[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
ACCOUNTING AND AUDITING OVERSIGHT:
PENDING PROPOSALS AND EMERGING
ISSUES CONFRONTING REGULATORS,
STANDARD SETTERS, AND THE ECONOMY
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
SECOND SESSION
----------
MARCH 28, 2012
----------
Printed for the use of the Committee on Financial Services
Serial No. 112-112
ACCOUNTING AND AUDITING OVERSIGHT:
PENDING PROPOSALS AND EMERGING
ISSUES CONFRONTING REGULATORS,
STANDARD SETTERS, AND THE ECONOMY
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
SECOND SESSION
__________
MARCH 28, 2012
__________
Printed for the use of the Committee on Financial Services
Serial No. 112-112
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
U.S. GOVERNMENT PRINTING OFFICE
75-084 PDF WASHINGTON : 2013
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC
area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC
20402-0001
HOUSE COMMITTEE ON FINANCIAL SERVICES
SPENCER BACHUS, Alabama, Chairman
JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts,
Chairman Ranking Member
PETER T. KING, New York MAXINE WATERS, California
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois BRAD SHERMAN, California
GARY G. MILLER, California GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California JOE BACA, California
MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan BRAD MILLER, North Carolina
KEVIN McCARTHY, California DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico AL GREEN, Texas
BILL POSEY, Florida EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK, GWEN MOORE, Wisconsin
Pennsylvania KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO ``QUICO'' CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee
James H. Clinger, Staff Director and Chief Counsel
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
DAVID SCHWEIKERT, Arizona, Vice MAXINE WATERS, California, Ranking
Chairman Member
PETER T. KING, New York GARY L. ACKERMAN, New York
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma RUBEN HINOJOSA, Texas
DONALD A. MANZULLO, Illinois STEPHEN F. LYNCH, Massachusetts
JUDY BIGGERT, Illinois BRAD MILLER, North Carolina
JEB HENSARLING, Texas CAROLYN B. MALONEY, New York
RANDY NEUGEBAUER, Texas GWEN MOORE, Wisconsin
JOHN CAMPBELL, California ED PERLMUTTER, Colorado
THADDEUS G. McCOTTER, Michigan JOE DONNELLY, Indiana
KEVIN McCARTHY, California ANDRE CARSON, Indiana
STEVAN PEARCE, New Mexico JAMES A. HIMES, Connecticut
BILL POSEY, Florida GARY C. PETERS, Michigan
MICHAEL G. FITZPATRICK, AL GREEN, Texas
Pennsylvania KEITH ELLISON, Minnesota
NAN A. S. HAYWORTH, New York
ROBERT HURT, Virginia
MICHAEL G. GRIMM, New York
STEVE STIVERS, Ohio
ROBERT J. DOLD, Illinois
C O N T E N T S
----------
Page
Hearing held on:
March 28, 2012............................................... 1
Appendix:
March 28, 2012............................................... 59
WITNESSES
Wednesday, March 28, 2012
Attmore, Robert H., Chairman, Governmental Accounting Standards
Board (GASB)................................................... 13
Carcello, Joseph V., Ph.D., CPA, CMA, CIA, Ernst & Young and
Business Alumni Professor; and Director of Research--Corporate
Governance Center, The University of Tennessee, Knoxville...... 40
Doty, James R., Chairman, Public Company Accounting Oversight
Board (PCAOB).................................................. 10
Kabureck, Gary R., Vice President and Chief Accounting Officer,
Xerox Corporation, on behalf of Financial Executives
International (FEI)............................................ 41
Kroeker, James L., Chief Accountant, U.S. Securities and Exchange
Commission (SEC)............................................... 8
Melancon, Barry C., CPA, President and Chief Executive Officer,
American Institute of Certified Public Accountants (AICPA)..... 43
Quaadman, Tom, Vice President, Center for Capital Markets
Competitiveness, U.S. Chamber of Commerce...................... 45
Seidman, Leslie F., Chairman, Financial Accounting Standards
Board (FASB)................................................... 12
APPENDIX
Prepared statements:
Attmore, Robert H............................................ 60
Carcello, Joseph V........................................... 79
Doty, James R................................................ 87
Kabureck, Gary R............................................. 110
Kroeker, James L............................................. 132
Melancon, Barry C............................................ 144
Quaadman, Tom................................................ 158
Seidman, Leslie F............................................ 169
Additional Material Submitted for the Record
Biggert, Hon. Judy; and Capuano, Hon. Michael:
Written responses to questions submitted to Leslie F. Seidman 253
Fitzpatrick, Hon. Michael:
Written statement of the Investment Company Institute (ICI)
and the Independent Directors Council (IDC)................ 260
Written statement of the Mutual Fund Directors Forum (MFDF).. 267
Written statement of the Property Casualty Insurers
Association of America (PCI)............................... 275
Sherman, Hon. Brad:
``Blue-Ribbon Panel on Standard Setting for Private
Companies, Report to the Board of Trustees of the Financial
Accounting Foundation,'' dated January 2011................ 277
ACCOUNTING AND AUDITING OVERSIGHT:
PENDING PROPOSALS AND EMERGING
ISSUES CONFRONTING REGULATORS,
STANDARD SETTERS, AND THE ECONOMY
----------
Wednesday, March 28, 2012
U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:03 a.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Schweikert,
Royce, Biggert, Hensarling, Neugebauer, Campbell, McCotter,
Pearce, Posey, Fitzpatrick, Grimm, Dold; Waters, Sherman,
Miller of North Carolina, Maloney, Perlmutter, and Donnelly.
Ex officio present: Representative Bachus.
Also present: Representatives Renacci and Capuano.
Chairman Garrett. Good morning. Today's hearing of the
Subcommittee on Capital Markets and Government Sponsored
Enterprises is called to order. This morning's hearing is on
accounting and auditing oversight.
We will begin with opening statements. And I will recognize
myself for about 3 minutes.
We are here today to examine the accounting and auditing
profession. And the hearing is aptly titled, ``Accounting and
Auditing Oversight: Pending Proposals and Emerging Issues
Confronting Regulators, Standard Setters, and the Economy.''
Accurate and reliable financial reporting to investors is
obviously a key cornerstone to our Nation's capital markets. It
is essential that investors have the appropriate information
needed to make well-informed decisions on just where to invest
their capital, as our Nation continues to recover from the
recent financial crisis.
So we must work hard to restore the vitality to our markets
and to foster an environment where American public companies
can do what they do best, which is create jobs.
There are three broad areas that I want to explore in
greater detail today with our great panelists here.
First, I would like to hear from the SEC where we stand
with international convergence of accounting standards.
I know this is a top priority for many in the business
community. I also realize that there is some disagreement
between the large and the small companies, as well as from
different industries as to what the preferable outcome of
convergence will be.
I am interested in discussing the steps that the Chairman
and staff are taking to overcome these various obstacles, and
how we can ensure that harmonization of these standards creates
an atmosphere here in the United States where companies and
investors have the best information possible.
Second, I look forward to learning more about the current
process that FASB and GASB go through to develop their
standards. And I agree that the integrity and the independence
of the standard-setting process is basically essential, and
that Congress should not legislate accounting standards.
I have seen some positive statements from the market
participants about the improvement in the standard-setting
process. And I appreciate that FASB and GASB balance that
delicate line of listening to the business community's
concerns, while also ensuring that there is an independent
process in place.
Finally, I would like to discuss some of the PCAOB's
current proposals and how and why these proposals came to pass.
I do think it is important to remind the PCAOB that it is
not a policy-making entity. Congress and this committee are the
policymakers here. The PCAOB's job basically is to regulate and
oversee the auditing profession.
So I am concerned about some of the recent activist-type
proposals put forth by the PCAOB. And I agree with the Chamber
of Commerce, where I was just speaking this morning as a matter
of fact, and others, that believe that they may be engaged in--
as someone called it--mission creep--crossing the threshold of
audit regulation into an attempt to regulate corporate
governance.
Specifically, the recent concept release on mandatory audit
firm rotation is concerning.
What is the specific problem they are trying to solve here
with that? What data are they examining? What kind of specific
cost/benefit analysis is being done? What solutions will this
lead to?
Too many times with many of our regulators, the policy
outcome is predetermined before the work--that is hard usually
to do--is determined and what the best solution should be.
So I would like to commend the gentleman from Pennsylvania,
Mr. Fitzpatrick, for his legislation that would prevent the
PCAOB from moving forward right now on its policies.
This hearing will serve as a legislative hearing for that
proposal. And it is my hope that the subcommittee will consider
this bill at the next possible markup.
So in conclusion, while I believe that those three areas,
especially the concerns around the PCAOB, are the most pressing
issues, I realize that there are many other issues that require
further discussion. And I look forward to a constructive
hearing this morning.
With that, I now yield 3 minutes to the gentlelady from
California, and good morning.
Ms. Waters. Good morning, and thank you, Mr. Chairman, for
holding this hearing.
Investors in my district, including workers with investment
and pension funds, have a strong interest in enhancing auditor
independence. After all, it is the auditors who are supposed to
reassure investors that they can trust the financial reports of
the companies they have entrusted with their lifesavings.
How we can achieve more auditor independence is obviously a
subject for our debate. And I appreciate that the Public
Company Accounting Oversight Board has put out its concept
release on auditor rotation, and held public meetings last week
to get this conversation started.
While I certainly think that we must explore ways to
enhance auditor independence, I am interested in understanding
the issue of mandatory auditor rotation more fully, whether it
would work, or whether there might be better alternatives than
mandatory rotation.
For example, should shareholders perhaps be allowed a proxy
vote to determine if they would like to have mandatory audit
rotation? Are there are measures that might increase
professional skepticism more than rotation would?
However, even if stakeholders come to the conclusion that
mandatory rotation is a good idea, I don't think anyone
believes that it could come close to resolving all of the
outstanding barriers to auditor independence. So I am eager to
explore any other ideas brought forward by our witnesses today.
Finally, I would also like to note that I have been focused
on ensuring that auditors are adequately and independent, and
skeptical under the OCC and Federal Reserve's market servicing
consent order process.
Under that process, banking regulators required servicers
to hire auditors to investigate their foreclosure practices
over the past few years, and to provide remediation to affected
borrowers.
We found that auditors often have other lucrative
engagements with the servicers they have been hired to
investigate; perhaps creating a disincentive to find wrongdoing
when it comes to looking at their foreclosure practices.
So along with Senator Menendez and some of my colleagues
from the House, I have asked the GAO to look into this issue.
There are also other issues I hope we can get to today,
including the role of audit committees, whether to make PCAOB
disciplinary proceedings public, and certain accounting issues.
I look forward to hearing the testimony of our witnesses
today.
Thank you. And I yield back the balance of my time.
Chairman Garrett. Thank you.
The gentlelady yields back.
The chairman of the full Financial Services Committee,
Chairman Bachus, is recognized for 2 minutes.
Chairman Bachus. Thank you, Mr. Chairman, for convening
this hearing.
I think it is important to have oversight of the SEC Office
of Chief Accounting, the Public Company Accounting Oversight
Board, and the Financial Accounting Standards Board.
There are several critical issues facing the accounting and
auditing professions, their regulators, and their standard
setters including the convergence of global accounting
standards, mandatory audit firm rotation, and audit quality.
While we all agree that sound accounting and auditing play
a critical role in the U.S. capital markets, regulatory
overreach and overly aggressive standard setting may disrupt
the economy and limit job creation.
Regulatory overreach at least appears to be alive at the
PCAOB. For example, the Board ignored what I consider
flexibility provided in the Dodd-Frank Act to scale its
oversight of auditors of broker-dealers, and instead imposed a
one-size-fits-all exam program for all of these auditing firms.
Moreover, there are some at the PCAOB who feel that public
companies should be required to rotate their audit firm. I have
serious concerns about such a proposal because mandatory audit
firm rotation would both increase the cost of auditing and
decrease audit quality. And for that reason, I am not sure it
is sound policy.
And no hearing on the accounting industry would be complete
without a discussion of Sarbanes-Oxley, which will have its
10th anniversary in 4 months. As we approach that landmark, it
is incumbent upon this committee to determine if Sarbanes-Oxley
has been completely successful, and specifically, if Section
404(b) has been worth the cost.
Being from Birmingham where HealthSouth is located,
obviously I know the value of good auditing. And I think
Sarbanes-Oxley has probably resulted in avoiding a lot more
HealthSouths and Enrons.
But particularly for small firms, the cost can be
significant.
I thank the witnesses for your testimony.
And I thank you, Chairman Garrett, for holding this
hearing.
I yield back the balance of my time.
Chairman Garrett. Thank you.
The gentleman yields back.
Thank you, Mr. Chairman.
The gentlelady from New York is recognized for 2 minutes.
Mrs. Maloney. Thank you.
And thank you, Mr. Chairman, and welcome to all the
witnesses.
Oversight of the accounting industry is an important
function of this committee. And I am so pleased that we have
all of the accounting standard setters here with us this
morning.
If we have an accurate and fair accounting system, then we
have safety and soundness in our financial institutions. We
have an oversight of how to be more effective in our government
programs. And there are so many ways that an accurate
accounting industry can contribute to the strength of our
country.
We have also seen how if there are slack standards, we can
end up with total economic disaster such as Enron and Tyco and
others that led to the passage of Sarbanes-Oxley. And as we
approach the 10th anniversary, I look forward to hearing your
comments on how Sarbanes-Oxley is working or not working.
With the 404(b) exemption, we made permanent in Dodd-Frank
an exemption for public companies under $75 million, because of
the cost, because many are start-ups, because of the need to
have the right balance to allow them to grow without costly red
tape.
I would like to hear whether you feel we got the right
balance for exempting companies under $75 million, and that
have not been required to comply with 404(b). I am also
interested in hearing more about proposals to make disciplinary
proceedings public.
I understand the concern that the PCAOB has about firms
dragging disciplinary proceedings. But I also want to hear
whether there is any concern that by making these proceedings
public, we are necessarily harming the reputation of a firm
before any official action is taken.
Personally, I don't think we should do so unless there is
an official action.
I am also concerned about the cost and quality of audits.
That is always a top concern, and one that I hear concerns, and
about this thing about rotating of the oversight with the
accounting firms.
I wonder whether there are other ways to boost auditor firm
independence without putting an arbitrary requirement in there
that might disrupt the relationship between the firm and the
company it is auditing, and also the cost and quality effects
that it has with the mandatory firm rotation.
So you have a big responsibility. If our audits are
correct, then our economy and our private and public
institutions are fair and honest and open, and hopefully
thriving.
Congratulations on the work you do. And I look forward to
your testimony.
Chairman Garrett. The gentlelady yields back.
Mr. Fitzpatrick for 1 minute.
Mr. Fitzpatrick. Thank you, Mr. Chairman, for convening
this important oversight hearing.
Our economy is in the midst of the slowest economic
recovery since World War II. And what the American people need
is for the economy to grow and for the private sector to create
jobs.
What the people do not need is their own government getting
in the way of that economic recovery or the private sector job
creation.
For the last 15 months, this chamber and this committee has
examined areas where regulations are stifling job growth and
holding back our recovery. This hearing is consistent with that
effort. And I thank the chairman for holding it.
According to the Small Business Administration, regulations
cost our economy $1.8 trillion annually. It is a very heavy
burden on companies that we are looking to for job growth.
So when the Public Company Accounting Oversight Board
issues a concept release for mandatory audit firm rotation,
that elicits a negative response from almost 95 percent of the
respondents in American companies from Krispy Kreme to Xerox to
Coca-Cola. And they are unanimous in their opposition. I think
that more than justifies a very, very careful examination.
We cannot afford to hamper job creation, and to lock up
capital at this very fragile time.
So as we prepare to hear testimony today, I am curious to
know what sort of cost/benefit analysis has been done or will
be done.
And ultimately, I want to hear how this new regulation is
going to help the economy and create jobs.
Thank you, Mr. Chairman.
Chairman Garrett. The gentleman yields back.
Mr. Perlmutter is recognized for 1 minute.
Mr. Perlmutter. Thanks, Mr. Chairman.
And just sort of in response to my friend, Mr. Fitzpatrick,
in the summer of 2008, the stock market was at about 12,500. By
the end of the Bush Administration, 6 months later, it was at
6,500, a loss of 6,000 points. It is $1.3 billion per point,
about $7.6 trillion, $25,000 for every man, woman, and child in
America. And we were losing about 800,000 jobs a month.
We are now gaining about 200,000 jobs a month. We have
doubled the stock market to about 13,000. We have had 23 months
of job growth, and a doubling of the stock market.
And so allowing Wall Street or any financial markets to run
pretty wild without regulation, without some responsibility
through the accounting sector--and I am not throwing any
disparagement towards you--but it is important to have
reasonable regulation in place, because the cost of the loss
that we suffered in the fall of 2008 was monumental. And we
can't have something like that again.
Now I agree with Mr. Fitzpatrick in terms of, let us be
reasonable. Let us make sure that we are not doing things that
are just obstacles only for obstacle purpose, but have a real
direction and a real effort in helping investors.
