U.S. Auditing Oversight Board Begins Policing Role

After a rocky start, the government's accounting oversight board is getting down to the business of policing the nation's most important accounting firms.

In a flurry of major personnel announcements and votes on new rules on Tuesday, the board indicated that it would be ready early next year to begin intensively inspecting many of the auditors of publicly traded companies — the first time accountants will face systematic examination by a government entity. The largest firms will have annual inspections, while smaller firms will be inspected every three years.

Under its new chairman, William J. McDonough, the board has also waded into a continuing controversy. In a closely watched proceeding that will soon require larger publicly traded companies to begin extensive disclosures and audits of their internal financial controls, the board proposed the rules for conducting those activities.

Many companies have complained that the new audits will be too expensive, while accounting firms have supported the changes because they would bring in new business and could expose financial problems early. The requirement, in general terms, was set by Congress, but the board's specific proposal cannot go into effect without the approval of the Securities and Exchange Commission, which reviews its major rules and enforcement actions.

The requirement followed failures of internal controls at companies including WorldCom, Xerox, Rite Aid and Cendant.

The accounting board also announced that Esslie W. Hughes, a former executive at the Bank of New York, would head its New York office and that Paul E. Bijou, a former partner at PricewaterhouseCoopers, would lead the office's inspection team. The New York office is expected to play an important role in enforcement and oversight because the big accounting firms have their largest operations there.

Known officially as the Public Company Accounting Oversight Board, the agency's creation was a cornerstone of the Sarbanes-Oxley Act, the Congressional response last year to the wave of corporate scandals and accounting meltdowns. Despite the announcements on Tuesday, however, the young agency has yet to confront many of the most significant issues.

It must set standards and conflict-of-interest rules, inspect firms in the United States, fill several crucial offices and make sure overseas companies that sell securities in the United States are adequately audited.

“The oversight board is very much like a start-up company in its first year of operations,” said Lynn E. Turner, a former chief accountant at the Securities and Exchange Commission and a critic of the profession. “They are getting some of the initial tackling and blocking done. They have done a few positive things. But we really haven't seen any major decisions or policy issues. We haven't seen the standards that will drive the quality of the audits. We have yet to see enforcement and inspections. That's not a criticism. People need to be patient.”

In an interview on Tuesday afternoon, Mr. McDonough said the agency had begun preliminary inspections of the four largest accounting firms and had been receiving “a high degree of cooperation” from them.

“The examinations have been thorough and intrusive,” he said from his corner office overlooking K Street in Washington, part of a larger suite whose previous tenant had been the failed accounting firm Arthur Andersen. He acknowledged that the inspection staff remained small, but said that it could nonetheless be effective by gaining the confidence of employees at all levels of the accounting firms.

“The people in these institutions will be our eyes and ears,” he added.

Mr. McDonough said the challenge he and the board faced was in restoring the role of accounting firms, going back to their roots.

“They got their business model confused,” he said, “by having their audit business minimized or used as a loss leader for their consulting business. They have to restore auditing to primacy.”

A related problem, he said, has been the compensation practices of large firms that rewarded partners who brought in business far more than those who performed audits.

In the coming months, the oversight board faces significant tests that will determine whether it will be a captive of the industry, as its predecessor organization was, or will be fiercely independent and aggressive, as the lawmakers who created the board hope. Its relationships are evolving, with the Securities and Exchange Commission and with the American Institute of Certified Public Accountants, the profession's once-powerful lobbying group that was stripped of many of its disciplinary responsibilities after critics say it failed to police the large firms adequately.

Mr. McDonough, who joined the board last June after serving for a decade as president of the Federal Reserve Bank of New York, said that so far the accounting profession had been cooperative.

“The approach I'm taking is to help accountants help themselves,” he said. “We are much more likely to be effective that way than if we are combative.”

The board faces difficult decisions about the auditing and conflict-of-interest standards it will be setting, and in building a staff that is deeply experienced but not beholden to the largest accounting firms that will supply many of its inspectors and senior officials. It must also determine how it will go about monitoring the overseas accountants.

Perhaps most significant, the board is still in the early stages of figuring out how to alter the culture of the large accounting firms, an issue that was recently cited by a group of experts, the Conference Board's Commission on Public Trust, as the most important matter confronting the accounting business. The wave of accounting scandals has led critics to conclude that the firms were insensitive to conflicts, inadequately independent from their clients and more interested in winning consulting contracts than in bread-and-butter auditing.

Mr. Turner said the accounting board had been set back at least six months by the decision last year to select William H. Webster as its first chairman. Mr. Webster resigned after the disclosure that he had headed the audit committee of a company whose senior executive was under investigation for criminal fraud. The choice of Mr. Webster also led to the resignation of Harvey L. Pitt, the chairman of the S.E.C.

Experts say it may be a year or more before the board can be truly effective. So far, it has hired only about 50 inspectors, barely enough examiners to inspect a handful of branch offices of one of the four largest accounting firms.

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