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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Rule Proposal in Connection With the Establishment of a Framework of a Public Accountability Board


Robert K. Herdman

Chief Accountant,
U.S. Securities & Exchange Commission

Washington, D.C.
June 20, 2002

Thank you, Chairman Pitt.

I, too, want to express my thanks to the staff in the Office of the Chief Accountant, the Office of General Counsel and the Office of Economic Analysis and the other divisions and offices that have contributed to this rule proposal. The teamwork, effort and thoughtful manner put forward by all is a testament to this agency's resolve to protect the interests of investors. And finally, let me extend special thanks to Bob Burns and Sam Burke from OCA and to Meredith Mitchell and Michael Stevenson from OGC and their teams. Their tireless efforts have been integral to formulating the proposals presented to you today.

Chairman Pitt, Commissioner Hunt and Commissioner Glassman, I am pleased to be here today to recommend a rule proposal that provides a framework for a Public Accountability Board, or PAB, to oversee the auditors of public companies. The proposals address concerns that investors do not have sufficient confidence in the current auditing and financial reporting processes.

The investing public and the Commission must be able to rely on the competence, ethics, and independence of accountants who certify the financial statements of public companies. But, over the last few years, dramatic and sometimes sudden reversals of public companies' financial condition, among other things, have highlighted longstanding deficiencies in the regulatory systems used to oversee the quality of audits of financial statements that are filed with the Commission and relied on by investors. In particular, it is apparent that the AICPA's system of peer reviews, overseen by a Public Oversight Board that lacks the power to direct the conduct of those reviews or to discipline accountants for misconduct noted during those reviews, has not produced a credible result.

As a result, the proposed framework you are considering today represents a new system of independent "private sector" regulation designed to improve oversight of the auditing process and strengthen investor confidence in the financial statements that they rely on in making their investment decisions. Significantly, the new system would not be under the control of the accounting profession.

Based on public input we have received to date, and our own experience, we have identified certain other key elements of a new framework to improve oversight of the accounting profession through a PAB and to promote investor confidence in the auditing process. These key elements are described in more detail in the summary available here today and, of course, in the proposing release and include, among others:

  • Membership.  To assure that the benefits of the new regulatory regime extend to investors in all public companies, the financial statements of SEC-registered companies would not be deemed to comply with Commission requirements unless the company's outside auditors were members in good standing of the PAB. To ensure that the PAB has access to diverse, non-discretionary, funding and full information about audits, an SEC-registered company's financial statements also would not comply with Commission requirements unless the company was an adjunct member in good standing of, and thereby bound to cooperate in any review or proceeding commenced by, the same PAB as its accountants. The PAB would not conduct any investigations of public companies.
  • SEC Oversight.  Because a PAB will serve an important public function, a private entity cannot serve as a PAB unless it is recognized by the Commission, after Commission review of, among other things, the entity's proposed structure, members, rules, budget, membership requirements, systems, and procedures. Conditions of a PAB's recognition by the Commission include a PAB's consent to various oversight functions by the Commission.
  • Independent PAB Board.  To ensure independence from the accounting profession that it will oversee, a PAB should be a diverse board, dominated by persons who are not associated with the accounting profession.
  • Independent PAB Funding.  A PAB must have a dependable funding source. To assure continuity and independence, a PAB should not be funded solely by members of the accounting profession. A PAB's operations should be funded through the assessment of fees on accounting firms who are members of the PAB and on the public company audit clients of those firms - a compulsory funding mechanism. We believe this same mechanism can be employed to provide guaranteed funding for the FASB, as well.
  • PAB Quality Control Reviews.  The PAB will perform quality control reviews of audit procedures and practices, at least annually for large firms (those that audit approximately 80% of SEC-registered U.S. public companies) and require such reviews at least triennially for all other member firms. Such reviews will be designed to ensure that audit firms have appropriate quality control policies and procedures.
  • PAB Disciplinary Powers.  The PAB will be responsible for conducting public disciplinary proceedings and imposing a broad range of disciplinary sanctions and remedial measures against its accounting firm and individual accountant members, including fines, censures, removal from client engagements, limitations on activities and suspension from auditing either specific SEC clients, or all SEC clients for a time certain, or an unlimited time. A PAB may discipline individual accountants for unethical or incompetent conduct or other violations of professional standards. Importantly, a PAB will supplement, not supplant, the enforcement efforts of the SEC. The new system would expand the opportunities to detect and remedy ethical lapses or deficiencies in competence, thereby complementing the Commission's enforcement efforts. And, any accounting firm members of the PAB will not vote on disciplinary matters.
  • Audit Standard Setting.  A PAB should have responsibility for assuring high standards of ethics, auditing, and quality controls for its members. A PAB should either set such standards or oversee any private sector bodies designated to set standards. (The PAB will not, however, establish GAAP, which would continue to be established by the FASB, subject to SEC oversight).

In summary, we have the deepest and most liquid capital markets in the world largely because of the high quality of our financial reporting system. A common theme that exists in all of the Commission's rulemaking efforts is a steadfast belief that, with respect to our financial reporting system, investor protection is paramount. Investors rely on the integrity of the numbers to make their investment decisions, and the reliability of these numbers forms the very foundation on which confidence in America's markets is built. This proposal is a significant step to restore investor confidence in this system, which relies heavily on the work of auditors. As part of the proposal, we have recommended that the Commission receive comments for a period of sixty days. The staff looks forward to receiving comments from all interested parties and intends to ensure that this process is transparent to all.

We also are working on a companion SEC rule-making proposal related to auditor independence that will address requirements related to audit committees, audit partner compensation and, the adequacy of the Commission's independence rules adopted in November 2000, as well as how to enhance disclosures by companies of fees paid to their auditors. These recommendations should be finalized by mid summer 2002.

Thank you for the opportunity to discuss this proposal in this forum. I would be happy to answer any questions that the Commission might have.




Modified: 06/24/2002