But we must have good accounting in this country so that
investors and others feel protection, and a certainty and
reliability of the system.
With that, I yield back.
Chairman Garrett. The gentleman yields back.
I appreciate the reference to the Bush Administration.
Mr. Perlmutter. I thought you would like that.
Chairman Garrett. Thank you.
Mr. Grimm is now recognized for 1 minute.
Mr. Grimm. Mr. Chairman, thank you for holding this
hearing, and I thank all of the witnesses for coming today to
testify.
I think there are a lot of things that have contributed to
the financial meltdown. And I certainly think that government
intervention and the government's role cannot be left out of it
when you are factoring in all the different things in the
analysis.
But I certainly realize that job creation has to be at the
top of the list. And whether the stock market is going up and
down, I think there is a myriad of reasons why the stock market
has doubled.
I don't think necessarily the accounting standards or what
we are going to talk about in this hearing today is the reason.
But I do know that stability, certainty, and the rule of law
has always been an innate advantage for the United States.
And I think that preserving that, and making sure that
everyone around the world who is going to invest understands
our rules, and knows what they are going to be, not only today
but tomorrow, will certainly help create jobs.
So I am looking forward to hearing your testimony today.
And with that, I yield back.
Thank you.
Chairman Garrett. And the gentleman yields back.
Mr. Dold is recognized for 1 minute.
Mr. Dold. Thank you, Mr. Chairman.
Historically, our capital markets have been the most
transparent and the most efficient capital markets in the
world.
And our accounting and auditing profession, along with the
supporting balance regulatory framework, I believe, is an
important reason for the historical success of our capital
markets.
However, an increasingly interrelated global financial
system and constantly changing economic circumstances puts
significant pressure on our regulators and the Congress to make
sure that the existing regulatory framework still makes sense,
and that any necessary improvements are identified and
implemented promptly.
After studying the proposals and considering the written
testimony, and other expert resources, I am most concerned
about two proposals that I believe have been rejected for good
reason each time Congress considered them in the past: the
mandatory audit firm rotation proposal; and the proposal to
immediately make all Public Company Accounting Oversight Board
allegations public without any due process and without any
findings.
While I am always open to hearing counter arguments, these
two proposals seem to me like solutions that are searching for
nonexistent problems, while creating a serious risk of
inflicting severe, unnecessary, and actual harm on investors
and other end-users.
In any event, all of these proposals raise important
questions. And I look forward to hearing from my colleagues and
from our witnesses today.
Thank you so much for being here.
Mr. Chairman, I yield back.
Chairman Garrett. The gentleman yields back.
Do we have any other opening statements? Yes?
Mr. Royce is recognized for 1 minute.
Mr. Royce. The market is up, Mr. Chairman. But we still
have fewer people in the labor force, fewer people out there
working in jobs than we did 3 years ago.
And with the 10th anniversary of Sarbanes-Oxley coming up,
I think the question for us--we all know what the end goal is.
We are going to get the highest quality audits for public
companies. That is the ambition.
The question is, how you do that in a reasonable way in
terms of affordability, in terms of what is practical. What we
happen to see is that we have something of an anchor on the
creation of new corporate firms coming into the market.
We have fewer IPOs. We do have a consequence here. It is
incumbent upon us to look at this tradeoff, and ask ourselves
if we are taking actions that make it harder for this economy
to get back on its feet.
Have we made it harder for new firms to create economic
activity that employs Americans? Because at the end of the day,
we have to ask ourselves how it is humanely possible to have
figures that show so many people out of work, so much smaller
participation in the American labor force after only 3 years.
What creates a circumstance where we have such a slow
recovery?
And is part of it the overreach? The regulatory overreach
is part of it. The regulatory cost is part of it, the
impractical rules that we have put on our economic system.
Can we do something to get that balance so that the economy
recovers more quickly?
Thank you, Mr. Chairman. I yield back.
Chairman Garrett. The gentleman yields back.
And I think you are our final speaker, Mr. Renacci, for 1
minute.
Mr. Renacci. Thank you, Mr. Chairman.
I want to thank you and the subcommittee for allowing me to
sit in on this hearing this morning.
I realize most Members usually don't flock to hearings on
accounting standards. But as a CPA, I believe the standards are
the essential foundation for a sound and stable economy.
The reliability of a financial statement would allow
businesses to access capital, markets to attract investors, and
create jobs.
As lawmakers draft laws and propose regulations, we must
remember that without uniform, consistent, and independent
accounting standards, the accuracy of financial statements will
deteriorate, making it more difficult for investors to invest,
and companies to raise capital.
I want to thank the witnesses for being here today, and I
look forward to hearing your testimony.
I am especially interested in hearing about FASB's latest
efforts to coordinate international accounting standards, the
progress of implementing the Dodd-Frank accounting provisions,
and the PCAOB's proposal to mandate audit firm rotation.
Thank you again, Mr. Chairman, for allowing me to be here
this morning. And I yield back.
Chairman Garrett. And thank you. The gentleman yields back.
Thank you for being with us here today, and for all those
people who are not flocking here, they obviously just do not
know what they are missing, because today we have the SEC, the
PCAOB, the FASB, and the GASB here, all here to testify on the
first panel.
So I welcome you gentlemen, and gentlelady.
As all of you who have been here before know, we will
recognize each of you for 5 minutes, and your complete written
statements will be made a part of the record.
And so with that, Mr. Kroeker, good morning, and you are
recognized for 5 minutes.
STATEMENT OF JAMES L. KROEKER, CHIEF ACCOUNTANT, U.S.
SECURITIES AND EXCHANGE COMMISSION (SEC)
Mr. Kroeker. Good morning and thank you, Chairman Garrett,
Ranking Member Waters, and members of the subcommittee.
I am Jim Kroeker, Chief Accountant of the Securities and
Exchange Commission, and I serve as the principal advisor to
the Commission on accounting and auditing matters.
I thank you for the opportunity to appear before you today,
to testify on behalf of the Commission regarding current issues
related to the accounting and auditing profession.
The reliability of financial reporting is critical to the
confidence of the investing public. The objective of financial
reporting is to provide information that is useful to providers
of capital in their decision-making process.
This information must be neutral, reliable, and portray
economic results in an accurate and faithful manner.
I am pleased to be on today's panel with individuals who
have important roles in promoting high quality financial
reporting.
I would like to summarize for the subcommittee some of what
I view to be the principal current issues on this subject,
beginning with accounting developments.
In February of 2010, the Commission issued a statement in
support of efforts of the Financial Accounting Standards Board
and the International Accounting Standards Board to converge
U.S. GAAP with International Financial Reporting Standards, or
IFRS.
This statement also directed the staff of the SEC to
execute a work plan to evaluate issues relevant to a potential
Commission consideration of incorporating IFRS for U.S.
issuers.
With respect to convergence, the two Boards have continued
to work diligently to complete their priority projects. Despite
several successes, many challenges remain.
In addition, in response to concerns about the pace of
standard setting, the Boards have extended several times the
timetable for completion of these projects.
With respect to the work plan, the staff has expended
substantial efforts towards its execution. To inform the
Commission and the public of our progress, the staff has issued
several progress reports and other papers.
At this point, we have completed what I believe to be the
field work related to the work plan, and we anticipate
publishing a final report in the upcoming months that will
summarize our findings and observations in each of the areas of
the work plan.
Moving on from international accounting standards, in
recent years we have seen how important it is that financial
regulation and accounting and auditing standards keep up with
changes in the business environment.
In response, we have launched the Financial Reporting
Series, an ongoing series of roundtables designed to examine
emerging issues in financial reporting.
The inaugural roundtable was held in November of last year
and discussed measurement uncertainty and its role in financial
reporting.
Turning to auditing issues, this coming July will mark the
10th anniversary of the Sarbanes-Oxley Act. Despite the Act's
many beneficial reforms, the PCAOB's inspection program
continues to identify audit deficiencies of varying nature and
severity, which may increase the risk of material misstatement
in financial reports.
In response, the PCAOB is engaged in several efforts to
enhance audit quality. It has undertaken efforts to identify
and analyze further the underlying root causes of these audit
deficiencies.
It has issued a concept release on auditor independence and
objectivity, an important component of audit quality, that
considers audit firm rotation, and it has issued a concept
release on whether there should be changes to the information
that auditors provide in their audit reports to investors.
Other jurisdictions, including the European Union, are
currently considering these and other auditing reforms.
The PCAOB is working on a number of projects to update
existing audit and quality control standards to reflect the
lessons that it has learned from nearly a decade of audit firm
inspections.
This type of project may have a direct positive impact on
audit quality. My staff will continue to work closely with the
PCAOB as it moves forward with these projects.
Finally, I would like to highlight two auditing areas
related to the Dodd-Frank Act.
First, last summer the Commission proposed amendments to
the financial reporting requirements for broker-dealers. And
the PCAOB proposed new auditing and attestation standards that
would apply to the audits of broker-dealers.
Both sets of proposals are still under consideration.
Second, the staff performed a study with respect to Section
404(b) requirements for issuers with market capitalization
between $75 million and $250 million. This study was delivered
to Congress last April.
To conclude, there is a substantial amount of activity in
the accounting and auditing area. We will continue to work
closely with the FASB and the PCAOB on these matters, guided by
the Commission's mission of protecting investors; maintaining
fair, orderly, and efficient markets; and facilitating capital
formation.
Thank you. And I would be pleased to address any questions.
[The prepared statement of Mr. Kroeker can be found on page
132 of the appendix.]
Chairman Garrett. Thank you, and the gentleman yields back.
Mr. Doty from PCAOB, welcome to the panel, and good
morning.
You are recognized for 5 minutes.
STATEMENT OF JAMES R. DOTY, CHAIRMAN, PUBLIC COMPANY ACCOUNTING
OVERSIGHT BOARD (PCAOB)
Mr. Doty. Thank you.
Chairman Garrett, Ranking Member Waters, and members of the
subcommittee, I am pleased to appear before you today. The
PCAOB is focused on taking appropriate steps to improve audit
quality and enhance protection of the investing public.
By law, all of the PCAOB's responsibilities are discharged
under the oversight of the Securities and Exchange Commission.
Chairman Mary Schapiro, the Commissioners, and Chief
Accountant Jim Kroeker have taken a deep interest in the
PCAOB's work, and I am grateful for their support.
The Sarbanes-Oxley Act of 2002 requires the PCAOB to
conduct a continuing program of inspections of registered
accounting firms.
Our global network firm program covers the largest U.S.
firms and approximately 190 of their foreign affiliates. In
2011, the PCAOB issued 344 inspection reports which included
global firms, foreign affiliates, and smaller firms subject to
PCAOB inspection.
During an inspection, PCAOB inspectors evaluate the design
and effectiveness of a firm's quality control system, as well
as the quality of the firm's work in the proportions of the
audit selected for inspection.
The PCAOB has also continued its work to implement the
Dodd-Frank Act which gave the PCAOB authority for inspection,
standard setting, and enforcement for the audits of brokers and
dealers registered with the SEC.
To this end, we have established a pilot inspection program
for auditors of SEC-registered broker-dealers. This program
will assess compliance with existing auditing standards, all of
which were set by the profession prior to the Dodd-Frank Act.
The pilot program is intended to help the Board determine
the scope and elements of a permanent inspection program,
including whether to exempt any public accounting firms such as
the auditors of introducing brokers from inspection.
No firm's specific reports will result. But that should
provide us valuable information needed to move forward with an
intelligent permanent program.
We have also commenced a series of meetings with smaller
firms that audit smaller broker-dealers, which we call forums
on auditing smaller broker-dealers. These forums allow smaller
firms to learn about the PCAOB's work and to provide their own
insights and suggestions.
In addition to inspection authority, the Board has the
authority to impose sanctions on registered firms and
associated persons who have violated applicable laws and
standards.
Under the laws that exist today, however, the PCAOB's
disciplinary proceedings are nonpublic. This is not good for
investors, not good for the auditing profession, and not good
for the public at large.
I commend Congressman Westmoreland and Ranking Member Frank
for bringing forward bipartisan legislation, H.R. 3503, to
bring transparency to the PCAOB's disciplinary proceedings.
Turning to standards, the Sarbanes-Oxley Act also charges
the Board with establishing audited and related professional
practice standards. The Board has recently proposed new
standards relating to communications with audit committees and
related parties in transparency.
The Board has also recently issued two concept releases
soliciting public comment on the auditors reporting model, and
auditor independence, objectivity, and professional skepticism.
The concept release on independence, objectivity, and
professional skepticism included questions about the pros and
cons of mandatory firm term limits.
These concept releases did not propose new auditing
standards. Rather, they sought the public's views on particular
matters so that the Board can better evaluate the need for
future standard setting.
Just last week, the PCAOB held a 2-day public meeting on
auditor independence, objectivity, and professional skepticism,
at which 47 prominent leaders of the business world and
academia offered their views.
This dialogue on auditor independence, objectivity, and
professional skepticism was prompted by, among other things,
concerns developed over the last 9 years of the PCAOB
inspections of public company audits.
Concerns about auditors' skepticism have also been
expressed by regulators in other countries. If this process
results in the PCAOB proposing any rules--I emphasize ``if''--
and whether those would involve any form of audit rotation,
term limits, or not, any such standards, any such proposed
standards would be subject to further public comment and SEC
approval.
I am certainly not wedded to any particular outcome. But I
do believe that the PCAOB must continue to explore issues of
such fundamental importance for the audit.
In conclusion, I appreciate the subcommittee's interest in
this work. And I look forward to any questions you may have.
Thank you.
[The prepared statement of Mr. Doty can be found on page 87
of the appendix.]
Chairman Garrett. And I thank you.
Ms. Seidman, you are now recognized for 5 minutes.
STATEMENT OF LESLIE F. SEIDMAN, CHAIRMAN, FINANCIAL ACCOUNTING
STANDARDS BOARD (FASB)
Ms. Seidman. Good morning. Chairman Garrett, Ranking Member
Waters, and members of the subcommittee, my name is Leslie
Seidman, and I am the Chairman of the Financial Accounting
Standards Board, also known as the FASB.
The FASB is an independent private sector organization
which operates under the oversight of the Financial Accounting
Foundation and the Securities and Exchange Commission.
Since 1973, the FASB has established standards of financial
accounting and reporting for nongovernmental entities,
including both public and private businesses, and not-for-
profit organizations.
Those standards are recognized as authoritative generally
accepted accounting principles, or GAAP, by the SEC for public
companies, and by the American Institute of Certified Public
Accountants for other nongovernmental entities.
GAAP is essential to the efficient functioning of capital
markets. Investors, creditors, donors, and other users of
financial reports rely heavily on relevant, comparable, and
unbiased financial information.
Accounting standards are not intended to drive behavior in
any particular way. Rather, they seek to present financial
information so that financial statement users can make informed
decisions about how best to deploy their capital.
An independent standard-setting process is the best means
of ensuring high quality accounting standards, since it relies
on the collective judgment and input of all interested parties
through a thorough, open, and deliberative process.
We meet regularly with several advisory councils who advise
us about emerging financial reporting issues, the practical
implications of our proposals, and opportunities for
improvement.
We also meet regularly with the staffs of the SEC, the
PCAOB, and banking regulators as well as policymakers and their
staff.
We recently added a project to reconsider the accounting
for and disclosures about repurchase agreements, as a result of
recent feedback obtained through these processes.
Broad consultation helps to identify unintended
consequences, and to assess whether the benefits to users of
improved information from our proposed changes outweigh the
costs of the changes to preparers and to users.
The FASB recently completed several standard-setting
projects to improve the transparency and overall usefulness of
information provided in financial reports and to reduce
complexity.
These projects include: new disclosures about a company's
commitments to multi-employer pension plans; a simplified
approach for determining whether a company's goodwill is
impaired; and guidance to help creditors account for and
disclose troubled debt restructuring.
The FASB also has a number of ongoing projects including
its projects to improve and converge U.S. GAAP and
International Financial Reporting Standards. We have already
made substantial improvements on converged accounting standards
in a number of areas, and are making progress on four remaining
priority projects: revenue recognition; leasing; financial
instruments; and insurance.
In all of these projects, we are making a significant
effort to understand the perspectives of all of our
stakeholders through public meetings, field visits, workshops,
and the exposure of our proposals for public comment.
We have made a number of changes in response to the
suggestions and concerns that have been expressed through these
various means. For example, on our financial instruments
project, we have modified our original proposal relating to
loan accounting and impairment. And we are proposing new
disclosures about liquidity risk that were suggested by
investors.
In addition to our standard-setting activities, the FASB
has recently made numerous process changes to improve our
ability to understand and act upon private company concerns. We
now have Board members with significant experience with private
companies and staff dedicated to addressing private companies
issues.
We have broadened our outreach activities to seek out and
listen to private company practitioners, such as at dedicated
roundtables.
In short, the FASB has taken these steps to understand
private company perspectives in every standard that we set. The
FASB is taking similar steps to enhance its consideration of
the accounting and reporting needs of not-for-profit
organizations.
