SECURITIES AND ~~~EXCHANGE COMMISSION ~\, ,~

Washington, D. C. 20549. .liJ

(202) 755-4846 Cb~

IMFROVING THE ACCOUNTING PROFESSION:A SHARED RESPONSIBILITY

Address byJohn R. !vanJ.Commission€r

Eighth Annual SEC ConferenceFlorida Institute of

Certified Public AccountantsMiami, FloridaD;cembGr B.~•

Last week a newspaper columnist suggested thatamong hazardou~ professions, the "economist stands at thetop of our list, right beside guide to Mt. Everest and NewYork City bomb~di~posal expert." As an economist, I foundthis categorization interesting, and considering thepersistent serious problems in our national economy, believethat it is not unfounded. It is generally recognized,however, that by their very nature, opinions expressed byeconomists are subject to a significant degree of imprecisionbecause they are based on assumptions and judgments that oftenprove to be invalid. To some extent, accountant's opinionsalso are based on imperfect knowledge and judgment, but, asmany of you may be painfully aware, accountants generally donot enjoy the luxury of expected imprecision.

Although accountants are subjected at times to tneconsequences of e~ectations of precision which are neitherintended nor possible, users of accountants' work product,including government regulators and members of Congress, andmembers of the accounting profession itself, are also expressinglegitimate conce~s. It does not take an economist to understandthat the ultimate value of a service is dependent not on whatthe provider of that service believes it to be, but rather onthe extent to which ~sers of the service perceive it as meeting

The Securities and Exchange Commission, as a matter of policy,disclaims responsibiltty for speeches by any of its Commissioners.The views expressed herein are those of the speaker and do notnecessarily ~eflect the views of the Commission.

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their expectations. There can be little question thataccountants' services have not met the expectations of asignificant segment of users.

The AICPA's Commdssion on Auditors' Responsibilities("Cohen Commission") concluded that "a gap exists between theperformance of auditors and the expectations of users offinancial statements," that "In general, users appear tohave reasonable expectations of the abilities of auditorsand the assurances they can give," and that "The burden ofnarrowing the gap between performance and expectations fallsprimarily on auditors and other parties involved in thepreparation and presentation of financial information." TheCohen Commission made a number of recommendations intendedto bridge this gap and to make the accounting professionmore receptive to the forces of change in the future.

Similarly. the Metcalf Subcommittee Staff Reporton the Accounting Establishment concluded that:

Doubts as to the accuracy and reliabilityof information reported by corporationshave resulted from continual revelationsof corporate misconduct which was not foundor not reported by independent auditors.Congress and the public have littleassurance that corporate financial statementsaccurately portray the results of businessactivities because of flexible. alternativeaccounting standards. Public confidence inindependent auditors. which is essential tothe success of the federal securities laws,has been seriously erroded.These are criticisms not only of the accounting

profession but also of the Securities and Exchange Commission

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because of the Commission's responsibility to oversee thesetting of financial reporting standards for publiccorporations and to assure the independence of accountants inthe certification of financial statements. The MetcalfSubcommittee Staff Report went on to suggest that the Commissionwas not fulfilling its responsibilities and stated that "theSEC's long association with the private accounting establishmentand insistent determination to rely on its accountingpronouncements casts substantial doubt on the SEC's abilityto establish accounting standards which would restore publicconfidence in corporate financial reporting."

The Commission has long believed that it is in thepublic interest to create and maintain an environment inwhich members of the accounting profession will use theirexpertise and resources to fulfill the primary role inimproving accounting standards and practices. I firmlysupport this approach because.it encourages private initiativeand minimizes government involvement and expense. Nevertheless,the Commission and the profession have been less thansuccessful thus far in accomplishing what has been expectedof us. To the extent that user expectations are unreasonableor misplaced, investors and others must be educated as towhat can legitimately be expected from financial reportingand what the accounting profession's role in that reportingis. However, to the extent that user expectations arerealistic, steps must be taken to see that every practitioner

does his or her best to fulfill them.

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Significant progress toward these two goals isbeing made. I believe a major step was taken last week whenthe .Fi~~ncial Accounting Standards Board issued its FinalStatement on the Objectives of Financial Reporting. This isto be .!ollowed by an Exposure Draft on the Elements ofFinancial Statements. If the profession and other interestedparties can agree on what financial statements should convey

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and how they should convey it, we will have come a long waytoward, correcting the public's misconceptions aboutfinancial reporting.

The efforts of the AICPA to implement various ofthe Cohen Commission's recommendations should also be helpfulin clarifying the limits of financial statements. Particularlyimportant in this regard is the work of the Special AdvisoryCommittee on Reports by Management which is studying theCohen Commission's recommendations to expand public financialreporting to include Or be accompanied by a report of•management acknowledging management's responsibilities forand the completeness of the financial data included in thereport. Also important is the work of the Auditor's ReportsTask Force which is exploring the desirability of expandingthe auditor's report to communicate more effectively theauditor's role and responsibilities.

