Statement of Paul A. Volcker
The Securities and Exchange Commission
Public Hearing on
Proposed Auditor Independence Rules
New York, September 13, 2000
I appreciate this opportunity to comment on the rules proposed by the SEC for better protecting the independence of auditors.
I do so not as one deeply involved and experienced in preparing and reviewing accounting statements. Rather, my particular perspective has been shaped by years as a banking regulator and supervisor and more recently as a corporate director; in other words, as one much concerned with the reliability of those accounting statements in reflecting the true condition of a business enterprise. Broadly, my concern is the effective operation of the market system and its financial mechanism here in the United States and globally, upon which so much of our well being depends.
In that connection, it's worth recalling here how much emphasis has been placed by American officials, by international institutions and by economists alike on the need in the so-called emerging world for better accounting and auditing, for greater transparency of business financial operations, and for minimizing conflicts of interest and "cronyism" in financial institutions and markets. By implication or directly, U.S. practices are set out as the appropriate benchmark for evaluating performance.
All that implies a special responsibility for American leadership in auditing practices. We need to make sure we practice what we preach. Yet, I must state clearly that my own experience suggests, and even casual reading of the press reinforces the impression, that there are weaknesses in our auditing practices and even serious lapses in the objectivity and integrity of audits that need attention.
Surely, a number of factors can and do impair the quality of auditing: the sheer complexity of international businesses and global markets, lack of sufficient skill and diligence, inadequate training in the face of changing technology, poorly defined or enforced standards, and inadequate staffing among others. Good accounting and auditing demands adequate resources.
But beyond the question of quality is the nagging issue of objectivity and independence. My sense is that, too often, auditors, consciously or not, do not challenge management accounting, reporting and control practices as fully and as aggressively as required by their public mandate. Too often we are surprised by business failures or control breakdowns when the symptoms should have been detected and reported. The SEC proposals are clearly designed to deal with one cause of such failures - a possible lack of diligence that may arise because of business incentives inherent in the way accounting firms are structured and compensated.
Conflicts of interest are inevitable in any professional practice and certainly in large and complicated business organizations. Strong legal and professional standards are necessary to help resolve those conflicts. What is true generally is especially pertinent for the auditing profession.
Its mandate, in law and public expectation, is clear and unequivocal: the interests of investors (and other users of financial statements) come first. Maintenance of that single principle has, in my judgment, been increasingly placed in question by the extent to which auditing firms have undertaken extensive and highly remunerative consulting or other assignments for auditing clients. That is, the essential justification, it seems to me, for the SEC to take action to limit non-auditing activities by auditing firms and to more clearly define what is appropriate and what is not.
I understand that the proposal has been attacked as simply tilting at windmills, as being concerned with appearance more than reality. But that is surely a misconception. The conflict is real. The public perception, so potentially damaging to the confidence we should attach to audited statements, is not a misconception.
The extent to which the conflict has in practice actually affected a distorting auditing practice is contested. And surely, instances of overt and flagrant violations of auditing standards in return for contractual favors - an auditing capital offense so to speak - must be rare. But more insidious, hard-to-pin down, not clearly articulated or even consciously realized, influences on audit practices are another thing.
It is clear that within large auditing firms there has been considerable tension between "auditing" and "consulting" partners, tension rooted in the division of revenues and the marketing of services. An increasing number, voluntarily or by force of circumstances, have taken action on their own to end that internal conflict by separating lucrative consulting practices. In that light, the SEC proposals proscribing activities unrelated to auditing seem, in general concept, neither misbegotten nor draconian. They should, to the contrary, be reassuring that the prime responsibility of auditing firms is fully respected.
While fully supportive of the purpose and broad trust of the SEC proposals, I am also aware that a number of important questions have arisen. Many of these concern the precise definition and boundaries of "acceptable" or "prohibited" areas. Others concern the sweeping definition of, and application to, affiliates, the consistency with approaches in other countries, and the work of the Independent Standards Board which the SEC itself has supported.
Based on my own experience as a regulator, I am certain that careful staff and Commission review of these concerns is warranted. The aim should be to ease compliance and understanding of the regulation without undermining its purpose and effectiveness. That is, of course, precisely the approach taken by the SEC in the proposed reworking of the limitations on stockholdings.
As all my comments imply, I do not sympathize with the broad scale attacks on the very purpose of the proposed regulation. I do not believe that disclosure alone is an adequate answer to the perceived problem. And certainly, it is the SEC itself that is the appropriate and established agency for developing and promulgating these rules. That is the approach consistent with the professionalism and independence from political pressures that has been the hallmark of this country'S approach toward securities regulation and the approach that we so fondly and staunchly urge upon other countries.