Protect the California public from the next Enron


Protect the California Public from the Next Enron: Tighten California Licensing of Public Accountants

Half of U.S. households have funds in the stock market, many in investments for retirement. Independent, reliable audits are a crucial element of investor confidence and investor protection. Consumers Union supports both state and federal measures to protect the California public from another Enron-style accounting disaster. New California law should remove the financial conflict of interest for auditors who are licensed as public accountants under California law.
California law should:
· Ban audit firms from performing non-audit services that are not integrally related to audit services, thus eliminating fees for non-audit services from audit clients as a significant revenue source for accounting firms.
· Impose a two-year “cooling off” period before responsible members of an audit team may accept employment as a financial officer of a company they have audited.
· Require rotation of audit firms.
· Require that the audit workpapers be adequate at the time an audit is completed, and ban shredding or other destruction of the audit workpapers.
· Strengthen the Board of Accountancy’s enforcement authority to suspend or revoke an accountant’s license.
The Sheer Size of Audit Fees Undermines Auditor Independence
Enron paid its audit firm more money in fees for non-audit services than for audit fees.
An analysis by the Wall Street Journal shows that audit firms are still collecting non-audit fees of nearly three times the size of their audit fees. The analysis examined 21 of 30 companies in the Dow Jones Industrial Average who filed proxy statements by early April 2002. These companies paid total fees of $725.7 million to their audit firms. Only 27% of the total was paid for audit services. The other 73% was paid to audit firms for non-audit services. Auditors Still Perform Nonaudit Services, Wall Street Journal, April 3, 2002, p. C1.
According to Business Week: “That accountants have become increasingly dependent on consulting is clear. In 1993, 31% of the industry’s fees came from consulting. By 1999, that had jumped to 51%.” An academic study of the first 563 companies to file financials after February 5, 2001 found that “on average, for every dollar of audit fees, clients paid their independent accountants $2.69 for nonaudit consulting.” One company, Puget Energy, is reported to have paid its auditor, PriceWaterhouseCoopers, “only $534,000 for its audit, but over $17 million in consulting fees.” Nanette Byrnes, et. al., The Enron Scandal, Accounting in Crisis, Business Week, Jan. 28, 2002, p. 44.
Audits are Failing to Ensure that Earnings are Accurately Stated
The Enron collapse alone accounted for $32 billion in lost stock market capitalization. Nanette Byrnes, et. al., The Enron Scandal, Accounting in Crisis, Business Week, Jan. 28, 2002, p. 44.
Andersen knew of serious problems with Enron’s financial statements as early as 1997 and suggested “adjustments” that would have cut Enron’s net income for 1997 nearly in half, yet Andersen signed off on the financial statement without the adjustment. Remarks of Joseph Bernardino, Managing Partner and Chief Executive Officer of Andersen, before the Committee on Financial Services of the U.S. House of Representatives, Dec. 12, 2001, cited in Consumer Federation of America, Investor Protection Lessons from the Enron Collapse and an Agenda for Reform.
Andersen overlooked the advice of a member of its own Professional Standards Group, which would have reduced the stated earnings of Enron for 1999, two years before the eventual collapse of Enron. Dec. 18, 1999 memo by Carl E. Bass, quoted in Peter Behr and David Hilzenrath, Andersen Accountants Were at Odds Over Enron, Washington Post, April 4, 2002.
Auditor Independence Problems Are Not Limited to Enron and Andersen
According to Business Week, between 1997 and 2000, the number of firms restating their earnings doubled, from 116 to 223. Nanette Byrnes, et. al., The Enron Scandal, Accounting in Crisis, Business Week, Jan. 28, 2002, p. 44.
According to Lynn Turner, former chief accountant for the SEC, and now a professor, “financial fraud and the accompanying restatement of financial statements have cost investors over $100 billion in the last half-dozen or so years.” David Hilzenrath, After Enron, New Doubts About Auditors, Washington Post, Dec. 5, 2001, p. A1. Other estimates are even higher.
In a year 2000 survey of 75 chief financial officers, 23% rated their own company’s auditors “not thorough enough.” David Hilzenrath, After Enron, New Doubts About Auditors, Washington Post, Dec. 5, 2001, A1.
Four in ten senior financial executives in the U.S. say that the auditing problems associated with the Enron bankruptcy are “more widespread” than Enron. Financial Officers Say Enron Damaged Credibility of Accounting Firms, Smartpros, Feb. 13, 2002, reporting results of a survey of 100 senior financial executives at Fortune 1000 companies conducted Feb. 5-8, 2002.