The SEC is encouraging and observing the effortsof these private groups and offering our counsel whereappropriate. Our staff is also considering the possibility

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of recommending that the Commission propose for comment arequirement that there be a report by management on internalaccounting controls. Such a report, in addition toaccomplishing other purposes, should help clarify theresponsibilities of the various parties inVOlved in corporatefinancial reporting.

I am confident that the combined efforts of theFASB, the AICPA and the Commission will result in a betterappreciation by the Congress, the investing public, thecorporate community and all users of financial statements ofthe nature and responsibility of the accountant's role infinancial reporting and a concomitant increase in theprofession's credibility.

The need to improve the quality of accounting andauditing work, which is the other side of the credibility gap,is also receiving considerable attention. While views differamong various groups and individuals as to how to improve thequality of accounting and auditing, there is generalagreement on the primary elements of appropriate action. Toassure continuing high quality professional work by accountants,there must be:

1. Functioning quality control procedures towhich all practitioners are subject.

2. Mechanisms for identifying sub-standard workand correcting its underlying causes.

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3. Appropriate remedial and disciplinary measuresfor those who demonstrate an unwillingness orinability to meet the high standards of theprofession.

4. Public credibility for all of these measures.These broad objectives are not limited to accounting

matters in SEC filings, nor even to the practice ofaccountancy as it relates to the wider area of public companies,but extend to all accounting and auditing by members of theaccounting profession. In my opinion, no single governmentor private sector body is in a position to meet all of theseobjectives in a satisfactory manner. Instead. they will beachieved only through the combined and coordinated efforts ofall public and private sector groups and individuals whoselegal or professional responsibilities give them a validinterest in resolving the problems.

As solutions are sought, it is important to keepin mind that public accountants are professionals. Asprofessionals. the fulfillment of their responsibilitiesrequires integrity, objectivity. high quality work, and theexercise of considered judgment based on training and experience.To be fully successful, I believe that any initiative,regulatory or otherwise, must build upon this professionalism.In turn, this professionalism should result in responsiblereactions to the initiatives which are now underway.

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In the Commission's July 1978 "Report to Congresson the Accounting Profession and the Commission's OversightRole" the bulk of the discussion regarding enhancement ofthe quality of auditing and accounting work was devoted tothe AICPA's newly created Firms Division, especially its SECPractice Section. While expressing our hope that this importantprivate sector initiative would be successful, the staff andthe Commission did not hesitate to point out that, in ouropinion, there are significant difficulties yet to beovercome if the program is to succeed. The Commissioncontinues to believe that the program would have a greaterchance of success if the Public Oversight Board has directauthority over the activities of the Section. In addition,the Board must address the problems of whether audits whichare the subject of litigation and the foreign portions ofdomestic audit engagements should be included in peer reviewsor whether there are acceptable alternatives. Also, theCommission must have sufficient access to the peer reviewprocess to permit us to evaluate its adequacy. Finally, inthe long run, the success of the SEC Practice Sectioninitiative will depend on the Board's commitment to assurethat the public interest is served. A viable SEC PracticeSection may well resolve many problems which are of concernto the SEC and the accounting profession.

Nevertheless, this program has certain limitationswhich preclude it from being the complete solution to the

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profession's credibility problems. Perhaps the mostsignificant limitation is that both the Private CompaniesPractice Section and the SEC Practice Section are voluntaryprograms and 100 percent participation by U. S. publicaccounting firms cannot be expected. Moreover, foreignaccounting firms and non-CPA accounting firms are not eligibleto join, although such firms constitute an important segmentof the accounting profession on which American investors andothers rely.

In addition, the as yet untested disciplinarymechanis~ of the Institute's program are restricted in theirimpact by both the voluntary nature of the program and itsemphasis on firm practices rather than individual performance~The Commission's oversight and support may serve to mitigatecertain of these Limiting factors, but the Commission'sauthority also has practical and legal limits.

It has been suggested that a partial answer to thelimitations of the Firms Division may lie in the ethicalprograms of the AICPA and state professional societies ifthese groups are willing and able to play a more activedisciplinary role than they have traditionally. However,the ultimate sanction which can be imposed by theseprofessional societies is expulsion from membership, aprivilege which is not necessary to practice public accounting.In addition," professional societies traditionally postponeremedial action until related legal proceedings have runtheir course. While this policy may be justifiable, nonetheless,

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it has created a credibility problem.A third group involved in the effort to improve the

quality of auditing and accounting work is comprised of themore than 50 state boards of accountancy which govern thepractice of accounting throughout the United States and itsterritories. The atate boards possess many of the attributeswhich the purely private sector bodies lack. These organizationsoperate under statutory mandate, and within its own jurisdictioneach board has full regulatory authority over all types ofaccounting professionals, including those who practice beforethe Commission.

