enron, were partly a result of
loosening central controls and having the engagement partners too much in
I think that is an issue. We have ordered and in effect, it takes time to
implement these things. But, yes, we said we wanted the company to have more
centralized strong control over accounting interpretations; and that the
engagement partners, a decentralized area of the firm, had to respect the
professional judgment. These are difficult questions. There are all these
borderline questions. But when it comes down to a difficult, borderline
question, you've got to go to the experts, the ones whose responsibility is to
defend a good audit. They ought to have the final say.
In fact, you're saying that if Carl Bass in the central office is
challenging David Duncan in the Houston office of Andersen, that the leadership
should be listening to the experts?
I can't comment on the specifics of that situation. But I do think you need a
strong central control over questions that inevitably arise. In every firm, in
every complicated audit, there are questions that arise. Does it fit, does it
not fit, at the margins? You've got to have some discipline in making those
But whether or not Andersen got in trouble, you should have strong central
control, because that helps provide protection against getting in trouble.
Andersen, as I indicated, was well known in the industry for having strong
central control, as being a relatively unified firm with strong controls. They
changed that to some degree, apparently, in the 1990s. I think they should
What happened when they changed it?
Well, they've had problems. They're not alone in having had problems, but
they've had problems -- obviously -- more problems than one would like.
We've talked to other people who remember Andersen in its heyday, and they
talk about Andersen as the U.S. Marines of accounting.
How does the U.S. Marines of accounting wind up in this kind of difficulty?
... I think they were subject to the pressures that have been endemic in the
market, I think, exaggerated by the kind of go-go atmosphere in the financial
markets -- stock prices going up, everybody's got a stock option. "Let's get
the stock up as high as we can," "Let's do a lot of leveraging." In that kind
of forced environment in the marketplace, generally, where people were looking
to what I will call "exotic" methods of finance, that had the effect, in cases,
of disguising debts, overstating earnings, hiding liabilities' visibility by
off-balance-sheet items, by other techniques. Uses of derivatives became very
These were not originated with the auditor or the accountants. They originated
with investment banks, sometimes with law firms, who sold the companies -- who
were quite willing companies -- techniques that, one way or another, made them
Got around the law.
Well, "Got around the law" is an exaggeration.
I didn't say, "Break the law." [I said], "Got around the law."
Well, got around the accounting rules. That's right. Tried to interpret the
accounting rules or tax rules. A lot of this is tax-driven. "How can we get
around specific IRS regulations?" "How can we get around specific accounting
things?" -- in ways that don't break the law, but may end up distorting the
purpose of the law, distorting the purpose of the accounting rules.
This has been endemic. Andersen got caught up in it, I think, as other
accounting firms did, as investment banks did, as other participants in the
market did. The difference is we do count on the auditor as the last line of
assuring the accuracy, validity of financial statements. They are at the end of
the line, so to speak.
It's a difficult place to be, in many cases, when you have all kinds of
pressures to say "yes" when you should be saying "no" in borderline decisions.
But you make one borderline decision, it leads to another borderline decision,
maybe a little further than you really want to go, and it gets caught up.
You had debates within Andersen, for instance, about whether -- "We really have
to draw the line here," or not. I think, in retrospect, they didn't draw the
line tightly enough. But I'm sure equivalent things were going on within
companies and within other firms. ...
But there's no question, as we thought initially in the early weeks of the
Enron scandal, that Andersen was unaware. Now it's perfectly clear from some of
the internal documents that come out that they not only knew, but they were
debating them. And these were judgment calls, not lack of information.
In some cases, I think they think they were misled. But that's a specific
situation. They certainly faced a lot of judgment calls, and those judgment
calls accumulated in a way, in retrospect, I'm sure they wished they would have
made the judgment calls in another way. But I'm sure those are the kind of
judgment calls that are being made all over industry as we speak.
Now, you made a point when I started to say "getting around the law." To
some people, it's not what's illegal that's disturbing. It is what's legal. It
isn't whether or not Andersen broke the law that's a critical issue; it's that
the rules are so fuzzy, the latitude is so great, the judgment calls are so
numerous, and the ability to get through loopholes is so enormous, that the
investor, the public winds up by getting misled without anybody breaking the
law. Is that the problem?
