Protecting The Public's Interest: Considerations for Addressing Selected Regulatory Oversight, Auditing, Corporate Governance, and Financial Reporting Issues
Published: 2002-04-09T00:00:00

Fast Facts:

Highlights:
section_title: What GAO Found
paragraphs: In the wake of the Enron collapse and the proliferation of earnings restatements and pro forma earnings assertions by other companies, questions are being raised about the soundness of private sector financial reporting, auditor independence, and corporate governance. In addressing these issues, the government's role could range from direct intervention to encouraging non-governmental and private-sector entities to adopt practices that would strengthen public confidence. GAO believes that Congress should consider a holistic approach that takes into account the many players and interrelated issues that brought about the Enron situation.

section_title: Letter
paragraphs: I appreciate the opportunity to share my perspectives on a range of issues  emanating from the sudden and largely unexpected bankruptcy of the  Enron Corporation (Enron) and financial related activities relating to  several other large corporations. These matters have caused a number of  accounting profession oversight, auditor independence, corporate  governance, and other related issues that are now receiving extensive  national attention. The failures of Enron and certain other public  companies have resulted in substantial losses to employees, shareholders,  and other investors. Certain significant financial statement earnings  restatements and the proliferation of pro forma earnings assertions have  raised questions about the soundness of the current financial reporting,  independent auditing, and corporate governance functions relating to  public companies. These events have also raised a range of questions  regarding how such dramatic and unexpected events can happen under our  current system and the role and capacities of various key players under  that system.
To assist the Congress in framing needed reforms, on February 25, 2002, we  convened a forum on corporate governance, transparency, and  accountability to discuss a variety of systemic issues. These entailed  regulatory oversight, auditing, accounting/financial reporting, and  corporate governance matters. Forum participants included prominent  individuals from federal and state government, the private sector,  standards setting and oversight bodies, and a variety of other interested  parties. As expected, the forum participants expressed a range of views on  these broad topics, which do not necessarily represent our views. However,  there was general agreement by the participants that there are no simple  solutions, or a single “silver bullet,” to resolve the perceived problems that  exist. In fact, there was general agreement that while some actions were  clearly called for in the wake of Enron and other recent events, care should  be taken to ensure that government does not overreact in a manner that  could have unintended adverse consequences. This requires a careful  balancing of interests with a focus on what is in the best overall interest of  the investing public. On March 5, 2002, I issued highlights of the forum  meeting, which I would like to enter into the record. Also, on March 5,  2002, I testified before the Senate Banking Committee to further elaborate  on these issues.
As you requested, my comments today will primarily focus on oversight of  the accounting profession and related auditor independence and corporate  governance issues raised by Enron’s failure. I would also like to take this  opportunity to provide our perspectives about the related issue of financial  reporting. It should be recognized that these overarching areas are  interrelated keystones to protecting the public’s interest. Failure in any of  these areas can place a strain on the entire system. Any potential actions  should be guided by the fundamental principles of having the right  incentives for the key parties to do the right thing, adequate transparency  to provide reasonable assurance that the right thing will be done, and full  accountability if the right thing is not done. These three fundamental  principles represent a system of controls that should operate in  conjunction with a policy of placing special attention on areas of greatest  risk.
The issues raised by Enron’s failure are multi-faceted, involving many  different problems and players with various roles and responsibilities. In  that respect, needed changes to the government’s role should vary  depending on the specific nature and magnitude of the problem.  Specifically, the government’s role can range from direct intervention to  encouraging certain non-governmental and private-sector entities to take  certain steps designed to enhance trust and better protect the public  interest. For example, the issues surrounding the accounting profession’s  current self-regulatory system for auditors involves many players in a  fragmented system that is not well coordinated, involves certain conflicts  of interest, lacks effective communication, and has a discipline system that  is largely perceived as being ineffective. In this case, direct government  intervention to statutorily create a new independent federal government  body to regulate the accounting profession is needed. On the other hand,  the issues concerning corporate governance may be best addressed  through the Securities and Exchange Commission (SEC) encouraging the  stock exchanges to enhance public companies’ listing requirements and  promote “best practices” in connection with the boards, key committees,  and officers of public companies. If such an approach is not successful in  achieving the expected corporate behavior, the government can then take  further action.
