Thank you for inviting me here today.I am the Chief Executive Officer of Deloitte & Touche LLP, one of the five largest accounting firms in the country. I am appearing here today not only in that capacity, but also on behalf of the American Institute of Certified Public Accountants (AICPA). I am a member of the AICPA, as are many of Deloitte's partners and professionals, and Deloitte is proud to be a member of the AICPA's SEC Practice Section.
We at Deloitte have the same perspective as our colleagues in the profession and the AICPA with respect to the many proposals currently under consideration, and so my remarks today are intended to provide the Committee with the perspective of large firms and the AICPA, not simply Deloitte.
In the wake of Enron’s collapse, public attention has focused on ways to improve the effectiveness and independence of financial statement audits of public companies. That attention is welcome. America has the most secure and reliable capital markets of any nation—an achievement that should not be ignored—and we should continue to try to strengthen a system that serves as a model for the world.
But the current situation presents danger as well as opportunity. The danger is this: In the rush to enact reforms in response to perceived flaws in the system, we risk losing sight of the fact that the proposed reforms come with consequences—intended and unintended—some of which will diminish the stability and certainty that characterize our markets and that permit them to be the engines of economic growth. That is why we must think through the consequences of the proposals currently under consideration before implementing sweeping changes.
SEC Chairman Harvey Pitt has proposed the creation of a new regulatory organization, under the SEC’s oversight. The new organization would be dominated by individuals from outside the accounting profession and would be empowered to conduct disciplinary investigations and operate the program that ensures the quality control of firms that conduct audits of public companies. This regulatory model would effectively replace the profession's system of self-regulation in these areas with public regulation and should be fully explored.
We believe the time is right to create new systems for performing quality reviews of the practices of public company auditors and for disciplining those auditors. Accordingly, we support moving from a system of self-regulation to one of public regulation for these important processes. We further believe that these processes should be subject to SEC oversight.
Other proposals would effectively remove auditors from the audit standard setting process and burden the new regulatory organization with standard setting. Such a change would be a mistake. Audit standards should be set by professionals who understand auditing, not by lay people who have no practical experience in auditing.
I would like to say a few words about several specific proposals that many regard as quick fixes to the problems they perceive with the profession.
One proposal currently being debated is the periodic rotation of audit firms. The AICPA already requires that the lead audit partner on every public company financial statement audit be rotated at least once every seven years, an approach that ensures a fresh look at a company’s books at regular intervals. But requiring the rotation of entire firms is a prescription for audit failure. Rotation of audit firms would result in the destruction of vast stores of institutional knowledge and guarantee that auditors would be climbing a steep learning curve on a regular basis. It would result in increased "start-up" costs for the auditor, the company being audited, and the public, as every few years an entirely new group of auditors would have to be educated and brought up to speed on the intricacies, and legitimate accounting issues, presented by a given company’s operation.
And, it would expose the public to a greater and more frequent risk of audit failure since studies show that audit failures are more likely to occur during the initial years a firm is auditing a new client. In fact, at least one study has identified a link between financial fraud and a change in auditors.
Many groups have studied this very issue and concluded that audit firm rotation is a bad idea. The Commission on Auditors' Responsibilities, the SEC’s Office of the Chief Accountant, the Public Oversight Board, the General Accounting Office, and the Committee on Sponsoring Organizations of the Treadway Commission have all determined that the costs of mandated firm rotation would exceed any possible benefits.
Limiting an auditor’s ability to become familiar with the client’s business would also make it easier for reckless management to mislead the auditor. Regardless of how independent an auditor is, the likelihood of fraud will increase if the auditor lacks institutional knowledge and must therefore place undue reliance on the client’s guidance and representations. Mandating audit firm rotation will also make it easier for companies to disguise opinion shopping by enabling companies to portray a voluntary change in auditors as obligatory.
The Enron case illustrates the type of complex financial structures that auditors often confront. It would therefore be ironic were Enron used to justify any proposal, including audit firm rotation, that would result in auditors being less informed, less educated about the client’s business and operations, and less equipped to conduct a thorough audit. Particularly in today’s complex business environment, depth of knowledge is essential to performing an effective audit and making sound judgment calls regarding difficult accounting and reporting issues. Despite the superficial appeal of the idea, audit firm rotation likely would result in an increased number of audit failures.
A related proposal involves a ban on the so-called "revolving door"—situations in which an auditor goes to work for an audit client. The SEC and the Independence Standards Board considered the wisdom of imposing a "cooling off" period before an auditor could accept employment with a former client. Both concluded that such a rule would impose unwarranted costs on the public interest, on public companies, and on the profession. Indeed, limiting the career opportunities of accountants would make the profession less attractive and make it more difficult for firms to hire qualified people. Studies have shown and our experience is that existing safeguards, including the mandatory rotation of audit partners as well as the additional procedures that are put in place when a member of an audit team joins a client, are effective in addressing so-called "revolving door" situations.
Another proposal currently being debated involves placing increased limitations on the scope of services that firms may provide to their audit clients. Just last month, my firm announced that we will further separate our management consulting practice—a step we took reluctantly, but one we deemed necessary to address the market’s concerns about the perception of auditor independence and help restore investor confidence in the profession. All of the other Big 5 firms, in one way or another, have taken a similar approach. But, this is our model and it may not be right for other firms.
Further limiting the scope of services firms may provide to their audit clients is a bad idea. It is a bad idea because it will not make an audit team any more independent, but it will make the team less competent.
In conducting an audit of the financial statements of a company, you obviously need good accountants and auditors, but you also need technical experts. For example, in auditing the financial statements of a company like Enron, you would need experts in market trading controls and information technology. An audit team that does not bring with it the technical knowledge and skills necessary to understand the company’s business will not be able to perform a competent audit.
Why would additional limitations on the scope of services make it more difficult to bring specialists into the auditing process? Because these experts are not auditors. They do not devote their careers to audit support work. If we asked them to abandon their consulting work and do nothing but audit support work, we would not be able to retain them. The best and the brightest seek positions that will allow them to develop their expertise, to learn, to work on cutting edge issues, and few will choose to remain in jobs that offer limited opportunities and seriously restrict their professional development and employment options.
We do not believe that scope-of-services restrictions would have prevented Enron and will not prevent the next business failure. In fact, several recent studies have demonstrated that there is no correlation between the provision of non-audit services and audit failures. In not one of the audits considered by the POB's Panel on Audit Effectiveness did the Panel identify any instances in which non-audit services had a negative effect on audit effectiveness." To the contrary, the Panel’s reviewers concluded that in about one-quarter of the audits studied, those services "had a positive impact on the effectiveness of the audit". As to the remainder, "the reviewers either were neutral regarding the effects of non-audit services on audit effectiveness or concluded that the services had no impact on audit effectiveness." Investigators at the University of Southern California and Texas A&M International University, in their study, concluded that concerns that non-audit services impair auditor independence are unfounded.
The current search for fixes, for ways to prevent another Enron, is fitting and proper. The failures of American businesses often teach as much as their successes. We should learn from what has happened and make changes that provide meaningful opportunity for improving the quality of audits.
Thank you very much.
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