Speech by SEC Staff:
Remarks Before the 2010 AICPA National Conference on Current SEC and PCAOB Developments
James L. Kroeker
Chief Accountant, Office of the Chief Accountant
U.S. Securities and Exchange Commission
December 6, 2010
As a matter of policy, the Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the SEC Staff.
Thank you Chris, [Holmes, Chairman of AICPA SEC Relations Committee] for the kind introduction and thanks once again for the invitation to share my views at this 38th annual AICPA National Conference on Current SEC and PCAOB Developments. Throughout the course of this conference you will be provided with an update on the broad landscape of developments and individual perspectives on the accounting and auditing environment. Given the volume of activity, this is no small order – so I hope that you are ready for a very interesting and informative couple of days.
Let me just begin, as one of the first of many, by reminding those who have been here in the past and to inform those first time participants that, for all of the SEC staff speaking at this conference, the Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee, and the views expressed are each speaker’s own and not necessarily those of the Commission, the individual Commissioners, or other colleagues on the Commission staff.
While on the topic of the staff, we have a number of SEC staff from across Offices and Divisions that will be sharing their views on financial reporting matters and providing you with updates on recent developments over the next few days. We will cover a wide range of topics, including: recent standard setting developments, staff views on the application of GAAP, observations from our experience in reviewing filings, an update on our IFRS Work Plan efforts, auditor independence matters, and an update from our Division of Enforcement, just to mention a few.
But I’d like to take this opportunity at the outset to let you know that we want to address the issues that are on your mind – those issues that will assist you in your efforts. So please don’t hesitate to send up a card and ask that burning question. As it relates to the Office of the Chief Accountant, you will hear from the outstanding group of Deputies in OCA:
- Paul Beswick, who I am sure is relieved to no longer be wearing quite as many hats, is now focusing his attention to accounting and registrant matters;
- Brian Croteau, a familiar face to many of you from prior conferences, rejoined the SEC staff and is responsible for overseeing auditing matters;
- Julie Erhardt, a veteran at this event, oversees our international group; and
- The newest member of our leadership team, Mike Starr, is heading up our efforts to be even more proactive in identifying emerging trends, weaknesses in reporting, and areas where we can all do a better job of improving the financial reporting system before a “crisis” develops.
In my remarks, I would like to focus us today on the importance of the public trust. As it relates to the role of each of us as members of the accounting profession, public trust includes the confidence that the numbers the investing public receives are accurate, unbiased, and subject to examination by a truly independent and objective 3rd party. But there is a lot packed into that idea, including some very fundamental questions like:
- When faced with a difficult decision, does the public trust that auditors are acting in the best interest of the shareholders and not acting as defenders of management’s conclusions?
- Does the public trust that accountants are faithfully applying the requirements of GAAP rather than trying to find creative ways to engineer around the next FASB pronouncement?
- Does the public trust that the comments given to standard-setting bodies on their proposals are given in the spirit of improving the transparency and integrity of the body of accounting or auditing literature?
- Does the public trust accounting professionals to tell them about bad news in as transparent and robust a manner as they would if they were reporting good news?
- Does the public trust that leaders of the accounting profession are guided first by a sense of responsibility to the public?
As we all know, building trust takes time, and maintaining trust requires continuous attention. Conversely, once trust is weakened, it is often very difficult to rebuild. Further, once trust is weakened, it has a tendency to foster suspicion even in the absence of a specific incident. As we all know, it takes only a few “bad actors” or a few “bad actions” to begin to chisel away at the valuable reputation of the profession.
Thus, I would like to challenge each of you to continue to do all that you can to:
(1) Improve the objectivity and integrity required of us as professionals;
(2) Continue to identify strong leaders in this profession who have a clear record of acting the interest of investors and the public, and
(3) Explore ways that we as professionals may be able to show leadership in enhancing trust.
It is this 3rd item that I would like to explore with you now.
Accounting as a Profession
If you haven’t noticed, I have referred to our collective calling as accountants as a profession (and to those members in the profession as professionals) more than a handful of times already this morning. While it is like fingernails scratching a chalk board to me, the phase “accounting industry” seems to be used with some degree of frequency to describe our activities. I know it’s a sore subject with many of you as well, but to those who aren’t attuned as to why, I think I can simply illustrate by just looking at the descriptions of the two.
- While acknowledging that Wikipedia may have its limitations as a source, I was interested in how it describes a profession - “A profession is a vocation founded upon specialised educational training, the purpose of which is to supply disinterested counsel and service to others, for a direct and definite compensation, wholly apart from expectation of other business gain”
- Merriam-Webster defines an industry as follows – “a distinct group of productive or profit-making enterprises”
Not unclear to me which of the two places an emphasis on public trust.
In some cases, it may well be that those choosing the word industry to describe our profession simply haven’t thought about the difference. Thus the choice of terminology may be made out of a lack of understanding – and I believe that everyone of us as a professional has a role in explaining and demonstrating by our actions the commitment to integrity, objectivity, public service, and high ethical standards that is the bedrock of our profession.
