9:22 a.m. The excitement builds as we accounting junkies gather around our internet feeds. Today the U.S. Senate Committee on Banking & Urban affairs meets to interview “expert” witnesses about the role of auditors. I’m still trying to get a good link to the webcast. We will be tweeting under #SenateRAP.
Read on for my log and responses to today’s meeting.
9:33 a.m. Senator Reed opens session, wonders if companies are too big to be audited. $11 trillion was lost in last crisis. Auditors gave no warning. Auditors have a special calling. The hearing is not about fixing blame for the crisis, but “This is more about what we need to do now to protect ourselves in the future.”
James Doty
9:39 a.m. James Doty (chair, PCAOB). JDA has high hopes for him. He says that secrecy related to PCAOB inspections is a problem and only Congress can remove this provision.
9:45 a.m. Leslie Seidman (chair, FASB). Will she shill for IFRS? Yes! She sys the FASB is ready and standing by.
9:49 a.m. James Kroeker (chief accountant, SEC). He’s a shill for the Big 4. He will absolutely get in the way of any meaningful improvements. Oh, he acknowledges that some critics are questioning the value of the audit opinion. He supports efforts to add to the audit report. And he’s in favor of convergence with IFRS.
9:55 a.m. Reed: why were there no timely auditor warnings? Doty, this is an enduring problem, as noted in audit inspections. The PCAOB is looking into whether the firms are doing anything about it. Reed: what are incentives/disincentives that kept audit firms from doing anything about it? Doty: momentum, habit. As to the prospect of meaningful change? “The audit profession know it is standing on the edge of change” Seidman: We are making changes to the accounting rules as we become aware of issues. Was there adequacy of guidance about fair value and impairment rules? “We are working on it.” Reed: Off-balance sheet financing provoked Sarbanes Oxley. Now, Seidman says by May 2011 it will be taken care of. Why is it taking so long to fix something that was identified long ago as being central to reporting problems? Seidman says that several changes have been made, including a more principles-based standard (IFRS). She is most definitely holding hands with the IASB. Kroeker: We have been, and are taking significant enforcement actions. Really? Why weren’t there more going concern warnings? It might not be a binary issue. We’re looking at it.
Leslie Seidman
10:13 a.m. Senator Hagen: to what extent were the accounting standard setters gamed by the international companies? Was using GAAP a deficiency? Seidman: the REPO 105 issue relates to a 1996 accounting rule. The FASB wasn’t even aware of a problem with the rule, until the Valukis report on Lehman Bankruptcy. An examination resulted in a review of the related accounting standard. Now the rules clearly state that the determination of control must take place at the consolidated level (not the subsidiary level). This should fix the problem with REPO 105. Hagen to Kroeker, what is SEC doing to reduce multiple sets of accounting rules? Kroeker: we’ve been moving toward a single set of high quality accounting standards for use around the world (for three decades!). It is imperative that the FASB and IASB continue to work together. Yikes!
10:23 a.m. Senator Merkley. Why have so few executives been prosecuted? Kroeker? That’s not correct. We’ve taken a number of actions. We’ve taken the Valukis report very seriously. The SEC took immediate action to stop REPO 105 transactions (what an overstatement). We’re continuing enforcement actions. Merkley: why is no one in jail? Kroeker, we only have civil authority, not criminal. (While technically correct, the SEC can work with agencies that can file criminal charges. Why have none been files?) Merkley: was it deregulation that created conditions favorable to causing a crash. Or was it integrity?
10:29 a.m. Senator Reed: Is auditing a loss leader? (Great question.) Actually, the Senator questions today have been very good. Doty: the issue is to create a counterweight to corporate management. Doty thinks that the firms are large enough, size is not the problem. We need auditors that will challenge management. There is a project underway. Seidman says this is not her area. Kroker: I hope that audits are not a loss leader. It used to be, but that has been addressed by new independence rules. Are auditors being selected on quality or low rates? Working with audit committees that they shouldn’t select auditors on price. The GAO has studied whether or not the Big 4 concentration is a problem, and they haven’t found it to be a problem.
Reed: did fair value accounting over value bank assets? Kroeker says that most assets aren’t carried at fair value, they aren’t marked down. Was waiting for determination of credit loss contributing to marking them down too late? Seidman weighs in. She’s working with IASB again. (Perhaps we need more items to be carried at fair value.)
