New Landscape for Audit Firms

Higher audit fees, a reshuffling of consulting clients and several high-profile prosecutions probably will result from an agreement on Capitol Hill on Wednesday on a package of accounting reform measures.

Accounting industry experts said the legislation’s establishment of an independent Public Company Accounting Oversight Board, with broad powers to regulate and discipline the profession, should foster significant changes in the way auditors conduct business. It replaces a largely voluntary, self-regulatory system within the profession.

“It is the most significant legislation for accounting since the establishment of the Securities and Exchange Commission in the 1930s,” said former U.S. Comptroller General Charles Bowsher, who headed a much weaker industry oversight board that dissolved in January.

One immediate result will be higher fees as audit standards tighten and as company boards of directors demand more assurance that the numbers are right, said senior accounting firm partners and other industry experts.

House and Senate negotiators reached an agreement on the structure and powers of the board Wednesday, ending weeks of debate. It is part of a broader corporate reform package that lawmakers expect to send to the White House as early as this week.

“This is the first public body that will have real oversight over all of the auditing industry’s operations,” said Bowsher, adding that the voluntary board he headed lacked both the power of a legislative mandate and the support of the accounting industry.

The new body, which must be appointed by the SEC within 90 days on enactment of the legislation, will set auditing and ethical standards for the profession. These standards range from the minute--how often or how many times auditors should look at a specific type of transaction--to the significant, such as what constitutes a breach of professional ethics.

Whether it uses that power will largely be up to whoever becomes chairman of the five-member board and the other individuals on the panel. The board is expected to consist of two accountants and three people who are not accountants but who are familiar with financial reporting issues and rules. The members will work full time for the panel and will not be allowed to collect pay from the accounting industry or other businesses.

Industry experts are already bracing for a series of high-profile investigations out of the board as it moves to assert its authority.

“A couple of severe sanctions on individuals or even firms will change the way this profession operates,” said Bill Cummings, an accounting professor at Northern Illinois University.

Already, the threat of outside disciplinary action “is forcing people to make sure that they are getting the numbers right,” said a senior partner with one of the Big Four accounting firms.

“This could be the most invasive thing the industry has ever seen in our lives or it could be only marginally different,” said Bob Bunting, chief executive of Seattle-based Moss Adams, a large second-tier firm based in Seattle. “If the chairman wants to be an aggressive regulator, this will be an agency as significant as the SEC.”

Accounting firms that conduct public-company audits will have to register with the board. Their registration fees will provide funding for the panel and its staff, which will have the power to inspect the work of auditors and investigate wrongdoing. The board will be able to levy fines, issue sanctions and even ban individual auditors and firms it determines are negligent.

“You will have real discipline, where right now you have no discipline,” said John C. Coffee Jr., a law professor and securities crime expert at Columbia University.

In a move to strengthen the independence of accountants, the legislation also tightens restrictions on consulting services that accounting firms can perform for audit clients.

Although the Big Four accounting firms have spun or sold off large pieces of their consulting businesses, especially in information technology, the firms still earn significant revenue from financial and management consulting.

For example, Bowsher said that the firms were partially responsible for helping companies to develop and structure many of the off-balance-sheet and often off-shore ventures that have been at the core of the series of recent accounting scandals.

“Now you will be auditing the ventures set up by others rather than by just another wing of the same firm,” Bowsher said. He believes such a system will provide both more independence and a greater check on accounting practices.

“These types of reforms would not have prevented outright fraud by top management,” said Cummings of Northern Illinois University. But he said they will reduce the kinds of abuses seen with accounting firm Arthur Andersen and its work for troubled energy trader Enron Corp.

“Andersen might have resisted the pressure to overlook Enron’s sleazy accounting if it wasn’t worried about losing more than $20 million in annual consulting work,” Cummings said.

Cummings expects to see a lot of shifting of consulting clients between the biggest firms as they comply with new independence standards. In some instances, a firm might decide to drop an audit client to hold on to a lucrative consulting contract, he said.