This is not largely a question of breaking the law. This is a question of
interpreting accounting rules. There's a big difference between an intent and
otherwise between interpreting a rule, and stretching a rule, and actually
fraudulently breaking the law, or breaking the rule knowingly. You have no
defense; you're just breaking the rule.
If we assume that most accountants and auditors aren't out there
deliberately, knowingly breaking the law -- and I think that's a perfectly
natural assumption to make -- have we got a systemic problem that you can wind
up by being within the law, and you can wind up by misleading investors?
This is getting a lot of attention now. It's a rather philosophical or general
issue. There is a debate going on--
It's pretty important to people's pocketbooks -- not philosophically.
It's an important issue, really. It ends up being important in pocketbooks, but
let me try to describe it to you.
The American tradition in this area -- in the accounting area, and I think in
the tax area -- has been to start with a law, or in accounting you start with
an accounting principle. You elaborate it. You try to describe how it applies
in complex situations. The American tradition is to write very detailed rules
to try to take count of every contingency, whether you're talking about tax law
or accounting law.
The feeling is that has created a philosophy -- aided and abetted by our legal
system and class-action suits - that, if it's not there in black and white,
prohibited, and you can find a way around the written rule, that's OK. A lot of
people have paid a lot of money to do that.
The contrasting philosophy is don't try to cover every specific application and
complication, because you can't, because people will find a way around it. But
try to be perfectly clear about what the intent is of the accounting rule, and
then put the burden on those who apply the rule to respect the intent.
So you've got a lot of argument. To take a kind of specific case that's been in
the news, off-balance-sheet items: when does it go off balance sheet, and when
it goes on balance sheet? Well, there're some fairly specific rules. What's the
ownership percentage? Who does this, who's a member of the board and all this
kind of thing. Then you fix it up and if the rule says X percent, you go X
percent minus one tenth of one percent, you're OK. And if you go over that,
you're not OK.
The other philosophy, you say, "Look. The general intent of the rule is you
cannot control it. You must have no conflict of interest with that
off-balance-sheet item. You must not control it, or it's going to be on your
balance sheet." That's more of a judgment thing, and it doesn't rest entirely
upon what that particular percentage is.
There's a lot of thinking now of going in that direction. I don't think it's
resolved, and there's no perfect answer. But I think there's a lot more
sympathy now in going in that direction and putting more burden on the auditors
and more burden on other people, of respecting the clear intent of the
regulation, the clear intent of the accounting rule, rather than trying to find
some way around some specific numerical -- typically -- explanation of the
rule. That's a tough burden. It's just not an easy problem.
If by the time our program is on the air and Andersen is back on its feet
and it's pulling its clients together again, and it's done the kind of reform,
it's moving in the direction you're proposing, what do you think the message of
a survived Andersen as an auditing firm is going to be to the markets and to
the auditing industry?
This is the whole game that I'm interested in, so to speak. Can we reestablish
Andersen as a first-class firm concentrating on auditing, first and foremost,
and practicing auditing in a disciplined, high-quality way? Will that attract
clients? Will the clients be willing to pay for that kind of audit without
worrying about a lot of other services? My bet is on that proposition.
What's that going to mean? That will mean, I think, that other firms will
follow in that pattern, too. They will attract clients, and that will be a
better auditing system. That's what this is all about. If we can be successful
here, I think we will get reform in the auditing profession, and the American
public can feel more comfortable about the accuracy of financial statements.
They will have more trust in what they read and learn.
The analysts will be better off, and we'll have better financial markets.
That's what this is all about. Can we restore a reformed auditing profession
that's up to the very heavy burden that we put on auditors as the last line of
defense in good, accurate, high-quality financial statements?