In considering changes to the current system that gave rise to Enron and  other areas of concern, it will be important that the Congress consider a  holistic approach to addressing the range of interrelated issues. It is  important to realize that effectively protecting the public interest is a multi- dimensional challenge involving a variety of players and issues. For  example, it involves company management, boards and board committees,  the accounting profession standard setters, analysts, regulatory oversight  agencies, investors, and various other parties. In addition, in the audit area  it involves a redefinition of who the client is, various audit scope and  responsibility issues, the number of firms, the quality of the firms’ quality  assurance systems, and the quality of the firm’s personnel. It is also  important that any responsible governmental bodies, such as the SEC, have  adequate resources to fulfill its responsibilities in these areas, which I will  briefly address later.
subsections: section_title: Regulation and Oversight of the Accounting Profession
paragraphs: The current model for regulation and oversight of the accounting  profession involves federal and state regulators and a complex system of  self-regulation by the accounting profession. The functions of the model  are interrelated and their effectiveness is ultimately dependent upon each  component working well. Basically, the current model includes:  licensing members of the accounting profession to practice within the  jurisdiction of a state, as well as issuing rules and regulations governing  member conduct, which is done by the various state boards of  accountancy;  setting accounting and auditing standards, which is done by the  Financial Accounting Standards Board (FASB) and the Auditing  Standards Board (ASB), respectively, through acceptance of the  standards by the SEC;  setting auditor independence rules, which within their various areas of  responsibility, have been issued by the American Institute of Certified  Public Accountants (AICPA), the SEC, and GAO; and  oversight and discipline, which is done through a variety of self- regulatory and public regulatory systems (e.g., the AICPA, the SEC, and  various state boards of accountancy).
Enron’s failure and a variety of other recent events has brought a direct  focus on how well the current systems of regulation and oversight of the  accounting profession are working in achieving their ultimate objective  that the opinions of independent auditors on the fair presentation of  financial statements can be relied upon by investors, creditors, and the  various other users of financial reports.
The issues currently being raised about the effectiveness of the accounting  profession’s self-regulatory system are not unique to the collapse of Enron.  Other business failures, restatements of financial statements, and the  proliferation of pro forma earnings assertions over the past several years  have called into question the effectiveness of the current system. A  continuing message is that the current self-regulatory system is  fragmented, is not well coordinated, and has a disciplinary function that is  not timely, nor does it contain effective sanctions, all of which create a  public image of ineffectiveness. In addressing these issues, proposals  should consider whether overall the system creates the right incentives,  transparency, and accountability, and operates proactively to protect the  public interest. Also, the links within the self-regulatory system and with  the SEC and the various state boards of accountancy (the public regulatory  systems) should be considered as these systems are interrelated, and  weaknesses in one component can put strain on the other components of  the overall system.
I would now like to address some of the more specific areas of the  accounting profession’s self-regulatory system that should be considered in  forming and evaluating proposals to reshape or overhaul the current  system.
subsections: section_title: Accounting Profession’s Current Self-Regulatory System
paragraphs: The accounting profession’s current self-regulatory system for public  company audits is heavily reliant on the AICPA through a system that is  largely composed of volunteers from the accounting profession. This  system is used to set auditing standards and auditor independence rules,  monitor member public accounting firms for compliance with professional  standards, and discipline members who violate auditing standards or  independence rules. AICPA staff support the volunteers in conducting their  responsibilities. In 1977, the AICPA, in conjunction with the SEC,  administratively created the Public Oversight Board (POB) to oversee the  peer review system established to monitor member public accounting firms  for compliance with professional standards. In 2001, the oversight  authority of the POB was expanded to include oversight of the ASB. The  POB had five public members and professional staff, and received its  funding from the AICPA.
