TAKING SIDES: SEC settles for half a loaf on auditor independence

It’s hardly the tough approach that it’s been threatening for the past two years, but the Securities and Exchange Commission has finally enacted controversial new rules that address inherent conflicts of interest when big accounting firms act as both an independent auditor of and a supplicant to public companies.

The decision came last week after an 11th-hour compromise with the Big Five accounting firms, which are the focus of the new regulations.

The SEC apparently thinks it got a good deal, and the compromise should pave the way for quick acceptance by the industry.

lucrative business

The SEC is also likely to melt opposition in Congress, where lawmakers had been threatening to block the more stringent proposal it released last summer.

So where do the new rules leave us?

As InvestmentNews reporter Sarah O’Brien noted in her coverage of the issue in this week’s edition, the auditor independence rule, as originally proposed in June, was one of the SEC’s most controversial.

Indeed, tens of millions of dollars are at stake.

Over the years, major accounting firms have built up lucrative consulting businesses.

They may have started out as ancillary services to their main accounting functions, but consulting has quickly grown into the tail that wags the dog in the industry.

The upshot is, you have accounting firms that are supposed to be acting as independent auditors on the one hand, bidding for consulting work as an outside vendor on the other.

If that doesn’t raise the potential for conflicts of interest, what does?

Add to that the numerous accounting scandals over the past several years, in which companies, mainly high-flying tech firms, were caught cooking the books. In each case, the outside auditors had signed off on questionable practices.

As Ms. O’Brien noted, the agency received more than 3,000 comment letters – second only to the response to controversial Regulation FD. It also heard more than 100 witnesses during 30-plus hours of testimony before arriving at the watered-down version of the rule.

Up until last Tuesday, accounting industry insiders were not even sure what the rules would include, but according to published accounts, the SEC has agreed to ease up on restrictions that would have curtailed consulting on computer systems – one of the most lucrative services offered by the firms. Instead, the agency has opted to go with tougher disclosure rules.

Paying the bill

In other areas, for example, public companies will have to disclose how much they pay for consulting services and auditing.

The industry also agreed to guidelines that will define inappropriate relationships.

Theoretically, the so-called “appearance” guidelines will make it easier for the SEC to take action against offending companies.

In reality, what the new rules do is increase the burden on the industry to police itself.

It leaves the issue of regulating potential conflicts, for the most part, in the hands of private industry instead of the government.

It’s a half-a-loaf approach, premised on the notion that self-regulation is the best kind of regulation.

That isn’t necessarily a bad route. But will it effectively restore confidence in the auditing process? That remains to be seen.

It’s hard to see how the industry will find the necessary discipline with so much cash on the table.

As the saying goes, “The client pays the bill.” And that almost always means: “What the client wants, the client gets.”