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SEC urges audit reform
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May 10, 2000: 2:33 p.m. ET
Commission chief says SEC will propose new rules for accounting firms
By Staff Writer Alex Frew McMillan
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NEW YORK (CNNfn) - The Securities and Exchange Commission will propose rules this summer to make sure accounting firms are sufficiently unbiased when they audit public companies, SEC Chairman Arthur Levitt said Wednesday.
Levitt also called on the Big Five accounting firms to investigate all possible violations of conflict-of-interest rules over the last 15 months. The issue came to the fore in January, when a review revealed that many of the partners at accounting firm PricewaterhouseCoopers owned stock in the companies that the firm was auditing.
 Though only the most serious conflict violations would prompt the SEC to act, Levitt said he believes conflict-of-interest violations are widespread at all of the large accounting firms. Such conflicts of interest include owning stock in the company the firm is auditing, or having an interest in soliciting future business from the company.
He thinks the reviews, which he said "a number of firms are very, very close to agreeing to," are necessary for the industry to move forward. "The public trust must be restored," he said.
Levitt added that the SEC supports an expansion of the powers of the Public Oversight Board, the accounting industry's independent self-regulatory body, and criticized the American Institute of Certified Public Accountants for pulling its funding of the board.
In a speech at New York University School of Law, Levitt emphasized a topic he first raised 18 months ago and has often returned to. The SEC chairman has also recently raised concerns about conflicts of interest with Wall Street analysts and about public companies that "massage" the numbers to appeal to Wall Street.
Faced with widespread conflicts of interest, accounting has reached a "pivotal point" and a "dangerous time," he said. The industry needs to prove to the public that audits are completely independent, Levitt said, one of the "golden rules" of the profession. No audit company "should be in the position of being an advocate," he said.
A dramatic shift in the industry
Levitt voiced concerns that accounting companies, like investment banks, have at times compromised themselves by owning stakes in or developing complicated "cross-selling" relationships with the public companies they audit or analyze.
The accounting industry has undergone massive change in recent years, he pointed out. Auditing now only generates 30 percent of revenues for the largest accounting firms, down from 70 percent in 1977, according to SEC calculations. On the flipside, consulting and other management services now represent more than half the firms' revenues, up from 12 percent in 1977.
As accounting firms lower costs on audits to try and cross-sell other, more profitable services, such as consulting, "it is becoming more and more difficult to ascertain where one relationship ends and another begins," he said.
Rules clarifying acceptable relationships
Levitt pointed out that all large accounting companies have considered splitting their consulting and audit arms into separate companies. Some, such as KPMG, which has filed to take its consulting wing public, are well along in the process.
But the spinoffs and public ownership of accounting firms bring issues of their own, Levitt said.
Within the next 60 days, the SEC staff will propose rules designed to clarify many of these points, he said.
For instance, the SEC will consider whether audit firms should be limited in the types of services they can offer clients. The commission will also consider rules governing how accounting firms and their affiliates are structured, to assure their independence.
The SEC will also consider the issue of whether an audit firm can be affiliated with an entity, such as a spinoff or a former unit, that offers services that the auditing firm itself would not be permitted to provide under existing accounting rules, he said.
The rules would then be opened for public comment. But Levitt said rulemaking was only part of the process. He called on the audit committees at public companies to require higher standards of their auditors. He said a psychological shift was necessary away from a culture that almost expects the rules to be bent in "gray areas."
"A careful balance of 'bright-line' rules establishing clear limits, coupled with greater disclosure, seems both warranted and prudent," Levitt said. But he added that strong self-regulation was also key to the success of improving audit independence. Disclosure only works if it doesn't dissolve into boilerplate, as it has in other areas of rulemaking, Levitt said.
Levitt conceded that some of the rules governing auditors owning stock are "silly" and "arcane." For instance, rules prohibiting accountants from owning stock through their company, through retirement plans or through their spouses need revision, he said.
The SEC is working with the industry's rule-setting body, the Independence Standards Board, on modernizing those rules.
The SEC supports a plan submitted by the Public Oversight Board, which oversees the profession, to expand its powers, Levitt said. But he criticized the American Institute of Certified Public Accountants, the accounting trade group, for "cutting off" its funding of the POB.
"It is hard for me to fathom ongoing industry resistance to the POB's plan," he said. The board has a right to "no-strings" funding, he said, and must be free of industry pressure regarding reviews of accounting firms' practices.
He called on all accounting firms to follow the lead of Ernst & Young and PricewaterhouseCoopers in repudiating the AICPA's move.
AICPA responded that it had suspended rather than cut off the POB's funding. The AICPA has already spent $100,000 on on-going POB independence reviews of the eight largest accounting firms and wants a better handle on future expenses before it renews funding, a spokeswoman said.
The AICPA supports the SEC's attempts to encourage accounting firms' to invest in infrastructure to monitor conflicts of interest, AICPA Senior Vice President Alan Anderson said. 
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