In other cases, however, it seems that some of those choosing to describe the profession as an industry have an understanding of the distinction. Where this is in fact the case, it would appear that this says something about how others perceive accountants and those charged with the responsibility for ensuring the integrity of financial reports – hitting right to the heart of the level trust or respect for our profession.
There may be those out there that feel that the perception is unfair, it isn’t deserved; but in the end when dealing with the public trust, perception matters every bit as much as fact. As we have seen so clearly over the course of the last several years, when the public and when investors perceive there is problem, they lose trust and confidence, and move away from those markets.
This leads me to the opinion that there is more that we should be doing to enhance the public trust. I’m not talking here about minimum compliance with GAAP and GAAS; that should be a given. Let me discuss just a few ideas that are illustrative of what I am talking about.
A Few Ideas Regarding Enhancing Public Trust
a. Rethink who the client is in the audit relationship
Reforms implemented after the Sarbanes-Oxley Act placed greater emphasis and greater responsibility on audit committees to act as shareholders' representatives. These reforms placed increased responsibility on the audit committee in engaging external auditors and overseeing the auditor’s activities. As it relates to the audit engagement, this is a powerful reminder that auditors aren’t hired to serve management, but to provide assurance to investors.
The reforms from early this decade notwithstanding, I believe more can and should be done to emphasize the importance of independence and the auditor’s duty to shareholders and the public. It is integral to the foundation of the reason for requiring an audit in the first instance.
We all know that those engaged in providing assurance to investors not only must act independently (independence in fact), but must also be perceived to be independent. Once again, perception can be every bit as important as reality, and independence in both fact and appearance are essential to creditability.
I often wonder whether a change to our collective vocabulary could be as fundamental to strengthening auditor independence as any rule or other reminder. The change? - Don’t use the word “client” to refer to the management of companies under audit. I know it is ingrained in how we speak, it shows up in existing audit standards and in many other places, but it’s a change that I believe is worth the effort to pursue. Think of the impact on the young professional who begins, on a daily basis, to think of investors as his or her clients. Think of the impact on public trust when that same young professional responds to a question like “who are your clients?” and the response from the auditor is “my clients are investors, the companies I audit include….”
Don’t get me wrong, I’m not suggesting that the role of an auditor should be that of an adversary; but it also cannot be, either in fact or in appearance, that of an advocate for the management of the company it audits. In a world where the mantra “the client is always right” can be typed in to Google and return over 8 million results in .30 seconds, I would suggest it is time to give serious consideration to changing the perceived “client” in audit relationships.
b. Meeting complexity with transparent accounting and disclosure
Accountants within a company play a critical role in maintaining the transparency of financial reports that serve as the bedrock of our vibrant, well-functioning capital markets and sound regulation. While the financial statements and supporting disclosure documents ultimately are management’s responsibility, accountants within a company must do all that they can to ensure those statements and supporting documents are accurate, complete, and provide a reliable picture of the company.
While financial reporting issues can at times seem daunting, especially when reporting complex financial transactions, accountants must not let complexity stand in the way of transparent financial reporting. It is no excuse or defense to say that a limitation in our accounting standards precludes an accurate and reliable presentation of a company’s financial reporting. Any limitation in our current accounting standards should be met with transparent and complete disclosure that provides the kind of information useful to investors in making reasoned choices in the allocation of capital.
While accounting issues at times can be challenging, the use of inappropriate accounting to manage numbers (whether it be net income, leverage, or some other metric) or structuring a transaction to be complex in an attempt to achieve an accounting objective continues to be an issue where a change in culture in the profession could also go a long way in enhancing the public trust.
One thing that the crisis has made clear to me is that transparency can be a wonderful antiseptic to concerns about quality and integrity. Further, I believe that we must do more to continue to prompt a change in culture when it comes to the integrity of select accounting policies, structured transactions and the use of accounting to achieve results. As a good starting point to proactively address these issues before a financial reporting dilemma occurs, I am very supportive of the efforts of the PCAOB as they consider potential changes to both the auditor reporting model and changes to the audit committee communications standard. Of course, as discussed by our Chairman, this is also an area where strong enforcement is necessary, but provides only cold comfort as a remedy after the public’s trust has been violated.
c. The Importance of the audit function
In vesting in the accounting profession such an important public trust, a system predicated upon auditors adhering to strong standards to ensure that financial statements are properly presented is crucial. Accountants should not take their position for granted; the role that auditors play was not put in place without considering the alternatives.
Just as I encourage auditors to stand firm and to maintain quality and credibility in their audit work, I also encourage leaders of audit firms to ensure that the audit is never again treated like a commodity. The auditing function should be the very soul of the public accounting profession – never again as a foot in the door for higher-fees related to services from their multidisciplinary firm.