Thank you for the opportunity to provide a brief overview
of the FASB, and its priorities for this year.
My written testimony provides extensive information about
our projects and activities.
I would be pleased to answer your questions.
[The prepared statement of Ms. Seidman can be found on page
169 of the appendix.]
Chairman Garrett. Thank you for your testimony.
And finally, Mr. Attmore, you are recognized for 5 minutes.
STATEMENT OF ROBERT H. ATTMORE, CHAIRMAN, GOVERNMENTAL
ACCOUNTING STANDARDS BOARD (GASB)
Mr. Attmore. Thank you.
Chairman Garrett, Ranking Member Waters, and members of the
subcommittee, thank you for this opportunity to participate in
today's hearing.
My name is Robert Attmore. I am the Chairman of the
Governmental Accounting Standards Board and have served in that
capacity since 2004.
Before joining the GASB, I was a deputy controller for the
State of New York, and served as the New York State auditor.
Because this is the first time in the 27-year history of
GASB that we have been invited to appear before Congress, I
would like to briefly provide some background on our
organization.
Sovereign state governments have the authority to establish
accounting and financial reporting standards for themselves and
their local jurisdictions. Before the GASB was created, State
and local governments' accounting and financial reporting
standards were established for over 50 years by the National
Council on Governmental Accounting (NCGA).
In the wake of a financial crisis in the 1970s, State
governments recognized the need for change. In order to
adequately meet the needs of financial report users in the
municipal bond market, State representatives determined they
needed an independent national standard-setting body for State
and local governments comparable to the Financial Accounting
Standards Board.
State organizations working with the Financial Accounting
Foundation (FAF), the American Institute of Certified Public
Accountants, local government organizations, and the Government
Accountability Office reached an agreement in 1984 to create
the GASB, which began operations that year.
Today, all State governments follow financial reporting
standards issued by the GASB.
The GASB was set up as an independent, private sector
organization that establishes accounting and financial
reporting standards for State and local governments in the
United States. GASB was directed to adopt the existing NCGA
standards, and then given the mission to establish and improve
standards for State and local government accounting and
financial reporting.
The mission is accomplished through a comprehensive and
independent process that encourages broad participation,
objectively considers all stakeholder views, and is subject to
oversight by the FAF board of trustees.
Our proceedings are public and transparent. GASB's rules of
procedure require that we circulate draft recommendations for
public comment. We also hold numerous roundtable discussions
and public hearings to solicit constituent views.
The GASB's work is accomplished with the seven-member
board. As the chairman, I am the only full-time member of the
board. The other GASB members serve on a part-time basis.
All board members have significant expertise in the issues
facing State and local governments obtained through their prior
work experience. The board is assisted by a 21-member staff.
In the past, the GASB was funded in a piecemeal, inadequate
manner by voluntary contributions from States, local
governments, the financial community, and sales of FAF
publications. The Dodd-Frank Act established for the first time
an independent stable source of funding for the GASB for which
we say, thank you.
Over the years, GASB has issued 66 standards on a wide
range of issues. Let me just mention two important projects on
the GASB's current technical agenda.
The first is our pension accounting and financial reporting
project. After extensive study, we have proposed several
changes in the treatment of pensions, including new approaches
to recognize pension expense.
We also propose bringing the net pension liability onto the
face of an employer government's balance sheet. Our goal is to
issue new standards for pensions in June of this year.
The second GASB project addresses economic condition
reporting. This deals with financial projections for State and
local governments.
GASB recently solicited public comments on a proposal that
would call for State and local governments to provide
projections of cash inflows, cash outflows, and total financial
obligations for at least a 5-year period going forward.
We will be considering all the responses received for those
proposals over the next several months.
Finally, the GASB could not achieve its mission without the
strong support and oversight of the FAF board of trustees. This
oversight assists us in maintaining our independence, and
provides additional credibility to the robust public due
process that the GASB follows when setting standards.
Thank you again, Mr. Chairman, for the opportunity to
appear before the subcommittee. And I would be pleased to
answer any questions.
[The prepared statement of Mr. Attmore can be found on page
60 of the appendix.]
Chairman Garrett. Thank you, and welcome to the panel for
the first time in 27 years.
Mr. Attmore. Thank you.
Chairman Garrett. I will now recognize myself to begin the
questioning.
And thanks to the panel.
We will start with Mr. Doty.
You may be familiar with the fact that I sponsored some
legislation, it is before the committee, that would require the
SEC and the PCAOB to do a cost/benefit analysis, and to
identify the problem before the whole rule process begins. And
I am sure you are familiar with that.
So looking at that issue in general, and then drilling down
a little bit to the area that I referenced in my opening
comments, and that you, I see, referenced in your discussion as
well, the mandatory audit firm rotation.
Can you drill down a little bit and go beyond what you
talked about as far as the panel that you discussed, with
regard to any analysis that has been done on this, whether it
is an economic analysis already, and if not already, what your
plans are going forward?
What specific type of economic analysis has been or will be
done? What sort of data would you be looking to collect? What
has been or will be done? What sort of people will be doing
that, economists or otherwise? How many have or will be done?
Can you just get into some detail on that particular area?
Mr. Doty. Yes, sir.
Chairman Garrett. Great, thanks, sir.
Mr. Doty. Yes, sir.
First, we are at the concept stage. The concept release
raised the issue of auditor independence because of the concern
about the inherent conflict in the auditor's fee. This all
comes out of a wide-ranging international focus on whether the
audit profession has an inherent conflict.
As you know, Congress originally, in considering this
subject, did in fact institute audit partner rotation; they
deferred the question of a firm rotation. The GAO took a look
at it, and said we should wait a few years, and then look at it
again.
We have in fact raised the concept release and asked people
to consider what would be involved here, because it is a fact
that nations around the world are rushing to adopt mandatory
rotation in some cases in 5 and 6 years.
So we thought it was important to ventilate this subject.
Without talking about it, you are talking about auditor
independence and the conflict of the fee in a--and ignoring the
elephant in the room.
At any time, at any point that we get to a proposal for a
standard, we will have considered in-depth the scaling, the
proportionality, the purpose of the standard, whether the
standard can be expected to engender the conflict--the conduct
in an auditor that we expect, whether there are unintended
consequences in the conduct of the auditor, scaling,
proportionality.
And then, we think a post-implementation review is a part
of any kind of analysis of the practicality and the cost of and
the utility of a standard. And we do that.
We have done it. And if you look at our outstanding
proposal on communications with audit committees on related
parties, I think you will see that.
In this particular context, I think it is clear that we
always have problems in the financial regulatory area, as the
GAO notes. And many times, you cannot monetize or quantify
either the costs or the benefits.
We will, I can assure the committee, be thinking as we move
forward in this area of independence, with any standards that
we are thinking of bringing in the independence area to address
these issues of conflict--
Chairman Garrett. Yes.
Mr. Doty. --skepticism, independence, objectivity--
Chairman Garrett. Right.
Mr. Doty. --we will be thinking about the utility, the--
Chairman Garrett. So--
Mr. Doty. --and the cost/benefit of it.
Chairman Garrett. Okay, so on that last point. I guess that
is where--I get the point on scaling, proportionality, and the
consequences.
In that analysis, once you--first of all, do you have a
timeline as to when that will begin? When you do that, will you
be bringing in an economist to be making that examination? And
how many economists would be making that analysis?
So start there: when; who; and how many?
Mr. Doty. Mr. Chairman, I can't tell you that we will be
bringing a standard on mandatory audit firm rotation. At this
point, we are a long way from any kind of decision on whether
firm rotation should be proposed as a standard.
We are holding discussions on auditor independence and
inviting a wide range of ideas on whether there is something we
should be doing about independence--
Chairman Garrett. And just--I only have about 3 seconds,
and I try to abide by it pretty closely.
Other than the general concensus or general thought that
this is an issue that should be looked at, was there any
specific data that you had received from anyone to say, here is
data that can show us that this is a problem area as opposed to
anecdotal, this is just another topic area that we should be
looking at?
Mr. Doty. It is a very fair question. If you go back in our
comments, the Board had--the Board's inspectors in inspecting
over the years, have found questions of skepticism, issues of
whether auditor skepticism was present, whether professional
independence was being compromised.
This is an area that crops up, recurs. It recurs in our
findings over the years. It is not an isolated issue. It is not
simply something that was raised without the basis in the--
Chairman Garrett. And I will close it on this.
I think your comment was that we are not wedded to this
outcome, so there is no preconceived notion as to--from where
you personally sit or anybody else as far as the outcome here?
Mr. Doty. Yes. In fact, Mr. Chairman, in the meetings of
last week, I think one of the hallmarks of those meetings was
that we heard a number of thoughtful comments on what could be
done to enhance skepticism, to enhance the professionalism of
auditors, but also to enhance the effectiveness of audit
committees.
There is great interest among audit committees in working
toward a more effective analysis of the audit function, and a
more effective evaluation of the audit service they are
getting.
That could come out of this very easily as a result.
Chairman Garrett. I thank you, Mr. Doty.
I yield back and the gentlelady from California is
recognized for 5 minutes.
Ms. Waters. Thank you very much, Mr. Chairman. I would like
to start with Mr. Kroeker.
J.C. Flowers & Company, a private equity firm and a major
MF Global shareholder, recruited Jon Corzine for the CEO job at
MF Global.
Moreover, until MF Global's failure, Mr. Corzine was an
unsalaried operating partner at J.C. Flowers. David Schamis, a
partner at J.C. Flowers, sat on the MF Global board, was deemed
an independent director by the firm and was able to sit on the
firm's risk and audit committee.
So I am looking at all of these connections--many contend
that the risk and audit committee at MF Global did not
sufficiently push back against Corzine's risk in sovereign debt
trade.
While I am not trying to get into the specifics of this
case, does MF Global teach us anything about how we can
increase audit committee independence?
Yes, Mr. Kroeker?
Mr. Doty. Ranking Member Waters--
Mr. Kroeker. Yes, again without commenting on any of the
specifics, and I think consistent with Chairman Doty's response
of what we heard in their 2 days of hearings yesterday on audit
committee effectiveness is that there are areas where audit
committees are probably--best practices with respect to audit
oversight.
Part of that is understanding the nature of PCAOB
inspections, how risk--financial reporting risk, how that
relates to operational or business risk. PCAOB has a standard
under consideration for finalization on auditors' communication
with audit committees that helps provide that linkage between
financial reporting risk and the audit committee's oversight
role.
Ms. Waters. Oh, and I am not so sure whether or not you--
related to my concerns about the overlapping directorate here
as it relates to those that I named that sat on both MF
Global's and the relationship that Mr. Corzine had with J.C.
Flowers, these connections I am concerned about.
What do you recommend?
Mr. Kroeker. Yes, and under existing requirements, again
without commenting specifically on any individual registrant,
the requirements to have an independent audit committee, I
think, have strengthened that audit committee oversight role.
So I think, taking those requirements very seriously, that
the audit committee members need to fulfill that independent
role of the overseer of the audit process.
Ms. Waters. Let me go to you, Mr. Doty.
Audit committees currently do not have access to PCAOB
inspection reports which assess whether auditors approach their
work with the required independence, objectivity, and
professional skepticism.
Would this information be useful to audit committees?
Does the PCAOB need legislation in order to share
inspection reports with audit committees?
Mr. Doty. Ranking Member Waters, that is a good question.
Auditors, the auditor can of course waive or make this
information available to an audit committee.
We cannot, under the statue. We cannot do it.
The auditor can choose to do it. But one of the remarkable
things we heard over the last 2 days of meetings last week was
an acute interest in audit committee members, mature and
thoughtful people who sit on many audit committees and who want
to see more of the detail that lies behind our published part
one inspection reports.
So we believe that there is enhanced interest among audit
committee members in understanding what our reports mean and
what kind of detail is behind them. And we believe that there
will be increasing interest on the part of audit committee
members as an attribute of their being an effective monitor and
evaluator of audit quality.
Ms. Waters. So again, you think you need legislation?
Mr. Doty. You would need legislation to authorize the Board
to deliver it upon request of an audit committee member.
There was interest in audit committee members in meeting
with the Board and having an exchange on that basis. And I
think you would need legislation before we could reveal what is
in the nonpublic portion of the report.
Ms. Waters. Thank you.
Back to Mr. Kroeker, while I still have a few seconds.
Recently, the United Brotherhood of Carpenters Pension Fund
and the Sheet Metal Workers Pension Fund have submitted a
series of proposals to public companies recommending a
shareholder advisory vote asking the companies to establish a
policy of mandatory auditor rotation every 7 years.
To date, the SEC staff has issued no action letters to each
of the companies stating it would not recommend enforcement
action to the SEC if the companies omitted, the unions audit
rotation proposal from its proxy materials.
Can you discuss the rationale for the SEC staff's decision
on this issue?
Mr. Kroeker. Yes, and principally that is an issue that is
handled by our Division of Corporation Finance and attorneys
who look at the existing requirements for such proposals.
So I would be happy as well to get additional information.
But under the existing staff no-action guidance, there is
an assessment made as to whether or not the request is a matter
of--just to put it simply, in the ordinary course of business.
And this has been a no-action process that works for many
different types of proposals.
I am aware that proposals were brought forward with respect
to auditor rotation and the staff's guidance was sought as to
action, and the staff's conclusion was that no action would be
recommended because it would be viewed as in the ordinary
course of business activities.
Ms. Waters. My time has been exhausted. I yield back the
balance of my time.
Chairman Garrett. Thank you.
Mr. Bachus is recognized.
Chairman Bachus. Thank you.
Mr. Doty, in my opening statement I mentioned the audit
firm rotation. And your statement, I think, basically is that
we are only at the start of considering this. And we have made
no decisions.
There seems to be at least a misinformed public who
believes that you are well on your way to doing that. And I
don't know why that is.
But, Mr. Garrett asked you if you had done a cost/benefit
study. And I think you answered, well we are just at the start
of the process.
But will that be a part of the process?
Mr. Doty. Good question, Chairman Bachus.
It would be putting the cart before the horse.
Chairman Bachus. Okay.
Mr. Doty. To start evaluating costs and benefits of some
form of rotation before you had any sense of whether you were
going to go there or what it would be, the initial inquiry here
is what should be done to enhance not only the perception of
auditor independence which suffered in the financial crisis,
but also the fact of auditor independence.
We are very aware of the pressures auditors are under.
Chairman Bachus. Right.
Mr. Doty. I personally, and I know members of the Board
with me want the private auditing profession to survive. We
want to see a private auditing profession and not have audit
become a public governmental function.
There is pressure on that at this point. And it derives, as
I said before, from the questions of whether there are
sufficient safeguards of objectivity, skepticism--
Chairman Bachus. Right.
Mr. Doty. --independence. One of the things you have to
look at is the fact that in some cases companies have had the
same auditor for a century--
Chairman Bachus. I mentioned HealthSouth in my opening
statement. And obviously, we all know accounting firms were
under pressure, auditors if they wanted to keep the business,
how closely did they look? I think skepticism is the right
word.
And I think Madoff isn't about a public company. That
auditor said that he just took everything at face value. And
obviously, that had disastrous consequences.
Will you at least keep a dialogue open with us as you move
along this, and give us your thought process and what you are
finding, and keep us abreast of--
Mr. Doty. We welcome the dialogue. And we want to be sure
that we keep you informed of where these concepts and these
proposals are moving.
And I would certainly tell you that the concepts on the
changes in the reform, the audit reporting model, are moving
toward a proposal. That enjoys a lot of support and input from
the audit profession, from the users, from all sorts of sources
of opinion.
We will be keeping you informed of that.
I would also simply volunteer the fact that we have no
doubt that audit quality has improved since Sarbanes-Oxley.
Chairman Bachus. Right.
Mr. Doty. There is no question about that. Audit committees
are the fulcrum of it. Audit committees are doing better.
Chairman Bachus. I think I see evidence of that in The Wall
Street Journal every day where people are questioning things.
And these are obviously issues that are tough to solve.
That is why they are still issues.
Let me ask the SEC--you have a role in this.
Will you do a cost/benefit or an economic analysis of the
effect? And I know it is hard to weight sometimes what is the
cost of not having skepticism or an auditor question something.
But it is hard to analyze what those costs are sometimes.
Mr. Kroeker. Those will be the--as Chairman Doty says, they
are not anywhere close to that point. But those will be
certainly if there was a proposal advanced, what would be the--
Chairman Bachus. Of course if you made a proposal, we are
going to go to that. And you hadn't done a cost/benefit
analysis.
Mr. Kroeker. No, we will be looking in advance of that and
working--
Chairman Bachus. Okay.
Mr. Kroeker. --with the--
Chairman Bachus. Let me switch gears for just a minute. I
only have about 30 seconds.
Madoff, obviously it wasn't a public company. It was a
private auditor. It was a two-man shop. They were regulated by
the State. The broker-dealer was regulated by FINRA.