On January 17, 2002, the SEC Chairman outlined a proposed new self- regulatory structure to oversee the accounting profession. The SEC’s  proposal provided for creating an oversight body that would include  monitoring and discipline functions, have a majority of public members,  and be funded through private sources, although no further details were  announced. The POB’s Chairman and members were critical of the SEC’s  proposal and expressed concern that the Board was not consulted about  the proposal. On January 20, 2002, the POB passed a resolution of intent to  terminate its existence no later than March 31, 2002, leaving a critical  oversight function in the current self-regulatory system unfilled. However,  the POB’s Chairman has stated that the Board will work to assist in  transitioning the functions of the Board to whatever new regulatory body is  established. In that respect, the SEC announced on March 19, 2002, that a  Transition Oversight Staff, led by the POB’s executive director, will carry  out oversight functions of the POB. However, on April 2, 2002, the POB  members voted to extend the POB through April 30, 2002, to provide  additional time solely to finalize certain POB administrative matters and to  facilitate a more orderly transition of oversight activities.
section_title: Need to Create a New Independent Federal Government Oversight Body
paragraphs: The issues of fragmentation, ineffective communication, and limitations on  discipline surrounding the accounting profession’s self-regulatory system  strongly suggest that the current self-regulatory system is not adequate in  effectively protecting the public’s interest. We believe these are structural  weaknesses that require congressional action. Specifically, we believe that  the Congress should create an independent statutory federal government  body to oversee financial audits of public companies.
The functions of the new independent body should include:  establishing professional standards (auditing standards, including  standards for attestation and review engagements; independence  standards; and quality control standards) for public accounting firms  and their key members who audit public companies;  inspecting public accounting firms for compliance with applicable   investigating and disciplining public accounting firms and/or individual  auditors of public accounting firms who do not comply with applicable  professional standards.
As discussed later, this new body should be independent from but should  closely coordinated with the SEC in connection with matters of mutual  interest. In addition, we believe that the issues concerning accounting  standard-setting can best be addressed by the SEC working more closely  with the FASB rather than putting that function under the new body.
subsections: section_title: Powers/Authority of the New Body
paragraphs: The powers/authority of the new body should include:  requiring all public accounting firms and audit partners that audit  financial statements, reports, or other documents of public companies  that are required to be filed with the SEC to register with the new body;  issuing professional standards (e.g., independence) along with the  authority to adopt or rely on existing auditing standards, including  standards for attestation and review engagements, issued by other  professional bodies (e.g., the ASB);  enforcing compliance with professional standards, including  appropriate investigative authority (e.g., subpoena power and right to  maintain the confidentiality of certain records) and disciplinary powers  (e.g., authority to impose fines, penalties, and other sanctions, including  suspending or revoking registrations of public accounting firms and  individual auditors to perform audits of public companies);  requiring the new body to coordinate its compliance activities with the  SEC and state boards of accountancy;  requiring auditor reporting on the effectiveness of internal control over  financial reporting;  requiring the new body to promulgate various auditor rotation  requirements for key public company audit engagement personnel (i.e.,  primary and second partners, and engagement managers);  requiring the new body to study and report to the Congress on the pros  and cons of any mandatory rotation of accounting firms that audit  public companies, and take appropriate action;  establishing annual registration fees and possibly inspection fees  necessary to fund the activities of the new body on an independent and  self-sustaining basis; and  establishing rules for the operation of the new body.
section_title: Structure of the New Body
paragraphs: The new body should be created by statute as an independent federal  government body. To facilitate operating independently, the new body’s  board members should be highly qualified and independent from the  accounting profession, its funding sources should not be dependent on  voluntary contributions from the accounting profession, and it should have  final approval for setting professional standards and its operating rules. In  that respect, the new body would have independent decisionmaking  authority from the SEC. It would approve professional standards, set  sanctions resulting from disciplinary actions, and establish its operating  rules. At the same time, it should coordinate and communicate its activities  with the SEC and the various state boards of accountancy. The new body  should set its own human resource and other administrative requirements  and should be given appropriate flexibility to operate as an independent  entity and to provide compensation that is competitive to attract highly  competent board members and supporting staff. The new body should also  have adequate staff to effectively discharge its responsibilities.