The California Board of Accountancy Audit Standards & Practices Review Task Force subcommittee on the Influence of Non-audit Services on Auditor Independence and Objectivity stated in part:
Audit standards and public expectations require that auditors be independent and objective in their performance of audit services. As accounting firms have expanded their breadth of services to include more and more consulting services for their audit clients, the accounting firm’s ability to retain independence and objectivity in its role as auditor has come into question. Accounting firms frequently use client relationships obtained via audit engagements to market lucrative consulting engagements. Revenues derived from these consulting services often exceed the revenues derived from the audit services. Many observers believe the auditor’s independence and objectivity are compromised by the incentive to secure more income from consulting services.
California Board of Accountancy, Audit Standards & Practices Review Task Force, Subcommittee on the Influence of Non-audit Services on Auditor Independence and Objectivity, Recommendations for Action at March 14, 2002 Task Force Meeting, p. 1.
The California Board of Accountancy has adopted a policy that, in order to promote and maintain auditor independence, California licensed accountants should not provide any of the following services to an audit client:
Bookkeeping of other services related to the audit client’s accounting records or financial statements
Information systems design and implementation
Appraisal or valuation services, fairness opinions, or contribution in kind reports
Actuarial services
Internal audit outsourcing
Management functions
Human resources
Broker-dealer, investment advisor or investment banking services
Legal services
Board of Accountancy vote, April 3, 2002. The Board’s policy placed a special focus on the conduct of California licensed accountants in audits of publicly held companies.
Consumers Union supports legislation to go farther, banning all non-audit services except those which are both integrally related to audit services and too small in volume to interfere with auditor independence.
Auditors Take Jobs With Companies They Have Just Audited
On April 3, 2002, the California Board of Accountancy adopted a policy in favor of legislation to impose a two year “cooling off” period before supervisory members of an audit team can take positions of financial responsibility with a company they have just audited. The Board’s policy placed a special focus on the conduct of California licensed accountants in audits of publicly held companies.
Enron hired its Chief Accounting Officer from Andersen. Kirstin Grimsley, Auditors Pushed Into “Revolving Door,” Washington Post, Feb. 26, 2002.
When Global Crossing filed for bankruptcy amid allegations of improper accounting, the firm’s senior vice president for finance had been the engagement partner on the audit for Andersen before joining Global Crossing, according to the Washington Post. Id.
According to the Washington Post, the senior audit manager from PricewaterhouseCoopers solicited a job as chief financial officer of a subsidiary of MicroStrategy while conducting an audit of MicroStrategy. MicroStrategy later admitted, in the words of the Washington Post, that “it hadn’t made the profits it reported,” and investors lost billions. Id.
Accounting partners now start looking for new jobs in industry when they reach their forties, according to an article by the Washington Post. The Chief of the Enforcement Division of the California Board of Accountancy called this practice “ingrained in the profession.” Id.
In 1993, the American Institute of Certified Public Accountants asked the SEC to prohibit public companies from hiring their audit partner as an employee for a year after an audit, although this trade group now appears to defend the practice. Id.
Auditor Rotation Could Help to Expose Inadequate Audits
Business Week describes auditor rotation as one of “seven proposals that could go a long way to reestablishing the public trust” in audits. Nanette Byrnes, et. al., The Enron Scandal, Accounting in Crisis, Business Week, Jan. 28, 2002, p. 44.
John Biggs, TIAA-CREF head, calls auditor rotation “a really good peer review,” and states: “You would break through all of these independence issues very neatly with rotation.” Id.
California Needs Stronger Rules on Audit Workpaper Content and a Strict No-Shredding Rule
On April 3, 2002, the California Board of Accountancy adopted a position in favor of new California legislation to require that audit workpapers contain sufficient documentation to enable a reviewer with no previous connection with the engagement to understand the nature, timing, extent and results of auditing or other procedures performed, evidence obtained, conclusions reached, and the identify of the persons who performed and reviewed the work. The Board also endorsed a minimum seven-year period to retain audit working papers, subject to change for specific categories of workpapers by future Board regulation.
Prepared by:
Gail Hillebrand
Consumers Union West Coast Regional Office
West Coast Regional Office
1535 Mission St.
San Francisco, CA 94103
April 15, 2002