But the investment advisor was the SEC. Does the Board
maybe feel like you ought to, that auditors of investment
advisors should be more scrutinized to avoid a Madoff, which
Dodd-Frank didn't address.
Mr. Doty. We have not been--we don't inspect--
Chairman Bachus. Oh, I know--
Mr. Doty. --privately held--private--
Chairman Bachus. Oh, I know.
Mr. Doty. --hedge funds and their investment advisors that
are neither SEC-registered brokers nor issuers.
Chairman Bachus. Right.
Mr. Doty. In the pilot program in the attempt to get to an
intelligent rule, a standard that suits what Congress clearly
wanted us to do, we will be looking at examinations and
reviews. Reviews of the representations that broker-dealers
make about their entitlement to the exemption, and the
examination of the compliance with what they say in that.
We are hopeful that at the end of this process, we will be
able to put in place a standard which will give the Congress
and the public assurance that we have taken steps to prevent or
detect the kind of fraud that Madoff perpetrated.
None of these are obviously foolproof, but we want to be
conscious of the proportionality that Chairman Garrett referred
to and I know you are interested in.
Chairman Bachus. Sure. Thank you very much. I appreciate
that.
Chairman Garrett. Thank you, Mr. Chairman.
The gentleman from California is recognized.
Mr. Sherman. Ms. Seidman I want to commend you on this
report to the blue ribbon panel on standard setting for private
companies.
Without objection, I would like to make it a part of the
record.
Chairman Garrett. Without objection, it is so ordered.
Mr. Sherman. And I know that that there is some discussion
in your shop of delay in writing another report--looks pretty
good.
Mr. Doty, you have talked--I believe it was you who talked
about smaller broker-dealers. And we saw this with Madoff where
the accounting firm was obviously too small to have done the
audit, if they chose to do an audit of Madoff, even if they had
devoted 100 percent of all their efforts to that one client.
Standards for independents generally say that an accounting
firm shouldn't have more than 5 or 10 or 15 percent of its
revenue coming from one client.
Because even if you have just enough staff to service that
one big client, if that one big client is half your business,
then you are not so much independent as an appendix or an
appendage.
What steps are you taking to make sure in dealing with
these smaller auditing firms around the country, that they are
big enough so that they can do the audit of the relevant
broker-dealer and still have 90 percent of their resources
available to handle other clients? In other words, that they
are big enough not only enough to do the job, but big enough to
have other sources of revenue and be independent of the client.
Mr. Doty. Congressman, you put your finger on an issue not
simply for the auditors of broker-dealers, but for many of what
we call the triennial firm, audit firms, the smaller audit
firms.
Mr. Sherman. Please speak into the microphone.
Mr. Doty. And we have inspected eight. We have selected
eight of the broker-dealer auditors exclusively--auditors
exclusively of broker-dealers that we inspected or we looked at
with a mutual consent in 2011.
We will do two more this year, three more this year,
probably--
Mr. Sherman. Mr. Doty, do you have standards or could--is
it entirely legal for an accounting firm to get 30 percent of
its revenue from a company and attest to their--excuse me--
opine on their financial statement?
Mr. Doty. It could be one of the indicia of independence
and of capacity--
Mr. Sherman. So you have no--in a profession best known for
focusing on numbers, you don't have a numerical standard?
Mr. Doty. We think we would be precipitous to have
established some kind of hard threshold at this point. But I
would--
Mr. Sherman. So would 50 percent be enough, 60 percent, 80
percent?
Mr. Doty. I think we would--
Mr. Sherman. Do you even know--
Mr. Doty. --looking at firms--
Mr. Sherman. --when the broker-dealer files a statement
with you, do you even know what percentage of the CPA firm's
revenues come from that one client?
Mr. Doty. Yes we do. We do look at that.
We look at--
Mr. Sherman. Is it on your form or do you look at it only
in the 1 percent of the cases where you gather additional
information?
Mr. Doty. We--in all of our inspections of an audit--
Mr. Sherman. In all of your inspections, so 99 percent of
these you don't inspect.
Mr. Doty. But in every inspection that we do--
Mr. Sherman. Okay, why don't you ask for that information
on every filing--
Chairman Bachus. Mr. Chairman?
Chairman Garrett. Yes.
Chairman Bachus. I don't know that the witness is having an
opportunity to respond to the--
Mr. Sherman. I will give you a chance to respond, Mr. Doty.
Why don't you ask that question for every filing?
Mr. Doty. We get it--we do not ask for a general survey of
firms to give us, in advance, an entire breakdown of their
client revenue contribution. I believe I am right about that.
I will confirm that for you.
Mr. Sherman. Mr. Doty, if I can rephrase the question. Why
don't you simply ask the firms when they submit the statement
to indicate that that one client is less than 10 percent of 15
percent of their revenue, all the time, not just with the one
tenth of 1 percent where you are able to conduct an
investigation?
Mr. Doty. It is certainly an idea that we should consider.
Mr. Sherman. Okay. And--
Mr. Doty. --I don't--
Mr. Sherman. --the light is about to turn red.
I will say to Ms. Seidman, you have called upon me many
times to defend the FASB's role in writing accounting
standards, and the independence that the FASB has obtained.
And yet every time I have talked to the FASB about
accounting for research, I get no theoretical support for a
position. I am told, wait another decade. We will finally work
something out with the Europeans. And in the meantime, there
are tens of billions of dollars of research that isn't being
done because we have accounting standards with no basis.
And I will ask you to respond for the record, unless the
chairman wants to give me more time.
Chairman Garrett. We will let that go to the record.
Mr. Sherman. Thank you.
Chairman Garrett. And with that, I will go to Mr.
Schweikert for 5 minutes.
Mr. Schweikert. Thank you, Mr. Chairman.
This is one I want to try to get my head around on what
accounting--what economic modeling, what else goes into it.
And some of this is sort of family folklore reaching way
back when accounting recognition rules changed on installment
sales. And some of that is, I think, the first time that was
done was like 35 years ago, and then had multiple--and each
time that happened, in the real estate industry people,
particularly those who extended credit and had cascades of
evaluations.
My understanding, Ms. Seidman, is that rules are in
promulgation or being looked at in regards to how to recognize
leaseholds. I would like to first understand, where is the rule
going? What economic modeling has been done?
Is there differentiation made between credit tenant, long-
term tenants, tenants who will--how are you modeling that?
And what potential do you see happening, as to how we book
and value real estate across the country?
Ms. Seidman. Thank you, Congressman.
First, let me just explain the project you are referring to
is our joint project on lease accounting that we are conducting
with the International Accounting Standards Board.
The primary purpose of the project was to respond to
persistent concerns that we heard from investors and also
regulators that material obligations of leases were not being
reported on the balance sheets of lessees.
That is the primary purpose of the project.
We engaged in that because investors were trying to make
adjustments themselves, to put those amounts on the balance
sheets. So we are trying to take some cost out of the system
and provide more useful information to investors.
With respect to where we stand in the process of it, we are
currently working through the comments that we received on the
first exposure draft which generally supported the proposal
that longer-term leases would be recognized on the balance
sheet.
There were concerns raised about complexity. And there are
concerns that have been raised about the income statement
treatment of that basic approach. So we are currently working
through that.
We proposed some changes to the lessors accounting which is
directly related to the question that you asked. We have been
working through those issues, as well.
At this point, we have landed on a proportionate sale model
for everything except real estate. We are planning to scope
real estate out of the standard, and instead rely on a
different standard that we are developing for investment
properties.
Mr. Schweikert. Okay. Any sense where that is going?
And my reason is--I instantly can start to think of ways
this gets gamed. If I am showing a concern saying, okay, here
is a long term lease. We want to recognize that from the
tenancy.
Now do you start doing 5 years with some type of rolling
options?
At a way, so now, as the real estate owner, does it change
the valuation of how you capitalize your real estate?
My fear is we are heading towards a mechanic--where the
accounting standard may end up creating a certain level of game
playing here, where most of us who have done evaluations and
looked at REITs and those things, at least we sort of
understand the mechanics right now.
Ms. Seidman. Right.
Mr. Schweikert. Is my concern unfounded?
Ms. Seidman. We would certainly try to make sure that there
is no opportunity for arbitrage between the accounting
standards or game playing as you said.
Mr. Schweikert. Some of it would just be the way you
structured a lease. And therefore, if you did it for a certain
amount of term with then a certain creatively written option,
it would be recognized differently, wouldn't it?
Ms. Seidman. Yes, the proposal would include provisions to
enable people to form judgments about how to incorporate
options in the estimation of the lease term, and then
ultimately how the transaction is recorded.
Both of these standards are still under development. We
have already agreed that we will send the leasing proposal out
for comments again. So there will be an opportunity to provide
further comments on it.
And we are just starting the process of looking at the
comments we received on the investment property proposal, which
is the one primarily related to real estate. And we got lots of
substantive comments on it.
It is going to take us some time to work through them.
Mr. Schweikert. Aren't these pretty well disclosed also in
the footnotes, though?
Ms. Seidman. There are certain requirements to disclose
minimum lease payments in the--
Mr. Schweikert. And duration, isn't that also in there?
Ms. Seidman. The lease term, yes.
Mr. Schweikert. Okay.
Ms. Seidman. But it is minimum lease payments rather than
expected lease payments.
So what we are trying to do is have everybody perform
similar calculations to take some of the work out of the hands
of the investors.
Mr. Schweikert. Okay.
Mr. Chairman, thank you.
My only concern is that sort of law of unintended
consequences that if we reach way back in time, we saw the
devastation happen when we changed the installment sale rules.
Ms. Seidman. Right.
Mr. Schweikert. Thank you, Mr. Chairman.
Ms. Seidman. May I just add that we do plan to conduct
significant outreach with stakeholders to try to avoid any
unintended consequences.
Chairman Garrett. Thank you.
Mr. Miller is recognized for 5 minutes.
Mr. Miller of North Carolina. Thank you, Mr. Chairman.
There has already been some discussion of concerns about a
lack of independence for conflicts of interest by auditors.
That is the reasoning behind the proposed requirement of
retaining auditors.
But that seems to be a recurring concern.
It was a concern in Enron and those other scandals during
that period. And the biggest auditing firms, the big four
accounting firms, still have consulting firms that are
affiliated that are as large, and as possible, as the
accounting firm.
I know that there are some not some limitations on how much
overlap there can be between the--consulting firms and the
auditing firms.
But right now, the OCC and the Fed are both doing reviews
of foreclosure practices by the bigger servicers that are all
affiliates of the biggest banks. And both essentially have
allowed the servicing firms to pick their own reviewers.
It appears from the engagement letters that had they made
public that most of the reviews are being done by the
consulting firms that are affiliated with auditing firms. And
it certainly has raised some questions about conflict of
interest.
Most notably for JPMorgan Chase, their affiliates that did
servicing, they picked Deloitte. And a big part of their review
will be mortgages that came to JPMorgan from Bear Stearns,
which they acquired, and from Washington Mutual, which JPMorgan
Chase acquired.
Deloitte was the auditor for Bear. And they are in fact a
defendant in investor litigation for what went on at Bear and
mortgage securitization. They are a defendant with Washington
Mutual, also for the mortgages originated by Washington Mutual.
It seems like there is an ample disincentive for the
auditing firm to find large problems with the mortgages
originated by JPMorgan Chase, or now liabilities assumed by
JPMorgan Chase, when they bought Bear and when they bought
Washington Mutual.
There was an article in the American Banker earlier this
month by Francine McKenna raising those questions. She has
concerns about conflict, or certainly the appearance of
conflict, or the lack of distance.
I have those concerns as well.
Do you all have those concerns?
And should this have happened? How should the rules be
changed, if you think so?
Yes, sir?
Mr. Doty. Congressman, first of all, you have highlighted
the scope and complexity of the independence question.
Independence and skepticism are a state of mind. And part
of the exercise that we are engaged in is to try to understand
as much as we can about that.
I would have to say that with respect to the issue you put
your finger on, it is an issue of another regulator's area of
expertise and jurisdiction.
It is not part of our jurisdiction. It is part of the
jurisdiction of the Federal banking regulators.
And I think in the McKenna article you are referring to,
the appropriate official of the Office of the Comptroller of
the Currency speaks to it, and speaks to the issue.
But I really would have nothing to add or nothing to
comment on there. It is not my responsibility or the Board's
responsibility to confront that issue in this particular case.
Mr. Miller of North Carolina. I understand. I have heard
that it is not my job response many times.
But it seems like it should be your job if an affiliate of
an accounting firm is undertaking an investigation that may
look at the work of the accounting firm with which they are
affiliated.
Why is that not something that some of you will look at?
Would any of you look at that?
Mr. Doty. We would in inspecting an engagement of any
accounting firm. We would be concerned about business
relationships with the affiliates of the accounting firm and
the registrant or the issuer.
And we do look at, as I was saying to Congressman Sherman,
the relative contribution of non-audit fees to the revenue of
the firm when we do our annual inspection of the 10 largest
firms.
Mr. Miller of North Carolina. Anybody else? Mr. Kroeker,
you have your hand on your button. Was it just a nervous
twitch?
Mr. Kroeker. No, no, no.
As it relates to the independence of the financial
statement auditor, which is really the jurisdiction that we
have for registered public companies, we would certainly be
taking a look at that issue.
It is a tenet of the independence rules that you can't
audit your own work, and a tenet of the independence rules
follows that you can't be independent if you have less than an
objective sense of mind--that is, you are incented to come to a
particular outcome.
So as it related to the financial statement audit, that
would be squarely within our responsibility.
As it relates to any work that is done under a consent
decree for the OCC or others, I don't believe it would fall
within our jurisdiction.
Chairman Garrett. The gentleman yields back.
Thanks for the answer.
The gentleman from Texas is recognized for 5 minutes.
Mr. Hensarling. Thank you, Mr. Chairman.
Mr. Doty, I may be confused about an earlier part of your
testimony or actually an answer that you gave to Chairman
Bachus. I believe you said in response to a question of his
that it is premature for a cost/benefit analysis.
Is that what I heard you say?
Mr. Doty. You did.
Mr. Hensarling. Okay, so implicitly that means you intend
to conduct a cost/benefit analysis; the timing is simply wrong.
Is this what you are trying to say?
Mr. Doty. Not to put too fine a point on it, but one would
normally not conduct a cost/benefit analysis or indeed any kind
of analysis of the kind you are talking about on a concept
release.
It is when you get to the--if you got to the point of a
proposal, and as I have said, we don't have a proposal
outstanding--
Mr. Hensarling. If I could, Mr. Doty, let me ask you this
with respect to the concept release.
There is some reason you put it out. So I assume you
assessed that there is a benefit to be derived by putting the
concept release out.
You have identified some problem. You have proffered a
solution.
So implicitly, aren't you telling us it is not premature to
consider benefits, but it is premature to consider cost?
Mr. Doty. The concept release, it is a fair question.
The concept release took note of the fact that there are
other jurisdictions which are adopting term limits mandatory
for all of the audits in their jurisdiction.
The Netherlands is one. India is moving in that direction.
These are, in some cases, 5- and 6-year term limits. The E.U.
is considering these proposals.
The concept release said we would be interested in the
views of commenters on any of these proposals, but also what
about terms of more than 10 years.
What about extended terms?
What about segments of the issuer market other than all?
I think that the concept release is very clear that we did
not intend to suggest that we had reached some conclusion that
all--
Mr. Hensarling. Yes.
Mr. Doty. --2,500--
Mr. Hensarling. But let me speak of one conclusion. The GAO
study, when they last looked at this, it appears they employed
a cost/benefit analysis.
I am reading from their report: ``GAO believes that
mandatory audit firm rotation may not be the most efficient way
to strengthen auditor independence and improve audit quality
considering the additional financial cost and loss of
institutional knowledge of the public company's previous
auditor of record.''
So it appears they used a cost/benefit analysis. Again, I
am still a little curious as to what has changed since the GAO
study that has caused this concept release to be put out?
What additional evidence is there?
It just seems like they may be putting that cart before the
horse here. I am trying to--
Mr. Doty. These are very fair questions.
The lapse of time--the GAO report was in 2004. It did
direct us to take another look at it down the line.
The GAO report was tentative. It did not say that it would
not. It offered the cautionary concern about cost. But it
estimated--it was reporting an estimate it had received from
others of a 20 percent jump that would cost 20 percent more.
Congressman, I think we have received a good deal of
testimony, opinion, evidence that that number would be
exaggerated, that in fact, firms change their auditors. They
change their auditors all the time. And they don't experience a
20 percent jump in audit costs.
Audit costs have risen, but they haven't jumped through the
period post-Arthur Andersen when firms have changed their
auditors.
Mr. Hensarling. Mr. Doty, I see my time is starting to wind
down. I do want to get in a couple of other points.
I clearly have not had an opportunity to review all the
responses to your concept release. I have been informed though
that it is overwhelmingly negative. And in fact a majority of
the investor community, who have sent you comments on record,
are opposed to it.
Do you disagree with that characterization?
