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ACCOUNTANCY: The SEC should start listening

The Millennium did not start off too well for PricewaterhouseCoopers, or indeed, by association, for any of the Big Five. On

6 January 2000, Lynn E Turner, chief accountant of the US Securities and Exchange Commission said: ‘This report is a sobering reminder that accounting professionals need to renew their commitment to the fundamental principle of auditor independence.’ The report that led to this sombre statement was by independent consultant Jess Fardella, who had been appointed by the SEC to review possible independence rule violations by PwC ‘arising from the ownership of client-issued securities’. The investigation found that nearly half of PwC”s partners – 1,301 out of 2,698 – reported at least one independence violation.

Six weeks later, PwC announced that it would split itself asunder. It said that the break up was to allow the consultancy arm to seek ‘the financial partners, strategic alliance and joint ventures and access to capital markets on which their future success will depend – all of which are now largely prohibited by auditor independence requirements’.

Two weeks after that, IT consultancy Cap Gemini announced it had reached agreement to acquire most of Ernst & Young”s consultancy business. Add in the proposed KPMG/Cisco deal in the US and the Arthur Andersen/Andersen Consulting divorce, and, by the end of this year, the accountancy profession will look very different to the one finance directors have grown up with.

In some ways, once announced, the moves have an inexorable logic. Ever since the mid-1980s and throughout the 1990s – recession-induced hiccups aside – the management consultancy side of the business has driven the remarkable growth that the top firms have put in. Now it seems the consultants have grown up and want to leave home.

A few years ago, a separation of consultancy and audit may have been welcomed in the UK on grounds of independence and ethics. But a combination of factors over the past few years had turned the spotlight away from questions of structure and organisation between consultancy and audit. For a start, the generally benign state of the economy has prevented any of the spectacular corporate crashes that can raise questions over auditor independence and conflicts of interest. Secondly, badly mauled by the last recession, the accountancy firms have been dealing with some of the issues which soiled their reputation. And, by virtually inventing corporate governance (it was at the insistence of the English ICA that Cadbury was set up), auditors have managed to legitimately shift most of the responsibility for dealing with these concerns onto the board and the need for good internal risk management.

Added to the emphasis on corporate governance, the profession has responded to the cajoling of the Labour government. It is slowly putting the regulation of the profession on an independent footing through the offices of an independent foundation that will oversee reshaped auditing, ethics and discipline boards. However, many of these moves in the UK now seem to have been made redundant by the SEC, which, for whatever reason, appears to have had auditors and auditing in its sights for some time.

In the UK, the English Institute has asked the Joint Monitoring Unit (JMU) to conduct a review and find out if it can dig up as much dirt on the firms as found by Jess Fardella in the US. However, it will be surprising if it finds anything of substance.

Leaving aside the possibility of shock news from the JMU, there are two elements that have been missing from the debate so far. Firstly, there is the question of what clients want; and secondly there is a lack of debate about the nature of independence. Talk to UK-based finance directors and the overwhelming feeling is a sense of frustration that a regulatory body – especially a foreign one – can dictate how their advisers are organised. Their complaint is that the US regulatory and legal regime is not keeping pace with the modern economy. It would be fair to suggest that there is no great support for the SEC.

As for the question of independence, the UK has developed a framework approach. It”s the old problem that if you have a cook book for rules, some of the recipes will always be out of date. So in the UK the framework has two founding principles: the first is that a member should behave with integrity, which implies not merely honesty but fair dealing and truthfulness; the second is objectivity. Conflicts of interest are inevitable, whatever size the firm, and it is absurd to pretend they can be evaded – instead, they need to be managed. And managed they can be.

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