State Needs to Rein In Accountants

Since the 1930s, the regulation of accountants has been a shared federal-state responsibility. The Securities and Exchange Commission provides federal regulation, and state regulatory boards license accountants and enforce state laws.

Recently, these governmental bodies have been criticized for failing to do their jobs. For more than a decade, accountancy has been undergoing a profound evolution, which has led to a decrease in government regulation and an increase in self-regulation. Critics maintain self-regulation has translated into no regulation, creating an environment in the accounting profession similar to that for energy companies that resulted in huge profits for Enron at the expense of California ratepayers.

For example, in 1997, California passed a law permitting accountants to receive commissions for referring products or services to a client. The following year, a law was passed allowing nonaccounting businesses (that is, a stock brokerage) to have an ownership interest in a California accounting firm. Consumer groups and many accountants are deeply concerned.

Allowing California accountants to receive commissions creates excessive profit motives that can impair their objectivity. In addition, when a nonaccounting business has an ownership interest in an accounting firm, there is the potential for conflicts of interest and incentives to “churn” clients between businesses. Self-regulation and the Enron and Andersen debacle recently prompted the legislature to hold a hearing.

The purpose was to explore reforms of corporate audits and accounting methods to help protect Californians from future audit failures, and enhance the image of the accounting profession in the state. Participants included the Society of California Accountants, the California Board of Accountancy and other leading experts. Shockingly, the largest accounting firms refused to participate in the hearing. It appears that the “Big Five” have decided to embark on a well-known political strategy--hunker down until this all blows over.

They should rethink their strategy for three reasons. First, the members of their profession deserve better. Second, the citizens of California deserve better. Third, this is not going to blow over for the millions of investors. One out of every two adults in the United States owns stock, directly or indirectly. In order to make sound investments, audited financial statements must be truthful and accurate.

We invest for our retirement and for our children’s education. Californians cannot afford to let this issue disappear. The number of corporate financial “restatements” resulting from bad audits has climbed dramatically, from a low of three in 1983 to more than 200 in the year 2000. The real effect of these restatements was a loss in market value of more than $31 billion in the year 2000 alone.

Accordingly, the legislature has decided to take action. Rather than allowing accounting firms to continue on their present path of self-regulation, it will be considering several proposals aimed at protecting investors and strengthening professional standards for the accounting industry. The end result will help California investors as well as the accounting profession.