Rewriting the Rules

MARGARET WARNER:

Now to our own discussion of accounting practices and regulation. We're joined by Arthur Levitt, former chairman of the Securities and Exchange Commission in the late 1990s, he pushed, unsuccessfully, to sharply limit accounting firms from serving as consultants to the companies they audit; Donald Langevoort, a former special counsel at the Securities and Exchange Commission, he is now professor of law at the Georgetown University Law Center; and Rick Antle, associate dean and professor of accounting at the Yale School of Management, he has served as a consultant to the so-called big 5 large accounting firms.

Welcome gentlemen and Professor Donald Langevoort beginning with you, let's do a little Accounting 101 here — remind us of the role of the accounting firms, outside accounting firms in this whole system of financial reporting and how essential they are to the reliability of that system.

DONALD LANGEVOORT, Georgetown University Law Center:

Well companies do the financial reporting. They gather the numbers, the results of operations and put them together into the financial statements that are required to be disclosed. The temptation, of course, if you're inside the company, is to make your numbers look good, because we know that good earnings push stock prices higher; everyone wants a high stock price. The temptation is there. The job of the auditor is to come in, look over the shoulder of the internal accountants, check their judgments, make sure they gather the right numbers. And then if they're satisfied that the job was right, certify the financial statements as prepared within the rules.

MARGARET WARNER:

So do you agree with Harry Pitt that there is something wrong with the system?

DONALD LANGEVOORT:

There is something wrong with the system.

MARGARET WARNER:

What's wrong?

DONALD LANGEVOORT:

It's pretty clear that the pressure on companies to push stock prices high, to get their numbers up to engage in financial cosmetics as it's called has been so strong that it's overwhelmed what's really a very old system of accounting in this country that's based on a principle of conservatism and that pressure has just been like a tidal wave. And the wall — the sea wall that is accounting just has stood up quite as well as it should.

MARGARET WARNER:

Mr. Levitt you were quite critical of this whole system when you were head of the SEC. What is wrong with the accounting, outside auditing end?

ARTHUR LEVITT, Former Chairman, Securities & Exchange Commission: I think that the problem we have is not just the accounting but it's the standard setting, it's the board structure, it's the analysts, the investment bankers, the company itself and I think what's happened in effect is in the competition between the major accounting firms, the power of the client has become so great as a result of huge fees paid for not just the audit but for consulting fees, that more and more instances we see the accountant going along with the company as it tries to state earnings as they would like to see them, the rather than as they are. And the major problem is that the standard setters, in this case of Enron, were not able to come to grips with the kinds of standards to prevent this from happening.

MARGARET WARNER:

Wait. Let me interrupt you what do you mean standard setters?

ARTHUR LEVITT:

We have an independent standard setter called the FASB, but they're funded by the very companies for whom they provide standards and they are subjected to huge pleasure from corporate America and from the Congress. As a result of this every time they come out with a standard that may be controversial or not to the liking of the business community, they are held up literally for years by a constant series of debate and harassment and threats of legislation. The system has broken down and we must expedite the process of establishing standards. I think Mr. Pitt's suggestion for an oversight body for the accountants is important, but I hope the details will be worked out so that the accountants can't defer the mate findings of this panel, whatever it may be, for years as they have now until other litigation is settled. This question of deferral is a very important one.

MARGARET WARNER:

All right. Let me go to Professor Antle and before we debate Harvey Pitt's recommendations, just weigh in on the question whether you think there is something really wrong with the system that needs fixing and addressed the concerns that your two co-panelists here have raised.

RICK ANTLE, Yale School of Management: Well the first thing that comes to my mind is always the liability that auditors face and the market pressures that they have to acquire and service their clients. Let's just talk about their liability for a second. I know one of the large accounting firms recently lost 330 some million dollars in the case. I think that in the Enron situation it's been publicized Arthur Andersen has had to pay $110 million for waste management. So when we talk about more discipline needed I always think about the discipline that the courts provide and that the markets provide but mostly the courts and it's very difficult for me to see how any sort of regulatory body or other body would not be subject to exactly the kind of problem that Mr. Arthur Levitt was concerned about.

MARGARET WARNER:

But Professor sorry, but let me interrupt, do you agree or disagree with the point that there is an inherent conflict of interest for instance in the big accounting firms now having consulting contracts as Andersen did with Enron to serve the client in a different way and that their loathe to lose that contract being too enough their auditing.

RICK ANTLE:

I don't really view that as a very big problem. Let's take the case of Enron in which Arthur Andersen earned $52 million in fees last year. If you think that was a quarter profit — that's ten million in profit. I think that the partners of Arthur Andersen would trade the ten million and every other bit of profit they made from Enron the last ten years immediately today to be out from under this situation.

ARTHUR LEVITT:

Can I make a point?

MARGARET WARNER:

Certainly.

ARTHUR LEVITT:

That in any audit there are many, many subjective judgment calls that can be made. If the auditor is being paid a huge consulting fee of $27 million, for instance, is that judgment call likely to favor management or likely to favor the individual investor? It's obvious. The perception of that and the reality of that is that the accountant will go where the money is.

