The Securities and Exchange Commission voted yesterday to back away from some tough restrictions on accounting firms it had considered in the wake of widespread corporate accounting scandals.
One of the most controversial proposals would have prohibited accounting firms from crafting tax shelters for audit clients and could have cost the firms millions of dollars in lost revenue. Investor activists saw the proposal as a bold stroke to restore public confidence, but it was strongly opposed by the accounting industry.
The five commissioners — three Republicans and two Democrats, appointed by President Bush — voted unanimously for a rule that would instead allow those tax services to continue. Republican commissioner Paul S. Atkins said it was a complex issue that needs further consideration, perhaps by Congress. “What we really need is tax reform,” he said.
Some investors closely watching the agency's actions were disappointed by the vote. “Passing watered-down rules does nothing to restore investor confidence,” New York State Comptroller Alan G. Hevesi said through a spokesman.
The vote ushers in the most comprehensive set of rules for accounting firms that the SEC has adopted under the Sarbanes-Oxley Act, an investor-protection bill Congress passed last summer after financial scandals at Enron Corp., WorldCom Inc. and other companies sent stocks plummeting. To convince investors they could trust financial reports, and resume buying stocks, lawmakers said the close ties between accounting firms and their clients should be severed and other steps should be taken to force auditors to be more aggressive watchdogs.
The legislation banned several categories of non-audit work by accountants, such as consulting on technology issues and human resources, but did not bar any type of tax consulting. Many details of the law's implementation were left to the SEC.
The commissioners said the rules strike a good balance between protecting consumers without overburdening industry.
“These rules will greatly increase transparency,” said Democratic commissioner Harvey J. Goldschmid, making U.S. markets “stronger.”
Accounting industry officials praised the vote as a balanced approach that will help restore investor confidence. They particularly welcomed the commission's decision not to restrict auditors' ability to sell tax-consulting services. Such work makes up a quarter of the industry's fee income.
“This is not about winning or losing; it's about a comment period that we participated in,” said William F. Ezzell, chairman of the American Institute of Certified Public Accountants and a partner at Deloitte & Touche LLP. “I'm pleased that the process has been completed so that the market can get a sense of clarity. I'm happy about that. This rulemaking is consistent with the law.”
Last month, in an outline of the agency's preliminary thinking on the issues, the SEC said auditors may compromise their independence if they advise companies on how to cut their tax bills and then judge the effect on the companies' financial statements. The accountants institute, the auditing industry's main lobby, argued that minimizing taxes maximizes profit for the company, benefiting a company and its shareholders.
After hearing from numerous accountants in recent weeks, the SEC voted to leave all decisions on tax consulting by auditors to a company's board of directors, specifically its audit committee.
The agency also had considered requiring all auditors to rotate off a specific company's audit team after five years. Investor groups and critics of the accounting industry have said that when individual auditors stayed with a client for too many years they became too friendly and were influenced by the corporation.
But the accounting industry complained that requiring firms to rotate their audit teams would be too costly. The rule adopted yesterday requires only that the top auditors of a team rotate from every five to seven years. Some other members of the team will never have to change clients.
The SEC also adopted changes to a Clinton-era rule requiring companies to specify what portion of their auditing firm's fees comes from work other than auditing. The new rule will allow companies to include as audit work services that were not previously classified that way.
The SEC said the changes will make it easier for the public to see what financial conflicts, if any, auditors have with clients. Barbara Roper, director of investor protection for the Consumer Federation of America, said she is concerned the changes will permit industry to inflate its audit figures and downplay its non-audit consulting services, masking financial ties that could compromise an auditor's ability to make objective decisions about information the company must give to investors through filings to the SEC.
The SEC voted to require auditors to retain a better paper trail. Investor groups said this will help determine who is responsible when or if things go wrong. The commissioners also voted to make managers use the management-discussion portion of their annual report to give a clearer picture of the risks and rationale behind off-balance-sheet transactions like those that helped bring down Enron.
But investor groups said they were most concerned about the areas where the proposal was weakened. “The SEC did not address the main concern of shareholders, namely that auditing firms are too heavily influenced by management and that we still can't trust audits,” said Aaron Brown, president of eRaider.com Inc., a shareholder activist group based in New York that also manages an investment fund. “Once you hire your auditing firm to chisel the government out of taxes, how long before they are chiseling shareholders?”
“There was some watering down,” said Patrick McGurn, vice president of Institutional Shareholder Services Inc., a Rockville-based firm that advises pension funds on how to cast proxy votes. “If the SEC had outlawed some tax-shelter consulting, we wouldn't have to vote against as many audit-committee members as we will next proxy season.”
Hevesi said, “Particularly disturbing is that the SEC decided not to adopt restrictions on auditors providing tax-consulting work and then auditing their own work.”
Atkins, one of the commissioners, chastised the accounting industry for failing to act on its own. “Where have they been with respect to self-regulation? They failed completely,” he said. “It's a deep-seated problem and it's been going on for decades.”
Ezzell, chairman of the accountants institute, said: “I differ from that point of view.”
Today the SEC is scheduled to tackle several more widely watched issues. A majority of the commissioners is expected to vote to make mutual funds disclose how they vote on proxy issues on behalf of their shareholders. These votes can involve critical issues such as who will represent investors on a board of directors and how much top executives will be paid.
Investor groups favor the change; most mutual funds don't.
The commission is expected to back down on its earlier proposal to make lawyers report suspected violations by their corporate clients. The legal community argues such a rule would violate clients' rights to have confidential relationships with their attorneys.
Some investor groups disagree, saying that a company lawyer's ultimate client is the shareholder and that reporting misdeeds to regulators is in investors' long-term interest.
“That's exactly the problem, that lawyers think of management as the client,” said Brown of eRaider.com. “We feel strongly that an organization and shareholders are one and the same when it comes to reporting fraud.”