Now let me take the opposite scenario. Let's assume the opposite -- that
Andersen, in fact, doesn't survive; or it's pretty clear that, by June 20, it's
not going to survive. Does Andersen's disappearance mean the problem is solved,
that we got rid of the firm that was the difficulty? Or is the problem
I think the disappearance of Andersen clearly doesn't solve the problem. There
are those that argue, understandably, that this is a pretty dramatic event;
that this firm that used to be considered, really, the gold standard of
accounting has fallen on such difficulties that it disappeared has a chastening
and disciplining influence on others. But I don't think it substitutes for
ongoing reform. If Andersen can survive and prosper as a disciplined auditing
firm, I think that is more assurance of a reformed, stronger auditing
profession in general than if it just disappeared. ...
It's not just in the auditing profession. They're at the end of the line.
That's very important; they have a public responsibility. But these breakdowns
reflect pressures that are very strong and affect other professional groups,
financial groups, as well.
Andersen didn't make up all these things that Enron was doing. Other people
sold those techniques to Enron, or they developed them themselves. Andersen's
function was to rule on them in the end, but they didn't make them up.
So what you're saying is the Merrill Lynches, the investment banks, the
Goldman Sachs -- these were the people who were engineering the very vehicles
that have gotten Enron and Andersen in trouble.
And are they equally culpable?
The peculiarity of the auditing firm is that they do have a special public
responsibility. Law mandates that a publicly traded company has to have an
auditing firm, has to have an audit. That audit is the defense against these
other techniques, these other developments, passing over the line into
something that's misleading. The auditing firm is responsible for making sure
that doesn't happen. ...
People were saying this before the indictment had come down against Andersen
-- that the auditing profession has stonewalled, stonewalled, stonewalled; has
been very reluctant to admit it's done anything wrong; has fought every action
as long as it could, dragged it out. So the whole notion of self-policing,
"Leave it up to us," falls on deaf ears, at least in some quarters.
I think there have been criticisms of the auditing profession, generally,
resisting reasonable reform over the years. I don't think there's any question
about that. I have not been following this as closely as other people do, but I
have heard those complaints -- I think they have some force -- that the
industry oversight has not been strong enough and disciplined enough, the
self-oversight, to deal with the problems.
So why should people be willing at the moment, then, to trust the industry
to clean up its own act?
I'm not entirely trusting the industry to clean up its own act. The fact is I
think out of this it's very likely you're going to get a much stronger
oversight body -- governmental oversight body; self-regulatory body, maybe. But
it's going to have more disciplinary powers. It's going to have more
independence. It's going to have more authority for examination of audits from
the outside than anything that has existed before. I would be surprised if that
is not one development out of this situation. I think it's a healthy
development. The other is I think we're seeing different practices in the firms
The year 2000, when Arthur Levitt as chairman of the SEC tried to do what
you're trying to do right now -- that is, to separate the auditing and the
consulting functions -- the accounting industry marshaled a lot of
strength against that. They fought Arthur Levitt tooth and nail.
That is true.
That doesn't sound like an industry that wants the kind of regulation that
you think is necessary.
Well, they may fight this overall regulatory body, or they -- I don't know
whether they'll fight it in general or fight it in detail. But they will have
an interest in it. I think that kind of legislation is desirable and necessary.
I hope it passes. I said so. I've testified to that effect.
I also think that's not the end of the world. You're not going to solve all
these problems by an outside regulatory agency. It may help. The industry has
to reform itself, and that's what's at stake with the Andersen question. I hope
we're successful, but we'll see.
But you've got the head of the AICPA, Barry Melancon, saying, "Right now,
it's not necessary to separate the auditing and the consulting functions.
That's not the problem." So what do you say to him?
I think it's part of the problem and it ought to be done. I don't know any good
reason not to do it. These firms -- the suspicion is obviously there. The
perception is there. Whether it's a problem or not, there is a perception of a
problem. I think it's a real problem. I would like to see auditing firms return
to their roots and do auditing.
I think auditing is a vital public function. It's vital that it be done well,
and I think the best assurance of doing that well is that it be done in a firm
which is devoted to that function, and not just -- a part of a firm that has
bigger financial interests elsewhere.
Surely Mr. Melancon is not taking the position he's taking -- which is,
"Don't force the firms to separate auditing and consulting" -- without his
feeling that he's representing the views of the other Big Four firms.