MARGARET WARNER:

Professor Langevoort, that is true is it not that a lot of the accounting judgments are judgments… For instance Enron without the specific case they did a lot of creative financing mechanisms shall we say, that there is not an obvious industry standard that says this is verboten, this has to be accounted for this way. There is a question of judgment and therefore, leaves a lot of flexibility?

DONALD LANGEVOORT:

That's absolutely right and the pace of innovation as makers have tried to find ways to move risks off balance sheets to fry and find ways the things they don't want disclosed not put there, runs up against these very subjective standards and with that much pressure from management and standards that are sometimes so amorphous, so vague it's tough to ask for a lot of spine from the auditor.

MARGARET WARNER:

Mr. Levitt, to you on Harvey Pitts's proposals. Do you think that this kind of a new board, an oversight board will be any more effective at auditing the auditors which I think was the headline of your op/ed in the "New York Times" today, than the previous systems, because there are a lot of other bodies already involved including the SEC?

ARTHUR LEVITT:

I think this is a first rate initial step, but a lot has to follow and the details are terribly important in this question of deferral I think it particularly….

MARGARET WARNER:

I'm sorry. Explain the question of deferral.

ARTHUR LEVITT:

Well, right now if an action is brought by the AICPA, which is the trade group representing the accountants an individual firm can defer that action while other cases are being heard and as a result of that the matter can go on for many years. Under the new proposal of the SEC this group that is formed would be allowed to at least do the investigation before the deferral kicked in but as I understand it the final finding of this group could be deferred by deferral for some period of time. And I think that's one of the details that have to be worked out.

MARGARET WARNER:

Professor Antle what do you think of this idea of having another regulatory body, apparently or purportedly a tougher one that existed to date — do you think it's needed?

RICK ANTLE:

Well yeah I think it's fine. As some of the critics pointed out I think the AICPA and other bodies that discipline accountants have had a difficult time I think in large part because the court and litigation are always hanging over their heads. So don't really understand how we'll make a set of rules that will work that will preempt what might happen in the courts or do anything much faster than they're going to do.

MARGARET WARNER:

Is your point that the AICPA has been reluctant to discipline accounting firms because there is this threat of lawsuits out there?

RICK ANTLE:

Absolutely one of two case could occur. One they could discipline their members. If there is currently a civil trial going on the next day in court I'm sure that will be introduced as evidence or some sort of point for the plaintiffs. On the other hand,…

ARTHUR LEVITT:

The AICPA is the cheerleader for the kiting profession. This group has got to be totally independent. The AICPA is simply inadequate to providing this kind of discipline and never have.

RICK ANTLE:

You think you're going to set up some body that's going to be better or they are going to have subpoena power or are they going to basically do what the court will do or faster? I don't understand how this is supposed to work.

ARTHUR LEVITT:

I think Mr. Pitt's proposal calls for a group which will have investigative power and be able to bring their findings to the attention of the public — something that the AICPA failed to do. I think disclosure is one of the best ways to resolve this and it's something that the AICPA kept hidden in the back room. They were totally inadequate to this task.

MARGARET WARNER:

Professor Donald Langevoort what do you think are the prospects for Mr. Pitt to even get this proposal… This is just a proposal. He told Congress he wants to hear from them. What do you see on the prospects here?

DONALD LANGEVOORT:

Oh, I think something will half. The momentum has been building fire long time. When the stock market was riding high and people's losses seemed a little less important, you could understand why these kinds of reforms weren't happening as Arthur Levitt told us they should. Today with Enron and a whole litany of failures I think the public pressure to do something in a major way is going to lead to some action.

MARGARET WARNER:

Do you think this is the right thing?

DONALD LANGEVOORT:

I think it's the first step and I think Harvey Pitt is a very smart good person. I think he's going to engineer this the right way but we're just at the start of a long road.

MARGARET WARNER:

Mr. Levitt how do you rate prospects?

ARTHUR LEVITT:

I think the prospects are good, the times call for it. I think Harvey Pitt has the experience and strength to fight the enormous opposition he will get from within the industry and probably once again from the Congress. This is very complicated. But I wish him every good fortune in doing it, and it is not merely this committee that's important, it's the standard setters, it's the analysts, it's the investment bankers, and it's the board that has to be strengthened to bring about much greater protections for America's investors and restore confidence in the system.

MARGARET WARNER:

And, briefly Mr. Arthur Levitt he's not calling for baring the accounting firms from doing the accounting as you originally proposed; does that bother you?

ARTHUR LEVITT:

Well, I think you can only do so much at one time. I certainly believe that this clearly represents a conflicted demonstrated in this Enron case and I would hope that the Commission gets to that as they move forward with various programs to help reassure the public.

MARGARET WARNER:

Professor Antle very briefly do you agree with Mr. Arthur Levitt that the accounting industry will probably oppose some of this?

RICK ANTLE:

No. I think they have already come now the favor of revised governance procedures and they've actually had a record of improving financial reporting in auditing. And I think Mr. Arthur Levitt saying that it's… The Enron case is proof that somehow consulting taints auditing; I don't think we have shown that. But I think for improved governance I think there's going to be a lot of support and I think the details are going to be difficult to work out but I think it will get done.

MARGARET WARNER:

All right, gentlemen, thank you all three, very much.