NCPA - National Center for Policy Analysis

Are Auditors Inviting Draconian Regulations?

January 11, 2002

Knowledgeable observers are concerned that recent mistakes and misdeeds on the part of large accounting firms will prompt calls for a host of new rules and regulations governing how they operate.

The extraordinary actions of the giant accounting firm of Arthur Andersen and the role it played in the demise of the Enron Corp. is the latest and most dramatic example of something amiss in some sectors of the accounting industry, experts warn.

  • The number of public companies that have corrected or restated earnings since 1998 has doubled to 233, according to a study by Arthur Andersen itself.
  • Lynn Turner, former chief accountant of the Securities and Exchange Commission estimates that investors have lost more than $100 billion because of financial fraud and the accompanying earnings restatements since 1995.
  • Auditors have long argued that they can police themselves through their Public Oversight Board, created in the late 1970s -- which, although lacking enforcement powers, investigates alleged audit failures and oversees a triennial review process in which the major accounting firms examine each other's procedures.
  • The American Institute of Certified Public Accountants points out that accountants examine the books of more than 15,000 public companies every year -- and are accused of errors in just 0.1 percent of those audits.

Since auditing in and of itself is not a particularly lucrative business, a number of firms have also gone into consulting for management, which is far more profitable. But many critics say that double-duty relationship presents a serious potential for conflict of interest.

Under such an arrangement, an auditing firm works for the public in its capacity as auditor, then also works for management in its capacity as a consultant. "If you are auditing your own creations, it is very difficult to criticize them," points out Robert Willens, a Lehman Brothers tax expert.

The Arthur Andersen firm had just such an arrangement with Enron.

Source: Jeremy Kahn, "One and One Makes What?" Fortune, January 7, 2002.


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