Mr. Doty. First, it is helpful to us to know of 900 comment
letters, there is very strong opposition to any kind of one-
size-fits-all standard. And that is what the comment letters
say, that they oppose a one-size-fits-all rule which is exactly
what is being proposed in a number of foreign jurisdictions.
So that is a useful data point. It is a very important data
point--
Mr. Hensarling. If I could, as my seconds wind down, I know
you don't have to be wedded to it, but are the majority of the
comments from the investor community ostensibly those who would
benefit from this mandatory auditor rotation? Have they opined
negatively or positively?
Mr. Doty. There is a large and representative segment of
the CFO preparer community that is opposed to it. They are
opposed to it--
Mr. Hensarling. Thank you.
Chairman Garrett. Thank you. Thank you.
The gentlelady from New York is now recognized.
Mrs. Maloney. Thank you. Thank you for your testimony.
We are increasingly in a global economy and our firms are
part of a global economy now. And I would like to hear some
statements on how we are really merging the GAAP accounting
principles with the International Financial Reporting
Standards.
It seems like we should be trying to work together. It
certainly would make it more efficient for our companies to
interact in the global markets.
I would like to ask one specific question that really
impacts the district that I represent. And that is, the G20 has
urged FASB and the ISAB to converge GAAP and international
standards. And as part of this convergent process, the FASB
added a project to its agenda on accounting for the investment
property.
As I understand it, FASB's investment property entities
proposals relies on the type of entity that would determine
whether investment property would be reported at fair value.
As I understand it, this proposal is inconsistent with the
international standard that simply defines investment property
as fair value and to report the property at its fair value.
And my question on this particular one is also to a larger
sense why aren't we converging both and getting them to one
standard? Why have two separate standards? Why can't we get
together with GAAP and the international community?
But this is one specific example which then could probably
explain the broader challenges of trying to mesh the two
accounting standards that would make a more seamless and
efficient international accounting standard for Americans'
global businesses.
Ms. Seidman. Congresswoman, I think that question is
properly directed at me.
We indeed have a project on our agenda to consider putting
in place a standard on investment properties. The reason we put
it on the agenda was two-fold: first, it helps clarify what the
scope of the leasing standard will be, because we are talking
about leases of investment properties, for the most part; and
second, to try and converge, if possible, with international
accounting standards.
We certainly looked at the international standard as our
starting point. The reason that we did not move forward with it
was because it allowed an option for companies to decide
whether to carry their investment properties at fair value or
at cost.
And in very recent years, we have been urged by the SEC as
part of their committee on improving financial reporting, and
investors at large, to not allow choices in GAAP.
So we took the basics in the international standard and
instead decided to try and develop a requirement for when
certain types of investment properties should be carried at
fair value.
Mrs. Maloney. And where does it stand now?
Ms. Seidman. We issued a proposal for public comment and
the comment period just ended. We are in the process of
conducting roundtables with stakeholders on it.
I will share with you that the IASB has indicated a
willingness to consider the feedback that we have received on
our proposal with a goal of eventually converging.
But this is a case of leapfrogging where we have entered
into this narrow scope project for some very specific reasons
with a broader goal of convergence ultimately.
Mrs. Maloney. And how is convergence working in general
across all accounting standards? Are you trying to make that
one effort now or where does it stand?
That is one specific example, but generally in the whole
accounting process, where does it stand?
Ms. Seidman. Yes. We have been working on a number of
projects that were agreed upon between the FASB, the SEC, and
others which were representing the most significant
opportunities for improvement and financial reporting, as well
as the opportunities--
Mrs. Maloney. It sounds like you are making good progress.
I would like to say that I think your profession is
incredibly important, because if the private sector doesn't
trust the financials, then they are not going to invest.
Public companies now pay firms to audit them. And as has
been discussed in this committee many times at a basic level,
this presents a conflict of interest and a potential barrier to
auditor independence.
Are there any proposals either domestically or
internationally to change this model of auditor compensation?
And if so, what is it?
My time has expired anyway.
Mr. Doty. There are proposals that surfaced overseas,
Congresswoman, that suggest that insurance funds should be
created.
There are proposals that government funds should be
established--that an independent government agency would
employ, would select the auditor, negotiate, and determine the
compensation.
I would have to say that I think that again rushes a
process that is terribly important.
Audit committees have assumed since 2002 an increasingly
independent and important role in selecting the auditor,
negotiating the audit fee, and coming to terms with the scope
of the audit. All of that has improved the audit.
And our outstanding proposal on communications with audit
committees takes account of that. So we are not focusing a lot
of attention on these alternative payor systems.
We were much more interested in knowing whether there was
something in the concept release short of that kind of
alternative payor alternative appointment process that would
benefit independence.
Chairman Garrett. I thank the gentleman.
And the gentlelady yields back.
Mr. Fitzpatrick is recognized for 5 minutes.
Mr. Fitzpatrick. Thank you, Mr. Chairman.
Mr. Doty, why did you decide to extend the comment period
for entities to give testimony or write letters in connection
with this rule?
Mr. Doty. Good question. The 2 days of meetings we had
last--the 2 days of public meetings and hearings included
distinguished people such as Paul Volcker, John Bogle, and Don
Nicolaisen. Their commentary is written. It is all on our Web
site.
We felt it would be a good thing to allow other people to
react to that and to get their comments in. The more
information, the more comments we have, the better informed we
are.
And a number of the comments--a number of the proposals or
the--a number of the suggestions that came out of that meeting
that we should consider were actually not suggestions that were
encapsulated in the concept release. They were new.
So they deserve some consideration and comment.
Mr. Fitzpatrick. As I said in my opening statement, we are
in a fragile economic recovery right now. We are looking to the
private sector, including public companies, to get the private
sector economy moving again, to get people back to work.
And so I think we need to be very careful as we impose new
burdens, new regulations, and requirements upon them. And we
listen very carefully to them, because everything that we do
here in this town seems to dry up their capital that we are
asking them to free up to get people back to work.
I have started printing out some of the comments. And I
think I am about halfway through. This is half of them.
And following up on Mr. Hensarling's question, it seems
like the overwhelming majority--and I have seen a number
recently, maybe as many as 95 percent of the comments that the
Board is receiving on this concept are not just negative but
overwhelmingly negative.
I pulled out a couple of them from my State of
Pennsylvania. United States Steel has indicated the mandatory
audit firm rotation will result in increased costs and
inefficiencies and reduce audit quality with little if any
added benefits.
A company called Koppers Holdings Incorporated, has said
that mandatory audit firm rotation would cause higher costs and
inefficiencies. A company will be required to invest
substantial time, effort, and money each time it must select an
educated new audit firm.
And finally, a little closer to my part of the State,
AmerisourceBergen indicated, ``We strongly oppose mandatory
audit firm rotation for three primary reasons: number one, we
believe that audit costs will increase significantly because
new audit firm personnel will be required to invest time and
educate themselves about the company, its operations, and
business practices; number two, we don't believe there is
evidence that audit firm rotation will work to improve audit
quality--I thought this was interesting--; and number three,
mandatory audit firm rotation will also indirectly increase the
cost of our tax compliance.
``We use the same accounting firm for both audit and tax
services work as permitted by and in accordance with the rules
of the SEC to ensure that both audit and tax services are well
coordinated and provided in an efficient manner.
``We believe that if we are required to use a new
accounting firm for audit services, we would also need to use
that firm for tax services.''
And so, the great majority of companies are saying hold on,
that the benefits are minimal, and the cost is potentially very
significant.
I remember reading in one of these comments--I can't find
it right now, that it might have been the GAO predicted that
the increase in costs would be 20 percent.
I remember--was there a GAO study out there?
Mr. Doty. That is what--the GAO study did recite that if
that had been the estimate that some had.
I would tell you that there are people who would dispute
the accuracy of that now--
Mr. Fitzpatrick. Do you dispute the accuracy--
Mr. Doty. --7 or 8 years later--
Mr. Fitzpatrick. --of that?
Mr. Doty. Sir?
Mr. Fitzpatrick. Have you disputed the accuracy of the 20
percent number?
Mr. Doty. As I say, I have no basis for saying it is right
or wrong now. But I--
Mr. Fitzpatrick. What do you believe--do you have an
opinion?
Mr. Doty. I have--we have been told by people who are in
fact on audit committees and have engaged in the rotation of
auditors for very substantial companies, that in fact audit
rotation lowers the cost of the audit, reduces the fees that
are charged, and lowers the cost to the company.
So there is conflicting testimony among people who are
engaged in this process.
Mr. Fitzpatrick. And that is why, Mr. Doty--we really
believe it is incredibly important to have it a good cost/
benefit analysis done at the very beginning.
And so my question to you is, are you committed to doing a
cost/benefit analysis? If so, when? Who is going to do it? And
how is it going to be done?
Mr. Doty. First, Congressman, the question arises because
of the 2008 financial crisis in which people said auditors lost
independence. They lost objectivity.
We do not have a proposal out for any kind of firm
rotation. We are not committed to any particular approach to
independence and objectivity. We are going to hear all of these
comments.
And I assure you--
Mr. Fitzpatrick. But will you do a cost/benefit analysis
before you begin pushing that concept?
Mr. Doty. Before we came in with a proposal on mandatory
firm rotation, we would be doing a very careful analysis of
costs, unanticipated consequences, and benefits.
Mr. Fitzpatrick. Thank you, Mr. Chairman.
Chairman Garrett. I thank you.
The gentleman yields back.
Mr. Capuano?
Mr. Capuano. Thank you, Mr. Chairman, and I thank the
committee for its indulgence and its courtesies.
I would like to shift a little bit from the panel to talk
about an issue. I am the ranking member on the Oversight
Subcommittee of the full Financial Services Committee, and we
have been working for the last several months trying to figure
out what happened with MF Global. I have no doubt that most of
you have been, as well.
And in that time, for those of you--I am sure you all know.
But we have $1 billion missing. That $1 billion belonged to
investors, some big, many small, a lot of people hurt. And we
are trying to figure out what happened.
I haven't reached any conclusions yet. The committee hasn't
reached any conclusions.
But it is coming down to, in my opinion, three real
possibilities here, or maybe some combination of these
possibilities. One is possible criminal activity, which crimes
happen everywhere. That is life. But the other one is also
possibly the lack of true segregation and so-called segregated
accounts, different issue, not an issue for you guys.
But the third item is potentially the language of FASB
statement number 140, which attempts to define when a sale is a
sale and how to treat a sale.
Now most Americans, I think you would find, they know what
a sale is. If you sell it, you don't own it anymore. Someone
else owns it.
The fact that we have to define a sale in a specific
statement obviously answers the question that well, it is not
always that way.
And I am not looking to lay blame here. But I need to be
sure at this point--and as we speak, to my knowledge is at
least six different agencies, both government and
nongovernmental agencies, giving serious review to this,
including the SEC being one of the lead agencies, the CFTC, and
others.
But I guess I need to know just for the record. Mr.
Kroeker, I just want to be clear. I assume you are familiar
with the SEC's review of the MF Global situation at the moment?
Mr. Kroeker. Yes.
Mr. Capuano. Okay.
And Mr. Doty, I am just curious, is the PCAOB involved with
reviewing any of the rules or any of the appliance of those
rules that might have been related to MF Global?
Mr. Doty. Congressman, we shouldn't be commenting to you
publicly on--
Mr. Capuano. I am not asking about the specific issue. But
rules are rules that apply to others. And the reason there are
rules is not for a specific investigation. I am not asking for
a comment on that.
I am asking about any issue that you would read in the
newspaper in theory would either result or not result in a
self-review of what role might my group have had in this.
And did we do anything wrong? Or did we do anything wrong?
And not to say wrong, sometimes maybe we have to clarify
something. That is all I am asking.
Is the PCAOB engaged in self-review, internal review, as to
whether there can be any activities that you might be able to
take to address whatever may have happened there?
Mr. Doty. Yes, sir, we are constantly reviewing the
existing audit standards with a view to determining whether
there are areas where the audit standards can be improved--
Mr. Capuano. That is--and--
Mr. Doty. --and how we do that--
Mr. Capuano. --and you have done it or you are currently
doing it as it relates to potential issues that have been
raised in the public domain, I might add, relative to MF
Global?
Mr. Doty. I wouldn't want to suggest that we have a view on
what existing audit standards require for any currently
problematic audits that are out--I think that would--
Mr. Capuano. That is--
Mr. Doty. --be a mistake. But we are always looking at--we
read the papers. We listen to what you all do here.
We are always concerned about whether our standards,
whether we are looking ahead and thinking where our standards
should be to guide auditors and to produce better audits to
avoid--
Mr. Capuano. Yes.
Ms. Seidman, your agency?
Ms. Seidman. Whenever a major financial reporting issue
emerges, we take steps to try and evaluate whether there is an
issue with the standard itself or whether there is a compliance
issue with it.
Once we became aware of this situation, we did undertake
steps to try and get to the bottom of that. Our outreach
indicated that there was consistent interpretation of the
guidance. But through our outreach, we also learned that market
practices seem to have changed since the original standard was
written in 1996.
And the nature of the change seems to be related to the
types of securities that are involved in these arrangements. At
the time the standard was written, it seemed to involve
Treasury's and government agency's securities with very little
credit risk.
Whereas now, we understand that a much broader range of
securities--
Mr. Capuano. That is fair enough--
Ms. Seidman. --are being used.
Mr. Capuano. Mr. Attmore, is your agency involved with any
of these?
I am not sure that you would have a role in this.
Mr. Attmore. We do not have a role.
Mr. Capuano. I didn't think so.
The reason I ask is again, I only suspect, I am not looking
for anybody to say, this is what we are doing on this case.
That is inappropriate for this kind of a forum.
But I will tell you that you have a rule here that has
already been amended, 140 is an amendment of 125, which was an
amendment of a previous number. And I don't remember the
previous number.
So it is clearly a rule that requires an ongoing review.
And I just need to be satisfied at the moment--maybe at a
future time, I would like to know more--that at least all the
agencies--and by the way, when you are doing all this, are you
talking to each other? Because it is really not going to do any
good for FASB to come up with a new rule if PCAOB and
practitioners can't understand that one either.
You really have to be talking to each other. And I guess I
would like to know, are you communicating with each other on
this type of thing as to where you might want to go and what
might be an appropriate way, so that you have one clear,
unequivocal rule that every practitioner will be able to
utilize in the same fashion?
Chairman Garrett. And we will ask that they get back to you
on that in writing, as the gentleman's time has--
Mr. Capuano. Fair enough.
Thank you very much, Mr. Chairman.
Chairman Garrett. Thank you.
The gentleman from California is recognized.
Mr. Campbell. Thank you, Mr. Chairman.
At Ford Motor Company back in the day, they used to call
you a name based on what part of the company you came from.
If you came from accounting or finance, you were a ``bean
counter,'' right? And if you were from engineering and
manufacturing, you were a ``slide ruler.'' And if you came from
sales and marketing, you were a ``bozo.''
I used to think ``bean counter'' was a pejorative until I
heard them call a whole bunch of people ``bozos,'' and then I
was kind of happy about that.
As one of the three certified ``bean counters'' on the
committee this morning, good morning.
I want to ask about something that Mr. Kroeker mentioned.
And I think Ms. Seidman addressed tangentially a little bit.
But IFRS--and we are all talking about IFRS, and that IFRS
is coming, and that we have to move in that direction.
And we have been--I was trained as an accountant back in
the 1970s when principles-based accounting was a lot of what
they taught you. And we have been moving away from that into
rules-based accounting.
Ms. Seidman, you talked about a lot of the FASB things and
how complex they are. The one on stock options being the most
unbelievably byzantine complex thing I have ever seen in my
life. And it is all a part of this rules-based accounting.
But if we go to IFRS, we are going to go back toward more
principles-based.
My question is this: can we do that in this industry
without having some tort reform or some aspect of--how can we
do that with our legal system as it currently exists? Can we or
can we not?
Anybody who wishes to answer that, I will be pleased to
hear.
Yes, Mr. Kroeker?
Mr. Kroeker. I would be happy to answer that. My personal
view is I think we can.
The SEC staff delivered to Congress a report on principles-
based accounting standards coming out of Enron and other
financial reporting scandals, some of which were really tied to
what some have referred to as rules-based standards--that is,
somebody was on one side of a 3 percent test.
And really the sense of that study was we need to move
toward what we refer to as an objectives-based set of
standards, broad objectives but sufficient application
guidance, but not the detailed prescription that we have today.
And I think being on the good side of a judgment is a lot
better than the wrong side of a bright line rule.
Mr. Campbell. Okay.
But from a litigation standpoint, if there is a rule, even
if the rule is a bad rule, that is not the fault of the person
who followed the rule.
But if you are principles-based, which I personally much,
much, much, much, much prefer, that means there is judgment
involved. And judgment can always be second-guessed.
And so doesn't that create liability issues that are--that
under a rules-based system--now I agree with you.
A principles-based system will give us a better outcome,
give us better accounting. It will give us better financial
statements, in my view and my estimation.
But the question is what--when people can second-guess
things under our current--can we do that simultaneously and
still have the accounting firm stay in business?