Candidates for board membership could be identified through a nominating  committee that could include the Chairman of the Federal Reserve,  Chairman of the SEC, the Secretary of the Treasury, and the Comptroller  General of the United States.
The number of board members could be 5 or 7 and have stated terms, such  as 5 years with a limited renewal option, and the members’ initial terms  should be staggered to ensure some continuity. The members of the board  should be appointed by the President and confirmed by the U.S. Senate. At  a minimum, the chair and vice-chair should serve on a full-time basis.
Importantly, board members should be independent of the accounting  profession. In that regard, board members should not be active accounting  profession practitioners and a majority of board members must not have  been accounting profession practitioners within the recent past (e.g., 3  years).
section_title: Funding for the New Body
paragraphs: The new body should have sources of funding independent of the  accounting profession. The new body could have authority to set annual  registration fees for public companies. It could also have authority to set  fees for services, such as inspections of public accounting firms, and  authority to charge for copies of publications, such as professional  standards and related guidance. The above fees and charges should be set  to recover costs and sustain the operations of the new body.
section_title: Reporting Requirement of the New Body and GAO Access to Records
paragraphs: For accountability, we believe the new body should report annually to the  Congress and the public on the full-range of its activities, including setting  professional standards, inspections of public accounting firms, and related  disciplinary activities. Such reporting also provides the opportunity for the  Congress to conduct oversight of the performance of the new body. The  Congress also may wish to have GAO review and report on the  performance of the new body after the first year of its operations and  periodically thereafter. Accordingly, we suggest that the Congress provide  GAO not only access to the records of the new body, but also to the records  of accounting firms and other professional organizations that may be  needed for GAO to assess the performance of the new body.
section_title: The Independent Audit Function
paragraphs: For over 70 years, the public accounting profession, through its  independent audit function, has played a critical role in enhancing a  financial reporting process that has supported the effective functioning of  our domestic capital markets, which are widely viewed as the best in the  world. The public’s confidence in the reliability of issuers’ financial  statements, which relies in large part on the role of independent auditors,  serves to encourage investment in securities issued by public companies.  This sense of confidence depends on reasonable investors perceiving  auditors as independent expert professionals who have neither mutual, nor  conflicts of, interests in connection with the entities they are auditing.  Accordingly, investors and other users expect auditors to bring to the  financial reporting process integrity, independence, objectivity, and  technical competence, and to prevent the issuance of misleading financial  statements.
Enron’s failure and certain other recent events have raised questions  concerning whether auditors are living up to the expectations of the  investing public; however, similar questions have been raised over a  number of years due to significant restatements of financial statements and  certain unexpected and costly business failures, such as the savings and  loan crisis. Issues debated over the years continue to focus on auditor  independence concerns and the auditor’s role and responsibilities. Public  accounting firms providing nonaudit services to their audit client is one of  the issues that has again surfaced by Enron’s failure and the large amount  of annual fees collected by Enron’s independent auditor for nonaudit  services.
Auditors have the capability of performing a range of valuable services for  their clients, and providing certain nonaudit services can ultimately be  beneficial to investors and other interested parties. However, in some  circumstances, it is not appropriate for auditors to perform both audit and  certain nonaudit services for the same client. In these circumstances, the  auditor, the client, or both will have to make a choice as to which of these  services the auditor will provide. These concepts, which I strongly believe  are in the public’s interest, are reflected in the revisions to auditor  independence requirements for government audits, which GAO recently  issued as part of Government Auditing Standards. The new independence  standard has gone through an extensive deliberative process over several  years, including extensive public comments and input from my Advisory  Council on Government Auditing Standards. The standard, among other  things, toughens the rules associated with providing nonaudit services and  includes a principle-based approach to addressing this issue, supplemented  with certain safeguards. The two overarching principles in the standard for  nonaudit services are that:  auditors should not perform management functions or make   auditors should not audit their own work or provide nonaudit services  in situations where the amounts or services involved are significant or  material to the subject matter of the audit.
