Financial Debacles and State Regulation

Article excerpt

Boards of Public Accountancy and the 'Cascade Effect' of Sarbanes-Oxley

The AICPA, the U.S. Congress, and state regulatory agencies have taken the need for reform in the accounting profession seriously as a result of recent financial debacles. The AICPA announced a renewed effort in promoting exacting compliance to a strict code of professional conduct. Congress passed the Sarbanes-Oxley Act of 2002, which created the Public Company Accounting Oversight Board (PCAOB) to set and enforce standards for auditors of public companies. Sarbanes-Oxley docs not cover nonregistered public accounting firms; section 209 states that "the standards applied by the Board under this act should not be presumed to be applicable for purposes of this section for small and medium-sized non-registered public accounting firms." While the Sarbanes-Oxley Act was intended to apply only to publicly traded companies, state legislatures or state boards of accountancy could implement laws or regulations for nonpublic companies that follow the federal act, a "cascade effect."

Position of the AICPA

In response to concerns about cascading regulation, the AICPA created a Special Committee on State Regulation to provide recommendations to state regulatory agencies on actions that should be taken at the state level. The initial findings of this committee were issued in January 2003 in the first of a series of white papers and briefs referred to as A Reasoned Approach to Reform. In the first report, which details concerns of adding additional regulations to the audits of nonpublic companies, the committee says the regulations will result in increased audit fees and reduced quality of audits. According to the committee, "some audit firms are projecting that the expenses involved in complying with provisions of the Act could necessitate an increase in fees for public company audits (in the range of 20-30 percent)."

In expressing that the uniformity of state regulations is important to the accounting profession and cautioning individual states trying to enact legislation, the committee warns that "proactive and premature legislation or regulation by well-meaning state legislators and regulators will do little to protect the public good if they embrace efforts to Outdo' every other state."

In the report, the committee addressed the possibility of increased regulation at the state level and developed several conclusions. The committee wants states to be patient in their decision-making processes and wait until the impact of Sarbanes-Oxley on public companies can be evaluated. It believes that the costs and logistics of implementing mandatory concurring partner reviews and audit firm rotation are costly and damaging to smaller firms, and the quality of audits will be reduced: that "audit failures are three times more likely in the first two years of a client/auditor relationship, and that there is a positive relationship between firm tenure and auditor competence."

Recent research suggests that private companies are voluntarily implementing stricter governance and accounting practices to meet public companies' requirements. A survey conducted by Robert Half Management Resources found that 58% of CFOs of private companies with more than 20 employees adjusted their accounting standards voluntarily in the direction now required of public companies. These CFOs changed their companies' accounting and internal audit practices and reduced or eliminated the hiring of their auditors for consulting work.

The result of the costs and time commitments caused by new regulations may be that nonpublic companies decide to forgo having audits performed-the opposite of the intended purpose, which is to address the increasing public concern over reporting practices. The AICPA is working with state legislators and regulators to help them understand that Sarbanes-Oxley was intended for public companies and their audit firms, and that any regulation beyond that scope could be counterproductive. …