James Kroeker
Reed 10:39. Do reverse mergers create a problem? Doty: it is a priority to inspect Chinese auditors. If Chinese auditors are auditing companies that become U.S. companies via reverse merger, then this is a serious issue. Developments will come out in summer and fall. Kroeker: that this is a public issue is because the SEC is working on it.
10:44 a.m. Reed: now onto the second panel.
OK, after the first hour, what have we learned. Seidman (FASB) is married to the IASB. Doty shows that he knows his stuff. Kroeker, taking credit for everything good that has happened, although not much good has happened. I don’t think this current group of regulators (Doty, Seidman, Kroeker) offers much hope for fixing the broken system. Although Doty might guide the PCAOB to make meaningful proposals, every worthwhile improvement will be blocked by the others.
10:46 a.m. Second panel is seated and introduced.
Anton Valukas
10:48 a.m. Valukas: Auditors did not cause Lehman to fail. However, they played a role. Investors have a right to expect that a clean audit opinion means no disclosure problems. But Lehman had liquidity problems and its use of REPO 105 limited the public perception that liquidity was a problem. Lehman’s auditors were aware that these transactions had no business purpose, and the auditors did not object to Lehman removing the liabilities from its balance sheet. Both the SEC and the Fed (both of whom were aware, and said nothing about it. Then the auditors took no responsibility. This is the problem, no one took responsibility.
Cynthia Fornelli
10:53 a.m. Fornelli. Crisis not caused by either accountants or auditors. Auditors can and do provide warning signs. What do you expect? Her CAQ is a shill for the Big 4. “Investors greatly value the audit report” No they don’t!
10:58 a.m. Thomas Quaadman. Strong supporter of convergence of accounting standards. Has a 10 point plan. The problem was not corporate reporting practices, but the rules.
Lynn Turner
11:03 a.m. Turner. The questions asked today have been asked for 25 years. Why haven’t the problems been fixed? There has been a failure to go back and do some reflective thinking to go back on what caused the problems. He disagrees with just about everything that Quaadman advocates (hooray). The fairvalue problem wasn’t flawed, it was the people implementing it. The FASB hasn’t been issuing standards that work on a timely basis. The SEC hasn’t done a good job of oversight. The SEC needs to get serious about enforcement. This is the key. There has been no prosecution from Valukas, about Merrill, about Bear Sterns. SEC has been underfunded for two decades. “People in America are asking where are our watchdogs? Is the SEC a watchdog or a lap dog?
11:12 am. Reed to Valukis. Why were their no warnings? Valukas, if the auditors had gone to the audit committee, those practices would have ended immediately. So, an auditor threatening a public company has tremendous power. In Lehman’s case, the auditors too the view that it was not its responsibility to audit the practice. The default should be transparency instead of materiality. Fornelli: efforts to improve transparency are under way. Quaadman: (why is it he says nothing?) Turner: If the auditor says the accounting is correct, they we have a serious problem with the accounting standard. Valukas is very correct, materiality is not a shield.
11:21 a.m. Reed. A lot of helpful hints to management (resulting from audit) are not being followed through. Fornelli is evasive about increased disclosure. She’s very protective of audit firms. The current system is the solution! Quaadman. Too many SEC investigations without charges is detrimental to investors. Turner: Keeping enforcement actions under wraps is a problem. The SEC has public hearings when charges are being debated, and that has worked well. If the PCAOB determines that an audit hasn’t been done well, and keeps that from us, then that is wrong! Fornelli disagrees with Turner, she says that the disclosure mechanisms are adequate. The public is made aware of some inspection results.
Hearing is over. Absent senators will submit questions by Friday, and these will be passed along to the panelists for their speedy responses.
Thomas Quaadman
There were some interesting dynamics in the second panel. The Chamber of Commerce representative, Quaadman, was there to speak for corporations. The Center for Audit Quality representative, Fornelli, was there to speak for the audit firms. Both were interesting. Quaadman moved his lips, but never really said very much. Fornelli was the most objectionable. She says that the auditing system is functioning well under PCAOB and Sarbanes-Oxley. Of course, Valukas and Turner (who speak for the public) disagree.
Today, I’m more a fan of Turner than ever before.
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The last two days have been busy, fielding calls from reporters. One called asking my thoughts on convergence, the other asked about my thoughts on whether accounting can forestall the next financial crisis.
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