It seems like Ms. Seidman is jumping at the--
Ms. Seidman. I think you are asking an excellent question.
It is something that we live every single day working with our
international counterparts where there is much more tolerance
for the application of judgment.
And I will say much less severe consequences for someone
questioning your judgment.
And so in our daily work with the International Accounting
Standards Board, we have a tension every day abut the U.S.
stakeholders wanting a certain amount of specificity in the
guidance, so that they have a sense that they are going to hit
it down the fairway with good intentions; whereas
internationally, they are much more comfortable having a broad
principle expressed and not a lot of guidance.
To me, what we have been trying to do is provide enough
application guidance so that there is an acceptable level of
diversity, but at some point it becomes unacceptable. And we
need to step in and provide some guidance.
So through our field work, we try and test how consistently
do we think companies are going to be able to apply the
standard without getting into excessive detail.
Mr. Campbell. So how are we going to do--how are we going
to move to--
Ms. Seidman. Yes--
Mr. Campbell. --more principles-based without--how do we
deal with the other issue, with the litigation or the liability
issue.
Ms. Seidman. I do agree with you that it is a systemic
issue.
But I will share with you that we hear from our investors
as well, that they like to have a certain amount of consistency
in the information being reported which lends itself to having
some application guidance.
Mr. Campbell. Mr. Kroeker?
Mr. Kroeker. I don't know which from a litigation
standpoint is a better posture to be in, but we have so many
rules in certain standards, that I understand the profession
has a hard time in derivatives accounting when you get to the--
highest to the lowest of actually understanding each rule.
So I am not convinced that we wouldn't be better off to
have a principle where everyone understands the principle, and
then makes those informed judgments.
Mr. Campbell. Okay. I have more to ask but my time has
expired.
Thank you, Mr. Chairman.
Chairman Garrett. Indeed.
Mr. Perlmutter is recognized.
Mr. Perlmutter. I think I will start--you mentioned
independence and objectivity as being sort of key to what an
accountant and an auditor is trying to determine.
Are these good books or are these bad books? Are these
numbers real or are they phony?
So just sort of going back to Mr. Fitzpatrick's line of
questions, in 2008, where so many people lost so much, have you
found that there wasn't objectivity, there wasn't independence
exercised by accounting firms that come under your supervision?
Mr. Doty. I don't think the failures in audit, whatever
they may have been, have been fully explored, documented, and
pinned down.
I would have to say that if you are asking do we have a
clear electronic connection between some failure of
independence and objectivity, and an obvious audit flow that
led to the collapse of a major financial institution, I would
say no, Congressman, we don't have that.
We don't have that.
What we do have, as I have said before, is a pattern that
goes back beyond the--2008 in which inspectors do find failures
of skepticism and failure to perform necessary procedures, and
perform a good audit under circumstances that suggest that they
may be less than objective or less than independent.
Mr. Perlmutter. Well--
Mr. Doty. So it is much more difficult--
Mr. Perlmutter. I see where Mr. Fitzpatrick is coming from.
And you and I have had a chance to talk about this.
You don't want to have a cozy relationship between
somebody, whether it is the regulator and the regulated
company, or the auditor and the company. But auditors and
accountants also need to know how the business is put together.
You are sort of--on the one hand, if you are always
switching out auditors, they always have to learn about the
company. And that doesn't make a lot of sense to me.
But there is this need for independence and not coziness,
if you will. And so, I appreciate Mr. Fitzpatrick's questions,
the cost/benefit analysis.
I don't know if you--the cost you use is $25,000 per person
in this country which was potentially lost between the summer
of 2008 and the spring of 2009, or what the right cost/benefit
analysis might be.
I will--just as I was sitting up here, maybe you rotate
partners within the company if you are worried about having a
new set of eyes. Obviously, you have thought about all of these
things.
And so, I appreciate your concern. This rotation of
auditing firms, I think, is probably too much, just from my
point of view.
But I understand the value; you are trying to make sure
there is independence and objectivity.
Now, the question about this principles-based versus sort
of statutory or rules-based, when--let me step back and ask a
more specific question.
With Madoff, using some kind of an accountant to hold the
monies of the customers, does anybody disagree that if a
broker-dealer or an investment advisor is holding somebody's
funds, they ought to have a CPA or some kind of an independent
accounting firm checking on the books of the investment advisor
or the broker-dealer?
Mr. Kroeker. I agree they should.
Mr. Doty. I concur.
Mr. Perlmutter. Because we want to make sure there is
independence there as well. And--
Mr. Doty. And independence was a problem of course in the
Madoff case. It was an affiliated auditor.
Mr. Perlmutter. Okay.
I was thinking that whenever you all come and speak to us,
it is a pretty dry subject. But then you start really digging
into the weeds which is your responsibility when you look at
the books and records of your businesses and the people.
If you don't take a good look, we can end up with lots of
trouble.
So I just--you have been taking a little bit of heat from
us up here. But we appreciate your service. And we obviously
support the accounting industry in making sure that their
customers, who they are reviewing, have good books so that the
investors are protected.
So thank you, I yield back.
Mr. Fitzpatrick [presiding]. The Chair recognizes Mr.
Renacci from Ohio for 5 minutes.
Mr. Renacci. Thank you, Mr. Chairman.
Again, I want to thank all the witnesses for being here.
Mr. Attmore, Section 978 of Dodd-Frank established a
permanent source of funding for the Government Accounting
Standards Board by authorizing the SEC to require the financial
industry's regulatory authority, FINRA, to collect these fees
from its members.
If GASB had not received this Dodd-Frank funding source,
would the future of GASB be comprised?
I figured I would bring you into the questioning.
[At this point in the hearing, there were some technical
difficulties in the hearing room.]
Mr. Attmore. [audio malfunction.]
Mr. Renacci. So you are saying Section 978 has been
successful for you?
Mr. Attmore. [audio malfunction.]
Mr. Renacci. Okay.
Mr. Kroeker in a written statement, you mentioned several
SEC staff papers written in relation to the IFRS and its
incorporation to U.S. GAAP.
One of these papers mentioned that diversity and
application of IFRS presented challenges to the comparability
of financial statements across countries.
How do you--how does the FASB and the ISAB plan to overcome
these challenges in incorporating the IFRS into U.S. GAAP?
Mr. Kroeker. Part of the work that we are doing is really
to inform the Commission as to whether to make a decision to
incorporate. And so understanding the level of diversity in
IFRS is important to that decision.
So no decision has been made as of yet.
But there are suggestions as we moved along that would say
if there is an unacceptable level of diversity under IFRS, it
really illustrates the need for a continuing strong role
domestically for the Financial Accounting Standards Board
(FASB), to assist both with identification of diversity, but
then providing application guidance if needed if an
incorporation decision was made, and sufficient guidance wasn't
being provided internationally.
Mr. Renacci. How will the convergence of international
financial standards benefit the U.S. economy?
Mr. Kroeker. I think--first and foremost, it could benefit
investors in making allocation decisions of their capital
consistently across companies and across jurisdictions.
From a company's standpoint, that has a benefit to them
because their competitors would then have consistent reporting
that they do. For multinational corporations in the United
States, we have heard from many of those that it would assist
in a standard set of bookkeeping for them around the world.
But we have also heard plenty of challenges for those who
aren't competing internationally for capital.
Mr. Renacci. So do you think it will make capital markets
more attractive to foreign issuers?
Mr. Kroeker. I haven't reached a conclusion on that yet.
Mr. Renacci. Okay.
Ms. Seidman, what are your thoughts on if the FASB and the
IASB also agree to one set of accounting standards? What
happens if companies decide that they do not want to use IFRS?
And which accounting standards will they use?
Ms. Seidman. The approach we have been taking so far is to
work jointly on projects with the IASB that we would have
concluded needed improvement in the United States anyway.
So in other words, the approach we are taking is to make
improvements to U.S. GAAP that are consistent with the
improvements that are being made by the International
Accounting Standards Board.
So they are following U.S. GAAP. It just happens to be
consistent with IFRS.
I think the big question is, how much further do we want to
take this?
In other words, there are many, many pieces of U.S. GAAP
that are not consistent with IFRS. And so, are we going to
continue to do this or not?
That is really the crux of the matter that the SEC is
looking at, and with very much of a cost/benefit perspective in
mind.
Mr. Renacci. So I know I am running out of time here.
But do you think U.S. GAAP will remain a valid set of
accounting pronouncements?
Ms. Seidman. Yes. We completely accept our responsibility
to make sure that the standards that we set will continue to
fulfill our mission, which is to make sure that investors have
credible, complete, and transparent information regardless of
what we are ultimately going to call it.
Mr. Renacci. All right, thank you.
I yield back.
Mr. Fitzpatrick. At this point, I am going to ask unanimous
consent to make three written statements a part of the record:
one from the Mutual Fund Directors Forum dated March 28th; one
from the Investment Company Institute dated March 28th; and one
from the Property Casualty Insurers Association of America
dated March 27th.
Without objection, they are a part of the record.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 30 days for Members to submit written questions to these
witnesses and to place their responses in the record.
So with that, this panel is dismissed with our appreciation
for your time.
And we will ask that the second panel take their positions
at the hearing table.
The second panel of this subcommittee hearing includes: Mr.
Joseph Carcello, professor, department of accounting and
information management at the University of Tennessee; Mr. Gary
Karbureck, vice president and chief accounting officer at Xerox
Corporation, on behalf of the Financial Executives
International; Mr. Barry Melancon, president and chief
executive officer of the American Institute of CPAs; and Mr.
Tom Quaadman, vice president, Center for Capital Markets
Competitiveness at the United States Chamber of Commerce.
Your written statements, gentlemen, will be made a part of
the record, and you will each be recognized for 5 minutes for
an oral summary of your testimony, beginning with Mr. Joseph
Carcello.
Sir?
STATEMENT OF JOSEPH V. CARCELLO, PH.D., CPA, CMA, CIA, ERNST &
YOUNG AND BUSINESS ALUMNI PROFESSOR; AND DIRECTOR OF RESEARCH--
CORPORATE GOVERNANCE CENTER, THE UNIVERSITY OF TENNESSEE,
KNOXVILLE
Mr. Carcello. Congressman Fitzpatrick, Ranking Member
Waters, and members of the subcommittee, thank you for giving
me the opportunity to speak with you today about accounting and
auditing oversight.
I have served as a professor at the University of Tennessee
for approximately 20 years where I teach accounting, auditing,
and corporate governance.
My remarks are also informed by my service on the PCAOB's
investor advisory and standing advisory groups, both of which
are outside advisory groups to the Board.
I will focus my remarks today on auditing oversight,
particularly on three issues of concern to investors: internal
control over financial reporting; public versus private nature
of PCAOB enforcement proceedings; and audit firm rotation.
The Dodd-Frank Wall Street Reform and Consumer Protection
Act exempts public companies with a market capitalization of
less than $75 million from Section 404(b) of the Sarbanes-Oxley
Act. In addition, the Dodd-Frank Act requires the SEC to study
whether to extend the exemption from compliance with Section
404(b) to issuers with a market capitalization below $250
million.
I believe that expanding the number of public companies
that are exempt from auditor reporting on internal control
would ill-serve investors in the capital markets.
Over the last 5 years, a large body of empirical research
has emerged that establishes the importance of effective
internal controls and the benefits of auditor reporting on
internal control.
The most compelling evidence on the value of auditor
reporting on internal controls comes from a study by Bedard and
Graham 2011. Bedard and Graham examine issuers with revenues of
$1 billion or less.
They find that one, auditors, rather than management,
detect approximately 75 percent of the unremediated internal
control deficiencies. As Bedard and Graham point out,
``Importantly, this low level of client detection occurs when
clients are aware that auditors will soon follow with their own
tests.''
Two, when managers detect the internal control deficiency,
they tend to classify the deficiency as less severe, but
auditors frequently override those classifications.
Three, a significant percentage of the internal control
deficiencies in the control environment component and related
to the revenue account are detected by auditor control testing.
This is germane because fraud is often associated with control
environment weaknesses and revenue is the account most
typically misstated when fraud occurs.
Let me move on to public versus private nature of PCAOB
enforcement proceedings.
I understand that Representative Lynn Westmoreland has
introduced H.R. 3503, which would amend SOX to make PCAOB
disciplinary proceedings public. I favor such legislation.
The most compelling argument for making PCAOB disciplinary
proceedings public is that the nature of these proceedings is
private if brought by the PCAOB, but public if brought by the
SEC, even though the PCAOB is closely supervised by the SEC.
As former PCAOB Acting Chairman Dan Goelzer stated in his
August 24, 2010, letter to Congressmen Frank and Bachus, ``If
the SEC were to bring the same case as the PCAOB, alleging the
same violations, against the same auditor, the SEC's charges
would be disclosed at the time the Commission instituted its
proceeding. Any administrative trial would be open to the
public.''
Finally, on audit firm rotation, the PCAOB has outstanding
a concept release on auditor independence and audit firm
rotation. I understand that Representative Fitzpatrick is
considering draft legislation that would prohibit the PCAOB
from mandating audit firm rotation.
It is important to understand that the Board's release on
this topic emanates from a concern that auditors currently
exhibit an inadequate level of professional skepticism.
Without professional skepticism, audits are of little
value.
I believe that there is sufficient evidence to legitimately
question whether auditors are sufficiently skeptical.
The PCAOB's inspection process has found that at least one
of the largest accounting firms uses the following language in
a recent proposal to a prospective client: ``Your auditor
should be a partner in supporting and helping the company
achieve its goals.''
In addition, the PCAOB's inspection process continues to
identify a sizable number of audit deficiencies. And these
deficiencies are often related to inadequate profession
skepticism.
Given that the PCAOB's mission is to protect the interest
of investors and further the public interest in the preparation
of informative and independent audit reports, exploring this
issue is not only appropriate, not only is it within the clear
mission of the Board as articulated by Congress, it is arguably
the very mission of the Board and the reason the Board exists.
Thank you.
[The prepared statement of Professor Carcello can be found
on page 79 of the appendix.]
Mr. Fitzpatrick. Thank you.
Mr. Kabureck from Xerox?
STATEMENT OF GARY R. KABURECK, VICE PRESIDENT AND CHIEF
ACCOUNTING OFFICER, XEROX CORPORATION, ON BEHALF OF FINANCIAL
EXECUTIVES INTERNATIONAL (FEI)
Mr. Kabureck. Thank you, Congressman Fitzpatrick, Ranking
Member Waters, and members of the subcommittee for inviting me
here today.
I am Gary Kabureck, chief accounting officer of Xerox
Corporation. And today, I am representing the Financial
Executives International (FEI), a leading international
organization of senior financial executives.
I would like to discuss three items today of interest to
our members: the PCAOB project exploring the merits of
mandatory audit rotation; complexity in accounting standards;
and, time permitting, to provide some perspectives in the
concept of principles-based accounting.
Beginning with the subject of mandatory auditor rotation,
the FEI has always supported the critical need for auditor
independence and impartiality. There is no guarantee or
evidence that mandatory rotation will increase auditor
independence. However, it is clear that mandatory rotation will
be costly and operationally disruptive.
There are many reasons financial statement preparers oppose
a requirement to periodically rotate the company's auditors. My
comments today will focus on practical operational implications
and costs.
For the largest multinational corporations, realistically
only the big four firms have the resources to effectively
perform the audit.
I am on both sides of the table replacing auditors, and I
can attest the process for selecting a new auditor in
transitioning a new auditor will be lengthy and extremely
costly for both the company and the new auditor.
It requires a significant amount of incremental time of
company personnel at all levels to break in new auditors. And
it is usually at least 3 years before the audit effort achieves
the steady workflow state.
Company time and money are finite. Every hour and dollar
spent on changing auditors is not available for the uses in the
business or for return to investors.
Additionally, many multinationals have non-audit
relationships, for example, consulting with one or more of the
big four firms, which would need to be curtailed if such firm
was to be the new auditor.
This leads to additional business disruption, to replace
the firm in its non-audit capacity. Alternatively, companies
may decide to never retain the big four firms to provide non-
audit services, as one day that firm may need to become the new
auditor.
Beyond the audit, this notion has consequences for the
entire consulting industry.
The big four firms are not necessarily fungible as they
vary in industry concentrations and expertise, geographic
presence, and international reach, which potentially further
limits the pool of selection of new auditors.
Many capital markets and merger and acquisition
transactions extend over several periods. And under mandatory
auditor rotation, there will be instances when one auditor is
present at the beginning of the transaction and a different
auditor is present at the end.
I can assure you this creates its own set of unique issues.
In summary, mandatory rotation is a draconian step and it
is critical to keep in mind the actual project goals, which is
to find ways in which auditor independence, skepticism, and
objectivity can be enhanced.
My second subject, complexity in accounting standards, is a
significant issue for preparers of financial statements and
their auditors.
Of course, some complexity is unavoidable and appropriate,
but some can and should be avoided.
Unnecessarily complex accounting and disclosure
requirements result in significant operating costs to financial
statement preparers. It increases the risks of errors, mature
weaknesses in these statements.