Until recently, most state boards were inactiveand thus suffered from a lack of credibility. To the creditof many of you and your fellow professionals, this situationis changing as more state boards of accountancy begin toexercise their statutory responsibilities in an assertivebut responsible fash~on. Florida practitioners can bejustifiably proud that the Florida Board has been one of theleaders in taking positive steps to assure a quality ofpractice which will be of significant benefit in the overalleffort to restore public confidence in the accountingprofe~sion.

I understand that the Florida Board initiatedreviews of-financial statements which were prepared oraudited by CPAs and filed with state agencies and foundthat on their face, about one third of the rep~rts containeddeficiencies representing deviations from existing professional

standards.

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Florida practitioners have responded in a positiveway to these findings. The vast majority appear to be muchmore anxious to demonstrate the future quality of theirwork than to be contentious about its quality in the past.Other state boards which have instituted positive enforcementprograms have also found that the level of compliance withtechnical and professional standards unacceptable. It isencouraging, however, to note that the response of

practitioners in remedying identified deficiencies and intaking steps to assure that they do not recur has generallybeen both positive and professional. In Florida andelsewhere, it has been the consistent experience that theBoards have only rarely been forced to exercise their fullarray of regulatory muscle. Cynics would, of course, claimthat this is purely a matter of survival. I would like tothink, however, that it is an indication that professionalismis still the governing attribute among practitioners of theaccountant's art. Professional responses to professionalproblems have produced workable solutions.

In our July 1978 report to Congress, the staffreferred favorably to the progress being made by many stateboards but also noted that there are significant practicalproblems which are hampering their efforts. These problemsresult p~imarily from a lack of resources. For a state boardto perform credibly in its particular role of helping toensure quality performance by those it regulates, it must be

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able to carry out its administrative functions of examinationand licensing, to monitor the quality of public practitioners'work, to conduct inquiries and investigations whereappropriate, and to follow-up on those actions where necessary.

Board members around the country who have committedtheir board to making the switch from a passive to an activerole have been innovative and skillful in overcoming theseproblems. Some have supplemented their staffs withpractitioners working on behalf of the Board for nominalcompensation. This has frequently helped convince cost-conscious legislators to increase state board budgetssufficiently to permit expansion of their inadequate staffs.

Another potentially limiting factor is that thevast majority of state board members and their staffs arethemselves members of the accounting profession. I saypotentially because I do not view this as necessarilyundesirable. Certainly accountant members of boards inthose states such as your own which have taken steps toassure that their regulatory role is a meaningful one havedemonstrated their professionalism in an unmistakable manner.However, to the extent that accounting professionals who areboard members permit the continuation of passive--and largelyineffective--policies by their boards, critics Will chargethat control of accountancy boards by accountants representsa built-in conflict of interest and that such boards cannever be effective.

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One answer to this charge would be to removeaccountants from boards. A better answer. however. is forboards to vigorously pursue their statutory mandates anddemonstrate that accountant members are professional enoughto regulate meaningfully their peers and colleagues.

Other practical problems in instituting effectiveregulatory programs at the state level include enablinglegislation which is sometimes archiac or unclear andorganizational and technical snags which are always presentin start-up situations. These difficulties are being overcomeby the work of individual board members. interested membersof the profession. and the National Association of StateBoards of Accountancy. NASBA has served as a coordinatorfor and adviser to many state boards, has been responsiblefor assuring that the experiences of successful programscan be shared, and thus deserves substantial credit for theaccomplishments to date.

The increase? private and public activity at bothnational and state levels has given rise to the criticismthat the accQunting profession is becoming or perhaps alreadyis "over-regulated." This could be a serious problem ifunnecessary duplic~tion results. At present, however, theprincipal danger is t~at even the increased activity may beinsufficient to adequately address all of the problems atall levels .. . Therefore, I believe that it would be prematureto attempt to limit the role which any organization may play.

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In order to avoid creating new problems in thevery process of formulating solutions to old ones, it isespecially important to avoid "territorial fights." Iunderstand that there is some controversy between the AICPAand the state societies on the one hand and NASBA and thestate boards on the other over who should be doing what.My only comment on this dispute is that each group shouldbe working toward the same goal. Each professional andregulatory body has an obligation to recognize the roles ofthe others and to avoid placing undue burdens on practitionersto the extent permitted by particular statutory and otherresponsibilities.

