Investors and auditors differ on Sarbanes-Oxley's effectiveness

WASHINGTON, DC - Institutional investors and auditors remain at odds over how effective the Sarbanes-Oxley Act has been so far, with the former advocating a broader scope for the act and the latter warning that it may have already gone too far.

At a US Senate Banking Committee hearing last month, The implementation of the Sarbanes-Oxley Act and restoring investor confidence, representatives from the institutional investment and auditing industries expressed divergent views on implementation costs, how stringent a role the Public Company Accounting Oversight Board (PCAOB) should play enforcing accounting provisions of Sarbanes-Oxley, and whether to erect an outright ban on non-auditing services such as tax planning and consulting at accounting firms.

Sean Harrigan, president of the board of administration at the California Public Employees’ Retirement System (CalPERS), a major public pension system, testified that while Sarbanes-Oxley in its current form has done much to restore some investor confidence in US financial markets, CalPERS sees room for improvement.

"We believe there are significant conflicts of interest created when an auditor is simultaneously receiving fees from a company for audit services and non-audit services, such as consulting," Harrigan said. "While the goal of the act was certainly aimed at eliminating the conflicts inherent when an independent auditor receives fees for non-audit services, two significant types of services remain legal. Under the rules implementing the act, auditors may still, under certain circumstances, provide tax-planning and consulting services, as well as certain information technology consulting.

"CalPERS continues to feel that an outright ban on non-audit services is necessary," Harrigan asserted, adding that the organisation has already gone beyond Sarbanes-Oxley’s mandates by, at firms in which it invests, withholding votes for audit committee members who utilise auditors for non-audit services during the 2003 proxy season. "In the coming proxy season, CalPERS will continue to withhold its vote for audit committee members at companies that use the auditor for non-audit services," he said. "Because this remains such a significant concern, we urge you to pursue tougher rules through the Securities and Exchange Commission (SEC) and the PCAOB to address this issue."

One auditor took issue with the assertion that accounting firms be forbidden to provide non-audit services. Samuel DiPiazza, chief executive of PriceWaterhouseCoopers, argued, "The SEC largely settled the debate on tax services in the accompanying discussion section to its auditor independence rule, which rightfully acknowledges Congress’ intent to expressly permit audit firms to provide tax services to audit clients. This was in recognition that these services are an integral part of the services provided by an accounting firm... Precluding accounting firms from rendering tax services to their audit clients and the inevitable long-term consequences of an exodus of tax talent from accounting firms will not serve investors well."

Relationships
Unsurprisingly, both DiPiazza and Edward Nusbaum, chief executive of Grant Thornton, hoped that their firms’ relationships with the PCAOB would be co-operative rather than punitive."We have approached our interactions with the PCAOB and its staff with a mindset of co-operation and openness, with the hope that PCAOB will share our goal of continually enhancing our systems and processes," DiPiazza said. "We hope that the foundation of the inspection process will be the shared purpose of rebuilding the public trust in our profession rather than reprimands for unintentional errors."

Nusbaum went further, suggesting that the PCAOB actually reward auditors that comply. "The focus of the PCAOB and the government should not be on increasing litigation against accounting firms, but instead on helping accounting firms work with the PCAOB and government to ensure the successful implementation of the act into the foreseeable future," he testified. "It is equally important that the PCAOB, in addition to disciplining auditors, find the means to recognise and reward auditors who act without self- interest to protect investors."

CalPERS’ Harrigan, however, made clear his stance that the board should establish itself as a strict enforcer of the Sarbanes-Oxley mandates in light of the "clear failure of the accounting industry to self-regulate."

"To investors, ensuring proper internal controls over financial reporting is critical," Harrigan said. "I do not accept the criticism by some in the business community that the additional focus on this area is misplaced or the cost associated with improving internal controls is not worth it."

The cost of compliance
DiPiazza noted that his firm is complying with Sarbanes-Oxley at considerable cost. He cited costs associated with Section 404 internal control requirements, hiring and training, increased compensation, and insurance costs. "Our insurance premiums for practice protection have soared due to increased litigation in the accounting arena, fewer insurers, losses and unfavorable investment returns for insurance companies," he said, adding that practice protection for PWC’s US operations is now its second-largest cost of doing business.

But Sarah Teslik, executive director of the Council of Institutional Investors, lambasted such concerns. "It is much too early to write the history of Sarbanes-Oxley," she argued, "but that hasn’t stopped many from whining loudly to anyone who will listen that the act snuffs entrepreneurial spirit, prevents board seats from being filled, and forces companies to reincorporate on Mars to avoid killer compliance costs."

"Finally, the whining we hear fails to ignore the clear financial benefits that Sarbanes-Oxley is producing," she testified, adding that the SEC should increase the scope of the act’s powers to require more shareholder access to proxies and restructuring of self-regulating organisations such as the New York Stock Exchange to better reflect shareholder interests.Operational Risk