The FEI recommends that to the extent possible, new
accounting standards should result in financial statements that
reflect the company's business model.
We also believe the cost of implementation and compliance
should receive greater prominence in the FASB's decision
process.
The FEI does wish to recognize Chairman Seidman's efforts
during the last 2 years she has chaired the FASB. In an effort
to test the operational viability of potential new standards,
the FASB has been conducting greater than ever outreach both in
frequency and in visibility to its various constituencies.
Obviously, we encourage this path in the future.
One of the potential solutions, or at least partial
solutions to complexity is my last subject: the call for great
focus on principles-based accounting standards.
The FEI has long been a strong proponent of principles-
based accounting and encourages the accounting standards
setters to promulgate new standards with more emphasis on
principles and less on detailed rules.
We have noticed the recent change by the FASB in this
direction. But do note that old habits, for example the
drafting of very detailed roles, are hard to break. And there
remain many accounting standards on the books that include
extensively detailed rules.
However, the effective principles-based accounting
standards will require the acceptance of good faith application
of judgment by all constituencies in the accounting,
regulatory, audit, and user communities, and recognition that
there may be slightly less comparability between companies in
the future as local judgments may be different.
Thank you for your time today. And will be pleased to
answer any questions.
[The prepared statement of Mr. Kabureck can be found on
page 110 of the appendix.]
Mr. Fitzpatrick. Thank you, Mr. Kabureck.
Next, Mr. Melancon from the American Institute of CPAs.
STATEMENT OF BARRY C. MELANCON, CPA, PRESIDENT AND CHIEF
EXECUTIVE OFFICER, AMERICAN INSTITUTE OF CERTIFIED PUBLIC
ACCOUNTANTS (AICPA)
Mr. Melancon. Thank you, and good afternoon, Congressman
Fitzpatrick, Ranking Member Waters, and members of the
subcommittee. Thank you for having me today.
My name is Barry Melancon. I am a CPA, and president and
CEO of the American Institute of Certified Public Accountants
(AICPA).
I am pleased to be here to testify before you today about
the profession's commitment to the public interests, its role
in the global economy and capital markets, and the important
services CPAs provide to U.S. businesses of all sizes.
The AICPA was established 125 years ago by the accounting
profession to serve the public interests by fostering
independence, objectivity, confidence, and the highest possible
level of professionalism and ethical behavior.
To further that mission, we have identified five strategic
initiatives geared toward the continuing improvement of our
profession.
The first strategic initiative is attracting and retaining
the best and the brightest people into the profession. The CPA
profession recognizes that its principal asset is human
capital. And the AICPA is making significant investments in
ensuring that a vibrant and highly qualified number of
professionals are attracted to the profession, and see the
profession as a rewarding career.
The second initiative is ensuring the ongoing competency of
the best and brightest in their respective roles. Many bodies
are critical to the assurance--to assure the accuracy,
transparency, and quality of financial reporting, including the
AICPA, corporations, boards of directors, independent audit
committees, CPA firms, and the regulatory community. The AICPA
works to provide the ethical framework, training, and guidance
that the CPAs as management and as auditors need to get it
right.
Third, the AICPA promotes independent relevant financial
reporting, auditing, and ethical standards. Standards of
practice developed free of any special interests influences,
but with input from all relevant stakeholders, are critical to
the production of information that is meaningful to investors
and other users of that information. The AICPA supports the
ongoing independence of FASB and its activities to develop
financial reporting standards for public companies.
More broadly, we support the development of one set of high
quality global financial reporting standards. And we believe
that international financial reporting standards, or IFRS, are
best positioned to ultimately be that set of standards.
The fourth strategic initiative is developing and
implementing innovative solutions to the increasingly complex
issues and business environment that CPAs navigate skillfully.
Accounting and auditing solutions need to keep pace with
business activities in order to maximize the ability of the
profession to perform at the highest levels and to keep abreast
of complex global business transactions.
Nonfinancial information is becoming an increasingly
integral tool to assess current and future business
performance. Fraud detection and prevention will remain
critical factors for both the financial statement preparer and
auditor. Internal controls over financial and non-financial
reporting are becoming much more important as well. And of
course, technology solutions are critical.
The fifth strategic initiative is supporting robust but
balanced regulation. The AICPA believes in a strong and
balanced regulatory structure that protects the public but does
not detract or negatively impact quality reporting and
auditing, and does not restrict the effective and efficient
flow of capital.
The PCAOB is engaged in a number of projects which we
support, including its concept release on auditors reporting
model. There are two other projects about which we have some
concerns.
Last August, the PCAOB issued a concept release on audit
firm rotation. Sarbanes-Oxley delegated responsibility for
overseeing the hiring and firing of external auditors to
independent audit committees. We believe in the audit
committee's authority and support strengthening its role, not
undermining it.
If the PCAOB's release becomes a rule, it would present a
clear example of unbalanced regulation by imposing significant
strains on public companies and the audit profession, with
little evidence that Sarbanes-Oxley is not working.
Last October, the PCAOB issued a proposed rule on improving
the transparency of the audit which would require
identification of the audit partner and certain other
participants in the audit report. We have questioned whether
the identification of this specific engagement partner in that
report would improve audit quality and auditor accountability,
and we have suggested an alternative that provides a more
balanced approach. We appreciate the PCAOB's willingness to
consider our suggestions.
I also want to note two recent rulemakings that we believe
overlook the appropriate balance between regulation that
protests the public, and regulation that overly burdens
businesses and their auditors.
The first relates to audits of introducing broker-dealers
and the inclusion in the PCAOB's interim inspection program.
And the second relates to audits of pooled investment vehicles,
which results in effectively excluding certain CPA firms from
providing audit services.
We believe that regulations and the resources to implement
those regulations should focus on where there is the greatest
risk to the investing public.
Let me conclude my remarks by emphasizing that CPAs in all
areas of the accounting profession, along with the AICPA, join
you as we seek to advance a common mission of promoting the
highest quality accounting and auditing services that are
valuable to the public interest, and to the global capital
market.
Thank you for the opportunity to present this testimony.
And I would be pleased to answer your questions.
[The prepared statement of Mr. Melancon can be found on
page 144 of the appendix.]
Mr. Fitzpatrick. Thank you.
The final witness is Mr. Quaadman from the U.S. Chamber of
Commerce.
STATEMENT OF TOM QUAADMAN, VICE PRESIDENT, CENTER FOR CAPITAL
MARKETS COMPETITIVENESS, U.S. CHAMBER OF COMMERCE
Mr. Quaadman. Thank you, Representative Fitzpatrick and
Ranking Member Waters.
I am Tom Quaadman with the U.S. Chamber of Commerce. And I
think this hearing is appropriate the day after Congress passed
the Jobs Act. The Jobs Act obviously was to spur IPOs.
But we also feel at the Chamber, that there is a
significant outflow of public companies from the public
marketplace itself, which is something that Congress should
address. And we think this hearing is an important first step
to do that.
Businesses need to have strong, clear, concise financial
reports that accurately reflect economic activity.
Strong financial reports allow businesses to go out into
the marketplace and raise capital. They allow them to identify
counterparties for transactions, as well as determining what
the needs and capabilities of the company are.
Standard setting is at the very head of that financial
reporting process. Standard setting needs to be balanced and
needs to have integrity. And the products that come out of the
standard-setting process itself need to be done through
thoughtful deliberation--masquerades as financial reporting
will in fact drive investors and businesses out of the public
marketplace.
FASB, we believe years ago, had a problem with the
standard-setting process that was unbalanced, was not receiving
the appropriate input. That fair value accounting was actually
a symptom of that problem.
However, under the leadership of Jack Brennan with the
Financial Accounting Foundation, and with Leslie Seidman of
FASB, we think they have developed strong lines of
communication that have allowed for the convergence projects to
move forward in a very thoughtful way.
The PCAOB, in our view, does have a very, very important
role in the financial reporting process. However, currently we
believe that they are misguided in their priorities and that
they are actually engaged in mission creep.
Sarbanes-Oxley was very clear in delineating lines of
demarcation that corporate governance would reside either with
State corporate law or with the SEC. The PCAOB was given
jurisdiction over the regulation of auditing itself.
In a series of concept releases and proposals that the
PCAOB is currently looking at, they are crossing the threshold
into corporate governance. Those include: the concept release
on auditor independence which has rotation; audit committee
communications; revisions to the audited financial statements;
and apparently coming soon, the need for auditors to review and
pass judgment on executive compensation.
The reason why rotation is such an important issue--and I
think why there has been such important discussion on it today,
this as proxy access in its own way, has been around for
decades.
Yet there has been universal opposition to rotation.
Congress, in debating Sarbanes-Oxley, specifically declined
to include rotation. The GAO in looking at the issue twice
decided that rotation was not appropriate and that it would
increase costs.
The majority of investors who have commented on the concept
release have opposed rotation. All the businesses that have
commented on the concept release have opposed rotation. And
there are academic studies that oppose it as well.
But in the justifications we have heard about the need to
consider rotation, the PCAOB has failed to provide any
inspection evidence as to why this should be considered.
Furthermore, the concept release and the statements,
including this morning by Chairman Doty, have said that audit
quality standards today are better than they were 10 years ago.
So the question is, what is the need? The more fundamental
question is, why is it the role of the government to tell a
business what vendors they should or should not use.
We think not. We think that the draft bill that you have
put forward, Mr. Fitzpatrick, actually delineates the lines
that Sarbanes-Oxley stated.
We have a 12-point plan, outlined in our testimony, that
has a number of provisions we think would improve reporting,
including Chairman Garrett's SEC accountability bill, that
would have FASB and the PCAOB have to abide by the
Administrative Procedures Act as well as any advisory groups
through FACA.
They will in fact allow--force the arbiters of transparency
to be transparent. We think that the PCAOB should have a
business advisory group.
And finally, Congressman Miller had an amendment in the
Financial Regulator Reform bill to create a financial reporting
forum that would have allowed the regulators--FASB, the PCAOB,
investors, and businesses--to get together on a periodic basis
to identify problems in financial reporting as well as to
prioritize appropriate projects.
We think that these are all issues that Congress should
look at. And I look forward to taking any questions.
[The prepared statement of Mr. Quaadman can be found on
page 158 of the appendix.]
Mr. Fitzpatrick. Thank you. Thank you, Mr. Quaadman.
I want to follow up on your testimony in connection with
what you referred to as ``mission creep'' within the Board.
As we all know now, the PCAOB has this concept release
mandate auditing firm rotation. Yet, I believe they also
acknowledge that audit quality has increased post Sarbanes-
Oxley. So it has gotten better.
In addition, this concept release also states that there is
no data from PCAOB's inspections that were shown to demonstrate
the need for firm rotation, and also that the GAO studies have
estimated that rotation--GAO says that it will cost 20 percent.
Some say more.
Why do you believe that the PCAOB is continuing to expend
resources on this concept release at this point?
Mr. Quaadman. Part of the justification we have heard is
that this is being considered internationally and there has
been discussion about that today.
A couple of points on that. One is the Netherlands is about
the size of New Jersey.
The E.U.--and there has been discussion about auditor
rotation or changes to the audit model, they say we need to
move forward on this because the United States is considering
this.
And if you actually look at China, in China they are
talking about rotation. But they are talking about it in a way
that you would actually force Chinese companies after a period
of time to rotate out of global firms into Chinese-only firms.
And that might be a problem because it could actually be
protectionist in measure.
What is also troubling, I think, as well was that Chairman
Doty has stated to the press that ``This is an issue we will be
working on a year from now.''
If you look at the state of audit standards today, most
audit standards today predate Sarbanes-Oxley.
So why is the PCAOB engaged in this process using these
resources where there is no justification for moving forward or
for the consideration when there are other more important
issues that they should be working on?
Mr. Fitzpatrick. What are some of those issues in your--
Mr. Quaadman. As I said, reviewing audit standards is one.
The SEC 5 years ago, in 2008, before the financial crisis,
had an advisory committee that actually issued a number of
different proposals on how to reduce financial restatements,
including the use of materiality for investors.
That has sat on the shelf. And I think it is a question
Congress should ask the chairman: why aren't they moving
forward on the ability to reduce restatements?
Mr. Fitzpatrick. Mr. Kabureck what are some of the
operational challenges that companies would face if mandated to
rotate their firms such as being proposed?
Mr. Kabureck. I can think of several in the time I have.
Let me talk in the context.
Most multinational companies probably would have
independence issues with three of the big four firms.
In my company, we would. We have outsourced internal audit.
Another firm does work that will be constituted tax law. Still
another does joint go-to-market services for us.
So if you had to--as a big four--we would need a big four
firm. If we had to go to one of the other big four, is--they
would--the independence issue that they would have would have
to be remedied.
So for example, take an internal audit. We would have to
bring it back in-house, which would encompass finding new
people who are willing and qualified to do auditing. Or you
would have to move it to still another firm. You lose the
institutional knowledge that that outsourced internal auditor
has.
And then you don't want to have a break in internal audit
while you are transitioning from the old firm until you have
the new arrangement. That would not be a good thing either.
So I could go on and on. But basically, this example is
that the services that these vendors are providing would have
to stop. There are at least nine enumerated prohibited services
that exist today.
And the major corporations use the other big three firms
that sent their auditor for them regularly.
Mr. Fitzpatrick. So you are suggesting that if your
corporation were required to switch auditing firms that you may
be limited to only one to go too?
Mr. Kabureck. You would--at the moment, there would be
independence issues with all three. Some task would have to
stop by one or the others.
And you could--I used the internal audit as an example
because it--but the law--but the big four firm that does some
international tax work for us that would be more--can--would--
here would be considered practicing tax law, that would have to
stop. And they are doing a very good job if it over there.
So you are going to have to replace your tax attorney
abroad. And so it is a--something else changes besides just the
auditor.
Mr. Fitzpatrick. Mr. Melancon, you had talked briefly about
the importance of these firms being able, and the companies
being able, to attract quality auditors.
Given what Mr. Kabureck just indicated, you are now limited
to perhaps one company to transfer to. What does that do to the
sort of migration of auditors between company and auditors and
different auditing firms?
Mr. Melancon. The human capital issue is real.
One of the things in all this discussion about auditor
rotation that wasn't brought up today, that I think is very
important, it goes to your point, Congressman, is that
Sarbanes-Oxley actually in--passed--part of its law required
the lead partner and the concurring partner to rotate every 5
years, which was addressing the issue of that different look.
But at the same time, not going to the point that Gary
mentioned which was related to the audit firm rotation itself.
And we tend to sort of bypass that. But even that provision
requires huge human capital aspects within a firm because of
the difficulties of those particular issues.
If you go to a much greater extent, there will be
disruption, serious disruption within the firms as well as
within the corporations as he just mentioned.
Mr. Fitzpatrick. Mr. Kabureck, this question of audit
committees within public companies, my understanding of those
audit--the committees are independent. They have a job to do.
Their job is to understand the importance of the audit. How it
occurs. How many individuals are there day-to-day within the
company?
And that is an appropriate role in a public company for
that audit committee.
What essentially is being proposed is that the Federal
Government through one of its agencies' Boards is now going to
sort of reach into--not just mandate audit firm rotation, but
essentially usurp the proper role of an audit committee within
a public company.
Can you expand on that?
Mr. Kabureck. Certainly. As I understand it, the PCAOB
proposal, if it was to become the requirement, to mandatory
rotate audit firms, it absolutely is usurping a Board
governance, more specifically audit committee governance
responsibility.
Going towards local solutions to local issues would seem to
me, and I think to my colleagues in FEI, is that companies,
boards of directors, more specifically their audit committees,
their best position is to understand when is the right time, if
ever, to reconsider changing auditors and to challenge the
auditors, even just to rebid it just to get fees down.
But it would seem to me that every company situation is
different. Every audit situation is different. So the FEI
believes that is best left to companies and their boards of
directors.
Mr. Fitzpatrick. I now recognize the ranking member, Ms.
Waters, for 5 minutes.
Ms. Waters. Thank you very much.
I would like to thank all of our witnesses for being here
today.
I have to say that I am a little bit concerned about the
tremendous opposition to the rotation concept.
We have just gone through a subprime meltdown that
basically almost destroyed our economy. And we have found that
there were many individuals, agencies, organizations that
played a role in the demise almost of our housing market, which
negatively impacted our entire economy.
And yet this very, very strong opposition to rotation just
seems as if there is not a lot of understanding about auditing,
rating agencies, etc., etc.
I want to go back to our first witness here, and ask
about--under Sarbanes-Oxley's Sections 302 and 906, CEOs and
CFOs must sign certification attesting to the internal controls
of the corporation they are recording every year in.
If as a CEO, or if a CEO or CFO attests that those
certifications are accurate, and if they are not, they could
face civil and criminal penalties. Have these certifications
been effective in improving the quality of financial reporting?
Could you help me with this, Mr. Carcello?