Thus, while a regulatory body need not automaticallyaccept the conclusions of a voluntary peer review where itcannot objectively verify the nature, scope and results of thereview, it should recognize that private sector actionsalready taken or in progress may reduce or eliminate thenecessity for additional inquiry or disciplinary action. Onthe other hand, a state board which has identified sub-standard work on the part of a firm or practitioner which itregulates might give consideration to membership in the SECPractice Section and the expected benefits of such membershipin determining appropriate remedial action. Moreover, eachorganization involved in this process should, to the extentpracticable, share the information it has with the others.

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Certainly the Commission shares information with stateboards, the AICPA, and at their request, with the statesocieties.

Rather than dispute responsibilites, each groupshould concentrate on solving those problems which it isparticularly suited to address. Thus, certain aspects ofthe work of professional societies like your own seem certainto expand. Continuing professional education, for instance,is becoming increasingly important to practitioners in theireffort to stay current. Programs such as the one in which weare participating today can be of benefit to both theprofession and the public, and state societies are undoubtedlyin a position to administer them efficiently and effectively.

Professional societies should also be concernedwith striking the appropriate balance between theirrepresentation of the business and professional interests oftheir members and their obligations as societies ofprofessionals who serve the public to recognize the publicinterest. There is nothing inherently unsavory about self-interest. It is the driving motivation of a privateenterprise economic system. Professional groups should beencouraged to speak out on behalf of the business andprofessional interests of their members. As long as this isdone in an open and professional manner, it is beneficial.But it must be balanced against the broader public interestwhich each member of the profession is obligated to uphold.

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The credibility of professional societies--and ultimatelytheir effectiveness as the voice of the profession--willsurely be lost if the public perceives that positions takenby these societies are weighted toward private advantage andagainst the public interest.

The most important participants in improving thecredibility of the accounting profession are accountingprofessionals themselves. To the extent individual membersrespond with professionalism to the criticisms of yourprofession, develop creative and meaningful solutions intheir individual practice and support the progressive effortsof your professional organizations, there will be less needfor governmental bodies such as state boards, the SEC, andlegislatures on the national or state level to become moreinvolved in regulating the profession.

There is more than a little truth in the aphorism:"You're either part of the problem or part of the solution."Every member of the profession has a very real interest inthe process of seeking solutions and should participate inthis process fully. There are many ways that this can beaccomplished. I would like to mention only a few of them.

First, the measures being undertaken by bothprivate and public sector organizations are substantial ones,requiring people and resources at a level which is probablyseveral times greater than will be needed in the future, asthese programs become more established and routine. It is

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unlikely that any assistance you might offer will berefused.

Second) I think every professional accountantwould do well to consider the role which he or she canindividually play in the attitude adjustment phenomenon whichis an inevitable part of the changes taking place. No oneenjoys receiving criticism and few enjoy criticizing others.Yet, in the present environment, fulfillment of the difficultand complex obligations which accountants face appears todemand constructive criticism. Such criticism should betaken in light of what it has to offer. Conversely, thetraditional reluctance of accountants to criticize theirfellow professionals must be overcome, not merely in theinstitutional context, such as peer review) but in othercircumstances where valid criticism may be useful. Noprofessional should be content to remain silent when he isaware that one of his peers is doing work which fails to meetminimUm professional standards.

There is also another aspect to accountants'professionalism to which everyone should be sensitive.Whether a sole practitioner) or part of a national or evenan international accounting firm) every professional accountantis to some extent a specialist. I realize) of course) thatthere is no official or profession-wide recognition ofspecialization and I'm not sure that there should be.Nevertheless) nearly all accountants in public practice tendto gravitate toward a certain kind of work) be it systems)

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tax or aUdit. If nothing else, the explosion of governmentregulations, pronouncements by standard-setting bodies, andof information in general tends to assure that not even themost talented professional can hope to stay current in everyarea. The implications are plain: Every practitioner mustbe aware of both talents and limitations and be prepared torefuse a professional engagement when the necessary expertiseis not available. I am not suggesting that individualpractitioners and smaller accounting firms lack necessarytalent, because I do not believe that quality can be equatedwith size. Rather, the talents of practice units of allsizes should be carefully applied.

I realize that these suggestions I have made mayin some cases be difficult for accQuntants to carry outbecause so much is happening in the profession with regardto both standard setting and quality improvement. Theinitiatives which I have discussed, from those of the AICPAand the SEC at the national level, to those of the statesocieties and boards, are transforming the environment inwhich accountants practice and making numerous demands onmembers of this profession. This process of change isneither easy nor painless. I believe, however, that if themembers of the profession bring the traditional strong pointsof accounting professionalism--integrity, objectivity, andquality of work--to bear on the profession's problems,solutions will be facilitated and the accounting profession

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will emerge with a sense of pride and enjoy a renewed publicconfidence which will make the efforts well worthwhile.