How Directors and Auditors Can Improve Corporate Governance

Early in 1994, chief accountant of the Securities and Exchange Commission Walter Schuetze criticized independent auditors for not measuring up to their profession's high standards for integrity, objectivity and independence. His criticisms were similar to those also aimed at corporate directors--failure to act as guardians of the corporation and its stockholders and being passive supporters of management. In the view of Schuetze, auditors were at times being "cheerleaders," not just passive supporters. This article covers the response of the profession to those charges and its recommendations for improving financial reporting. The Public Oversight Board (POB) of the SEC practice section (SECPS) of the American Institute of CPAs appointed a three-member advisory panel on auditor independence, charging it to determine whether "the SECPS, the accounting profession or the SEC should take steps to better assure the independence of auditors and the integrity and objectivity of their judgments. " The advisory panel in its report, Strengthening the Professionalism of the Independent Auditor, suggested ways to enhance the value of the audit and better serve the auditing profession's principal client: the investing public. The POB had identified a similar need in its 1993 special report, In the Public Interest, commenting, "In too many cases [of alleged audit failure], the preference of client management.prevailed over the preference of the auditing or consulting partner. " A NEW FOCUS IS NECESSARY The panel said the time was now for the profession to expand existing "best practices," by shifting its focus from a compliance and rule-oriented audit to one recognizing the board of directors as its client and by becoming part of what is called a "corporate governance" approach to improved financial reporting. The major topic in the report was "strengthening the relationship between the board of directors and the independent auditor. " The panel's central suggestion was that corporate boards and audit committees should expect independent auditors to forthrightly communicate in a timely fashion their views on the quality--not just the acceptability--of a company's financial reporting. That quality assessment should encompass judgments about the appropriateness, aggressiveness or conservatism of estimates and elective accounting principles or methods and judgments about the clarity of disclosures. The intended result is an informed audit committee and board that will understand the quality of a company's financial reporting and thus be better equipped to fulfill their corporate governance responsibilities. THE RESPONSES OF THE POB AND THE SECPS The POB recently published a booklet, Directors, Management, and Auditors--Allies in Protecting Shareholder Interests, that urges the adoption of, and describes ways for audit committees to implement, the panel's major suggestions affecting the corporate community. The POB sent it to some 34,000 directors, chief executives and chief financial officers of companies listed on the New York Stock Exchange and other publicly held companies with revenues greater than $250 million. It also was sent to every member firm of the SECPS, in many cases in sufficient quantity to distribute to all audit partners and professional staff, as well as to the CEOs, CFOs and directors of publicly held companies not included in the POB distribution. The SECPS executive committee endorsed the panel's view by saying that the SECPS believed it was in both the public interest and the interest of the accounting profession for auditors to discuss with directors the auditor's judgments about the quality of a client's financial reporting. PERSONAL JUDGMENT, NOT PROFESSIONAL RULES The advisory panel, the POB and the SECPS executive committee agreed that establishing standards and authoritative definitions for commonly used terms, such as "appropriate" and "aggressive" would place emphasis on the form rather than the content of the communication and would overlook the key driver: personal judgment. …