Mr. Carcello. Yes, as you point out, Representative Waters,
under Sections 302 and 906, the CEO and the CFO have to certify
as to the accuracy of the financial statements.
There has been both anecdotal and empirical research. We
have talked earlier today about costs and benefits.
I would refer this committee to numerous studies that have
documented the benefits associated with that certification. So
it does seem to have helped.
I believe, although we haven't talked extensively about
this today, one of the reasons that the PCAOB has proposed a
requirement for the audit partner to be identified in the audit
report is if those certifications have provided benefits on the
part of preparers, public identification of the audit partner
may provide comparable benefits on the audit side of the house.
Mr. Kabureck, do you agree?
Mr. Kabureck. With respect to the 302 and 906
certifications, I think they have increased the quality of and
the liability of financial reporting.
I am also a signing officer for quarterly and annual
filings.
The CEO and CFO rely upon internal processes, which I lead,
to give them comfort and assurance that the statements that we
are releasing comply with GAAP and the relevant laws and so on.
So I think 302 and 906 certifications have been an
improvement from the pre-Sarbanes-Oxley practices.
Ms. Waters. What you are saying suggests that audit
partners should be required to sign off on the audit reports
they issue as proposed by PCAOB, and as is the case in the E.U,
Australia, Korea, and other countries?
Mr. Kabureck. No, if the question is directed to me, and I
don't know if FEI has a position on it. I personally support
the audit partners name being disclosed and associated with the
audit, either by signature or by in the text in the 10-K.
Ms. Waters. Let me turn to the U.S. Chamber of Commerce.
I have been reading some news reports that basically talk
about a clash between you and--as they refer to it, our top
watchdog. You have been very, very vocal. As a matter of fact,
you have demanded that Mr. Doty back up from this idea of
rotation.
Why are you so adamant that rotation is the wrong way to
go, and that the concept should not even be considered?
Mr. Quaadman. Sure. Thank you for the question.
As you know, we can't control what reporters write. But we
strongly believe in the internal controls in Sarbanes-Oxley. We
strongly believe in independent audit committees. And actually,
rotation has been considered over decades and been rejected.
Our concern is that rotation is going to neuter independent
audit committees. And in fact, that there are other things that
the PCAOB could be working on.
Ms. Waters. You mentioned cost. And I think cost was
mentioned several times.
What do you mean? And what is the difference?
And how much increase in cost do you anticipate that
rotation would cost?
Mr. Quaadman. I think there are costs that--in a couple of
ways.
First off, in any rulemaking that a Federal agency does,
they have to engage in a cost/benefit analysis. In fact, the
President's Executive Order last year on regulatory reform
enhanced what should be the economic analysis scrutiny that
agencies should engage in.
We think that both FASB and PCAOB should do that. Because
one, you have to identify problems, and two, you have to try
and look at alternative solutions, and what the costs and
benefits to those may be.
FASB and PCAOB do not provide a public cost/benefit
analysis as does the SEC.
I think the proxy access decision from last year was very
instructive in that. And furthermore, what the court also
talked about there is that if a regulator has a predetermined
outcome in mind when they begin a process, that is something
that the court is going to strike down.
So if you have an agency such as the PCAOB, despite the
fact that 92 percent of the comment letters oppose the concept
release saying we are going to be working on this issue a year
from now, we really have to wonder if they have crossed the
line of having a preconceived outcome in mind.
Ms. Waters. I am way past my time. And I thank you very
much, Mr. Chairman.
By the way, proxy access was my addition to Dodd-Frank.
Mr. Quaadman. I am very much aware of that.
Mr. Fitzpatrick. I recognize Mr. Campbell for 5 minutes.
Mr. Campbell. Thank you. Thank you, Mr. Chairman.
I know there is lots of talk about firm rotation. And I
have feelings on that too.
But I am going to go back to the line of questioning that I
had earlier, with the earlier panel. And I don't know if you
were all here.
I want to try and elicit perhaps a little more specific
responses from you all, who I think maybe have a little more
flexibility to do so.
Let me tell you what I think. And you tell me if you think
I am full of garbage or you agree with some of it or not, or
whatever.
But what I think is that IFRS is a good thing. From a
harmonization standpoint, we need to go in that direction.
I think principles-based accounting is a good thing. And
that we ought to move in that direction.
But under our current litigation system, if we do that, we
won't have a big four accounting firms. We may not have a big
one accounting firm, because it is too easy in a principles-
based system to second-guess a judgment call that turns out to
be wrong at the time perhaps it was made.
And that we need some now--people shouldn't go without
punishment for making bad--for making mistakes.
But that we need some kind of system that allows us to
use--make more judgment calls, have harmonization with world
accounting principles, have a much better system of accounting
statement. But not basically be setting up the situation where
we have a big one which is not going to enable us to meet
Sarbanes-Oxley, or Dodd-Frank, or any of the other requirements
that have been passed by this Congress over the past decade.
Somebody talk to me.
Mr. Melancon?
Mr. Melancon. Thank you, Congressman.
I think that first off, your line of reasoning is very
sound. We would agree with you that the IFRS is the ultimate
end game here. And that getting to a global set of standards
that are used around the world from accounting is a good thing
for investors worldwide, and U.S. investors who are investing
in foreign companies as well.
The premise of your discussion is really about principles-
based versus rules-based. And we see in America, obviously in
many instances outside of the--accounting, issues of
significant rules because of the environments that you are in
today.
And what we have said is that to move to IFRS, it requires
the entire system to move. It requires for instance where you
use professional judgment, there has to be reasonable
protection that this thought of 20-20 hindsight or second-
guessing reflects the professionalism that people bring to that
particular standpoint.
I think it applies to companies. I think it applies to
auditors. And I think it applies to audit committees and
everyone else in that particular process.
It is very important that when people use and deploy
reasonable, rational, professional approaches, and come to a
reasonable answer, that the system does not allow that to be
second-guessed with the emergence of facts 2, 3, 5, 8, or 10
years later that would say, you did wrong in that particular
circumstance
Because it is only natural then if that is the case, the
people in that system will say, then give me rules to comply
with. And I think that is what has driven where we are today.
Mr. Campbell. Dr. Carcello, I think you were the next most
anxious.
And then we will get to you--
Mr. Carcello. Thank you, Congressman.
In terms of a principles-based system, and your argument
for that, reasonable people can disagree. But let us take your
premise as a given.
In order to get better accounting, the role of auditors
will become even more important, because management will be
given more judgment.
But others here seem to oppose efforts to improve auditor
independence and skepticism, whether rotation is the answer or
not, that is a different question.
But there is a legitimate concern, as expressed by
virtually everyone who testified last week, if you go read the
statements, as it relates to auditor independence and
skepticism. In my opinion, those positions are not consistent.
In terms of litigation reform, I would point out for the
benefit of the Members here, let us not forget that in 1995,
this Congress passed a Private Securities Litigation Reform
Act. Let us not forget that in--
Mr. Campbell. Authored by my predecessor, Christopher Cox.
Mr. Carcello. Yes. That is right.
In 1998, this Congress passed the Securities Litigation
Uniform Standards Act to prevent an end run around Federal
jurisdiction by going to the States.
And let us not also forget that in the last 15 years, there
has been a series of Supreme Court decisions that have
substantially weakened the ability of third parties to sue
outside parties, starting with the Central Bank of Denver, the
Stoneridge, to Morrison to Janus.
Mr. Campbell. Okay. I want to make sure that Mr. Quaadman
has a chance.
Mr. Quaadman. No, Mr. Campbell, I think you have really
sort of highlighted what the third rail is with IFRS.
We support IFRS. We support a global system. We have raised
the same issues with the SEC about the stresses of the
litigation system here in the United States.
I think that is quite frankly one of the reasons why the
SEC, and Jim Kroeker in particular, are taking the time that
they are to try and get there because they also recognize the
same issue.
I also want to agree with you as well that a principles-
based system is the right way to go.
And just one small example with the convergence projects,
where we have had a very sharp difference of opinion, is
actually on lease accounting. And one of the areas where we
have a very sharp difference of opinion is this notion that you
have to frontload all the expenses, which doesn't seem to make
sense.
Yet, that has a direct impact on the bottom line for
companies.
So we think that a principles-based system will allow for
adjustments that won't have such harmful consequences.
Mr. Campbell. Okay, thank you. And my time is up.
I will just say on that that I--a lot of these rules-based
systems, I have looked at--and not taking anything away from
the FASB. They are doing what they have to do under the
circumstances.
But I can put together scenarios under which the outcome is
completely wrong. And everybody understands it is completely
wrong, because you can't make a rules-based system that covers
all potential scenarios.
But yet that is what we are doing. And it is--and I--many
of these pronouncements I have to agree, I look at them and go,
this is just wrong.
They--certain things you--if it looks like a duck, quacks
like a duck, and acts like a duck, it is a duck. And if it
doesn't, it is not.
And at some point we need to go back to that system.
I appreciate your indulgence, Mr. Chairman.
Mr. Fitzpatrick. I recognize Mr. Sherman for 5 minutes.
Mr. Sherman. Thank you.
Mr. Melancon, the Public Company Accounting Oversight Board
has urged us to amend Sarbanes-Oxley to make PCAOB disciplinary
proceedings public unless the Board orders otherwise.
Currently, those proceedings are not public until and
unless the PCAOB decides to refer the case to the SEC for
criminal prosecution.
What do you think of the Public Company Accounting
Oversight Board's proposal to amend Sarbanes-Oxley?
Mr. Melancon. Congressman, being a CPA, you know all CPAs
would be in favor of making sure the highest quality is there.
And certainly dealing with people who have performed
inadequately is a part of that process.
However, Sarbanes-Oxley built a system that addresses
actually the two aspects that are most important here: the
ability to address bad actors; but also the ability for the
professional's reputation to be protected through a reasonable
process in which their professional judgment--to Congressman
Campbell's previous question--can be aired out in that
particular process.
And that is the reason for that first layer of
confidentiality with the PCAOB. The PCAOB is not a government
agency. And as a result, it has certain exemptions from other
activities that other government agencies must abide by, which
includes Sunshine and Administrative Procedures Act and the
like.
And so what the system actually provides is that you have a
mechanism with the PCAOB in which you have, yes, a confidential
process for a while.
And an ability at any time, not just at the end of the
process, but at any time that the PCAOB if they believe there
is an egregious situation, where the public is at risk, or if
someone, quite frankly, is gaming the system, that they can
make an immediate referral to the SEC, which of course then
affords that investigation all of the transparency that is
being called for.
And so what we actually have in the construct of what is
there today is a system that tries to balance, as my testimony
talks about, balance regulation, both of those imperative in
the process.
Mr. Sherman. So you think this committee got it right on
this issue when we passed the original version of Sarbanes-
Oxley.
I would like to move to another issue and that is the PCAOB
issued its concept release on auditor independence and audit
firm rotation. They received, I believe, 600 comments, and 96
percent of them opposed that rotation.
Tell me what it would mean to the cost of the audit and the
quality of the audit if we went to mandatory rotation.
Mr. Melancon. A lot of people have been talking about cost
today. And it is--and I am sure Gary would agree with this.
There is not only the external cost changing an audit firm
which includes familiarity with the business, which is a big
component of these very complex global organizations. But also
the internal cost to the business itself in dealing with a
different set of individuals in that capacity.
There is also a cost overall to the system. There would be
a process that would be going on where different firms would be
constantly being reviewed by--or considered by different public
companies, some 15,000 or so of those.
That in itself consumes activity.
The premise of this discussion is about professionalism,
and independence, and skepticism. And my friend, Dr. Carcello,
at the end said, people here don't seem to be very concerned
about that.
We are absolutely concerned about that.
But the question becomes, as rotation addressed those
particular concerns--I travel all over this country. I can tell
you, auditors today are under more scrutiny and more pressure
and more aspects to do it right, both internally from their
firms, from the regulatory process, from independent audit
committees, and the like.
And so there is a high degree of skepticism. And Chairman
Doty, in fact, testified that audit processes are better today.
Now, we all agree we should be working on things to
improve. But we don't really believe that this is the way to
go.
We believe improving audit committees, getting them more
equipped to ask the right questions of auditors about
independence and skepticism. All of those things will add to
improvements in the process without sort of taking a very
direct approach like mandatory rotation.
And I want to make one final point.
I think it is very critical to understand that there are
other places around the world. And Chairman Doty referenced
that, that are talking about this.
But we are the deepest, most significant capital market in
the world. And it would be very unfortunate if our discussion
about that topic, even if it doesn't lead to a rule, would
imply to others that that is a direction outside the United
States that they should go, which would have the same type of
detrimental effect on the profession.
Because these are global--for the most part, global
companies, global audits that are going on, and it is teams
around the world that are involved in these particular
processes.
Mr. Sherman. And finally, I would point out that one part
of the oversight of the profession is if the firm screws up,
they are going to get sued, and not for just a few million
dollars.
I yield back.
Mr. Fitzpatrick. I recognize Mr. Perlmutter for 5 minutes.
Mr. Perlmutter. Thanks, Mr. Chairman.
And it is interesting that in the Congressmen you have
facing you, you have two lawyers and two accountants. So that
is who enjoys this kind of conversation, I guess.
Mr. Sherman. Actually, I am both.
Mr. Perlmutter. Oh and then--yes. So he has two stripes on
his epaulet.
But no, I appreciate the testimony. I thank you for--and
Noah who works with my office, Noah Marine, and you Mr.
Melancon educated me on what is in Sarbanes-Oxley, that there
is a refreshing or a new set of eyes every so often.
And for me, that is sufficient.
At the end of the day, I have to believe either accountants
are professionals, or they are not. They either know what they
are doing or they are bums.
The business needs from the officers to the investors to
the bankers to the lenders to the counterparties, as you
suggested, rely on good information, good financial
information.
And if we did a rotation, a mandated rotation with these
giant companies, for them to get up to speed, it just hasn't
made sense to me in the conversation. Especially now, knowing
that under Sarbanes-Oxley there is a requirement within the
firm to bring in a new set of eyes, just to make sure that it
isn't too cozy.
So I appreciate that. There has been a metamorphous I would
say to my friend, Mr. Campbell, over time.
Back in the 1970s, there was a business judgment rule. But
there were mistakes made. And there--the common law and the law
equity came into play.
And ultimately, there were losses. There were judgments.
And we kept getting more and more specific with--either with
statues or rules to provide safe harbors.
Now if we are going to go back to principles-based, it is
not going to--what his idea of a bad judgment might be--I might
say was a really bad judgment.
So, we are in this pickle between having the safe harbor
for those that are trying to interpret financial records versus
wait a second, the business has the right to make a judgment in
this respect.
So I did have a specific question rather than just a
conversation about this.
Mr. Melancon, you talked about now having to deal with non-
financial information.
What did you mean?
Mr. Melancon. Congressman, I think the world of business
reporting, I will call it and not just financial reporting is
rapidly evolving.
And this Congress has certainly had debate on Section
404(b) and the internal controls.
I think that if we were here 10 years from now talking
about what is it that the information that investors have, that
business decisionmakers are having as it relates to companies,
it is going to be much more expansive, much more real time,
much more complex than it is today.
And what controls are about is about building processes
around that whole information flow.
If you think about better decision-making and protections,
which is what obviously this whole process is about from a
systems standpoint, clearly businesses are reporting on broader
sets of information.
There are pilots going on around the world for instance.
And there is something called the International Integrated
Reporting Council which all of the large networks are working
on, in which companies are looking at a broader information
footprint, not just the financial statements, financial
statements plus, so information about how sustainable the
business process is; in other words, their supply chains, and
the ability for the company to survive as a going concern as an
example.
The key indicators that are important for management and
the Boards to be measured on by investors as to what is really
driving value in the organization.
And those types of things require an information system
that people who see the outputs of those can rely on that
information.
Mr. Perlmutter. But let me--
Mr. Melancon. And so, that is the broader footprint.
Mr. Perlmutter. My time is about up.
So let us say on the supply chain, does an auditor these
days, or somebody and maybe, Professor, you could answer, do
you guys have to opine on whether the supply chain is shaky or
not shaky or if there is a tsunami in Japan, it is going to--
Toyota here in the United States is going to have trouble. You
don't have to go that far, I hope.
Mr. Melancon. No, not today. But the fact of the matter is,
again, that when we look at information that is used for the
decision-making set, there is evolution to those broader
footprints today.
And as I said, there are pilots that are going on around
the world. Not so much in the United States, that is exactly
related to that particular concept of a broader set. Not to the
maybe a myopic point that you might be thinking, but the
broader strategic and critical performance indicators that are
necessary for us to understand how a business is operating.
Mr. Perlmutter. Thank you.
Thanks, Mr. Chairman.
Mr. Fitzpatrick. The gentleman yields back.
With that, the questions are concluded.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 30 days for Members to submit written questions to these
witnesses and to place their responses in the record.
So with that, I want to express our appreciation to the
members of the panel for your service here today.
And this hearing is adjourned.
[Whereupon, at 1:00 p.m., the hearing was adjourned.]
A P P E N D I X
March 28, 2012
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]