The public – and those who act in the public’s behalf, such as the Commission – need to be assured that audit firms will continue to make the necessary investments over time to ensure that audit quality is not compromised, and that auditor performance will continue to meet public expectations. While I have heard recently about the rebuilding of the consultancy practices within large accounting firms, I trust that the profession will not need to re-learn lessons of the past on the serious, adverse effects of under-investing in the quality or failing to strictly maintain the independence of their audit process. I am likewise hopeful that if significant investments are being made to pursue other lines of business within a “multi-disciplinary” firm, the potential impact on public trust and public perception of the audit practice is being considered.
d. Leadership in enhancing activities to benefit investors and the public
To me, one of the distinguishing characteristics of a profession is a broad commitment to public service. There are excellent examples of individuals and organizations in our profession contributing to the public every day, and there are countless ways that that this can be done.
For example, the financial literacy initiative – 360 Degrees of Financial Literacy – launched by the AICPA and others in 2004 is a shining example to me of a program designed for the profession to give back. This program supported by the AICPA, the state CPA societies, and individual CPAs, is designed to address the growing issue of financial illiteracy.
As another example, let me highlight the recent report entitled “Deterring and Detecting Financial Reporting Fraud – A Platform for Action,” and the related announcement of the CAQ, Financial Executives International (FEI), the Institute of Internal Auditors (IIA), and the National Association of Corporate Directors (NACD). This initiative to invest resources to expand the body of knowledge and research in areas such as developing techniques to enhance the application of skepticism and moderating the risks of focusing on short-term results are excellent examples to me of the type of contribution to the public that our profession should be doing more of.
These are just two examples of ways in which professionals can contribute to the advancement of education, the development and integrity of financial reporting, and the broader fabric of our system. The possibilities are endless – whether it is considering government service, working at a standard setter, volunteering as the treasurer of a charity - my point here is that as a profession and as individual professionals I think there is more that we can do in building our reputation, and this is an area where I challenge us all to consider what more we can do.
Independent Standard Setting and the Public Trust
The OCA deputies’ panel will include a much more expansive update on our Work Plan efforts, perspectives on the FASB and IASB convergence program, and other standards setting observations. However, I would like to discuss these areas briefly.
As we all know, the FASB and IASB are currently not aligned in certain key areas related to projects on the MOU agenda, particularly as it relates to the accounting for financial instruments. However, as I have stated many times before, the projects that they selected for their MOU were selected because they represent areas both in U.S. GAAP and in IFRS where there was room for significant improvement. Not surprisingly, some of these areas are among the most challenging in financial reporting. They are areas where there are strongly held views, sometimes vexing questions, and, in many cases, significant resistance to change.
Given the significance of the task put before them, I am pleased that they have issued converged exposure drafts dealing with lease accounting and revenue recognition. In both cases, I think that the proposals are solid starting points to reaching globally accepted high quality improvements to financial reporting. Frankly, with regard to leases, in my view it’s simply time to get the obligation recognized on the balance sheet and move on. If only it were that easy.
Of course, I expect that both boards will benefit from the exposure process and the others steps they are taking to test the proposals. I also expect that there will be modifications to improve the operation and understandability, and to determine whether certain areas of their proposals would benefit from an additional degree of pragmatism while achieving the broad objective set out in the respective proposals. However, I believe that the progress to date on these standards is a testament to the result of the significant expansion of their investment in working together, with joint teams, and deliberating issues collaboratively and collectively. It is a model for how convergence can and should be approached.
In that regard, I believe that every effort should be made on each of the MOU projects to continue and expand upon this model. While time constraints, the inconvenience inherent in operating on different continents, and many other competing pressures and priorities are placed on both boards, it is my strong hope that every effort will continue to be made to seek converged approaches. Doing so would go a long way toward facilitating the consideration of incorporating IFRS for U.S. companies and whether U.S. investors and our capital markets would be well-served as a result.
But let me also again be clear with my view – the resulting product of the convergence efforts must be standards that are improved, comprehensive and sustainable solutions. While redoubling efforts to achieve the goal of convergence in a timely manner is important, convergence without adequate due process and field testing in the standard-setting process will not serve us well in the long run. Even if convergence is successful, we must have confidence that future standards will continue to serve investors’ interests and the capital markets.
As it relates to our Work Plan efforts, I will not steal Paul’s thunder. Let me just say that we are working aggressively to pursue the broad goal of a single set of high quality standards, to do so in a way that protects U.S. investors and our capital markets, and to consider approaches to achieving both of those goals in ways that are as cost effective as possible. Once again, what we do here must be done in a way that places an emphasis on investor and public trust.
At the outset of my remarks, I posed a number of questions one could ask with respect to the public’s view of the profession. While I hope that the answers if the public were asked would be all yes, I think there is more that we can and should be doing, and I look forward to working with you all over the next year to find ways to do exactly that.
As part of a private profession with a public mandate, public accountants face unique pressures and challenges that demand careful attention and reasoned judgment. It is a franchise that demands a relentless defense, above all else, of the public trust; a public trust that insists that accountants stand firm.