I'm sure that's right. In fact, the other firms are separating some of their
consulting; because I think, partly they recognize there's a problem, partly
because the public pressure is in that direction. So at least they're moving in
some direction. ...
There are some people who feel that the only deterrent, in the end, to
potentially fraudulent behavior is, in fact, criminal prosecution. ... Do you
sense anything in the accounting profession that is so resistant to change that
it's going to take a criminal prosecution to send a message?
If there's criminal offense, you have criminal prosecution. And you should have
criminal prosecution. I don't think the problems of the auditing profession, in
general, are matters of outright fraud. That may exist in some cases; but
usually it's a matter of stretching interpretations, taking situations that are
not totally black and white and taking some that are so gray they ought to be
on one side, but making them whiter than they should be.
But those are matters of judgment and interpretation. They accumulate together
into unsatisfactory audits. ... But there's a big area that doesn't reach the
level of criminal intent and outright fraud. Those are the easy cases -- should
be the easy cases.
You've talked about -- and there certainly is good reason -- the complexity
of the rules, the complexity of modern financial engineering, derivatives and
so forth. But I've talked with a number of people, including at least two other
members of your oversight board, and they shall remain nameless. But one of
them said to me point-blank, "It isn't just complexities. People have forgotten
what Mom and Dad told them about doing what's right and wrong." Is there an
ethical issue, as well as complexity?
Oh, yes. I think there is.
Can you talk about that for a moment?
I think there is an ethical issue that runs right through the markets. It is
hard to describe, I think, but we have had an unusual decade. It wasn't
invented in the 1990s, but the amount of money made in finance in the 1990s,
the performance of the stock market -- which had a good side, but had some
elements of a bubble, and a temptation for operators, to use that word, to
engage in activities, engage in transactions that may not be outright
fraudulent -- maybe some of them are -- but end up with misrepresentation. ...
There was a lot of cutting of corners ... in too many areas -- in taxes, in
accounting and other areas.
A lot of it comes back to a basic ethical approach. Is the object to squeeze
out as much money as you can? Or, at some point, is there a question of what is
right and what's wrong? ...
What specifically do you think it's going to take to restore full public
trust in the integrity of the marketplace and a level playing field?
I think we have a lot to work with. We talk about these deficiencies, which are
very real and have gone far enough so they raise real questions. But the great
bulk of auditors are talented professionals who are doing what is right. The
great proportion of financial statements are reasonably clear, given all the
complexities that are around.
So I think we need manageable reforms ... that can get us through this episode
and restore the kind of discipline that's necessary in the markets. ... I think
it will take, just to reinforce the point, an oversight body with real
authority. Not an oversight over Andersen; an oversight body over the auditing
I think it also will help to restore auditing firms -- certainly some auditing
firms, anyway -- to a concentration on quality auditing as their whole raison
d'être. That's their business. That's their sign of corporate ethics,
corporate purpose. It's not consulting. It's not finding out ways around the
tax laws, or whatever. It is auditing, and that their stamp of approval means
I think we have to get that sense and that priority back in the marketplace and
show that it is, in fact, economically successful, too. I think people want to
have good, disciplined audits; so you have to be willing to pay for it, too.
Why do you think ordinary investors should care about this issue of Enron
Ordinary investors in the United States have participated in financial markets
in a way, I think, that's probably historically unprecedented -- here or
elsewhere. They have their fortunes tied up, their retirements tied up in the
performance of the stock market and financial markets, generally.
Those markets have had exceptionally, almost unreal performance in the 1990s,
and it was almost a magical way to make money. Now some doubts have arisen as
to how those markets functioned. ... I think its issues that are even broader
than the pocketbook. But they certainly touch upon the pocketbook of American
investors, who have been in the market like never before.
So naturally, this raises concerns that are potentially very damaging to the
operation and effectiveness of the financial markets themselves. That's why it
gets a lot of attention, and that's why it's terribly important that we deal
with this problem -- and in an effective way -- that we listen to these warning
signals that are in the press, and we act.
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