Both of the above principles should be applied using a substance over form  doctrine. Under the revised standard, auditors are allowed to perform  certain nonaudit services provided the services do not violate the above  principles; however, in most circumstances certain additional safeguards  would have to be met. For example, (1) personnel who perform allowable  nonaudit services would be precluded from performing any related audit  work, (2) the auditor’s work could not be reduced beyond the level that  would be appropriate if the nonaudit work were performed by another  unrelated party, and (3) certain documentation and quality assurance  requirements must be met. The new standard includes an express  prohibition regarding auditors providing certain bookkeeping or record  keeping services and limits payroll processing and certain other services,  all of which are presently permitted under current independence rules of  the AICPA. However, our new standard allows the auditor to provide  routine advice and technical assistance on an ongoing basis and without  being subject to the additional safeguards.
The focus of these changes to the government auditing standards is to  better serve the public interest and to maintain a high degree of integrity,  objectivity, and independence for audits of government entities and entities  that receive federal funding. However, these standards apply only to audits  of federal entities and those organizations receiving federal funds, and not  to audits of public companies. In the transmittal letter issuing the new  independence standard, we expressed our hope that the AICPA would raise  its independence standards to those contained in this new standard in  order to eliminate any inconsistency between this standard and their  current standards. The AICPA’s recent statement before another  congressional committee that the AICPA will not oppose prohibitions on auditors providing certain nonaudit services seems to be a step in the right  direction.
The independence of public accountants is crucial to the credibility of  financial reporting and, in turn, the capital formation process. Auditor  independence standards require that the audit organization and the auditor  be independent both in fact and in appearance. These standards place  responsibility on the auditor and the audit organization to maintain  independence so that opinions, conclusions, judgments, and  recommendations will be impartial and will be viewed as being impartial by  knowledgeable third parties. Because independence standards are  fundamental to the independent audit function, as part of its mission, the  new independent and statutorily created government body, which I  previously discussed, should be responsible for setting independence  standards for audits of public companies, as well as the authority to  discipline members of the accounting profession that violate such  standards.
section_title: Corporate Goverance
paragraphs: First, I want to underscore that serving on the board of directors of a public  company is an important and difficult responsibility. That responsibility is  especially challenging in the current environment with increased  globalization and rapidly evolving technologies having to be addressed  while at the same time meeting quarterly earnings projections in order to  maintain or raise the market value of the company’s stock. These pressures  and related executive compensation arrangements unfortunately often  translate to a focus on short-term business results. This can create perverse  incentives, such as attempts to manage earnings to report favorable short- term financial results, and/or failing to provide adequate transparency in  financial reporting that disguises risks, uncertainties, and/or commitments  of the reporting entity.
On balance though, the difficulty of serving on a public company’s board of  directors is not a valid reason for not doing the job right, which means  being knowledgeable of the company’s business, asking the right questions,  and doing the right thing to protect not only shareholders, but also the  public’s interest. At the same time it is important to strike a reasonable  balance between the responsibilities, risks, and rewards of board and key  committee members. To do otherwise would serve to discourage highly  qualified persons from serving in these key capacities.
A board member needs to have a clear understanding of who is the client  being served. Namely, their client should be the shareholders of the  company, and all their actions should be geared accordingly. They should,  however, also be aware of the key role that they play in maintaining public  confidence in our capital markets system. Audit committees have a  particularly important role to play in assuring fair presentation and  appropriate accountability of management in connection with financial  reporting, internal control, compliance, and related matters. Furthermore,  boards and audit committees should have a mutuality of interest with the  external auditor to assure that the interest of shareholders are adequately  protected.
section_title: Responsibilities of Audit Committees
paragraphs: There are a number of steps that can be taken to enhance the independence  of audit committees and their working relationship with the independent  auditor to further enhance the effectiveness of the audit in protecting the  public’s interest. We believe that the SEC in conjunction with the stock  exchanges should initially explore such actions. Therefore, any legislative  reform could include a requirement for the SEC to work with the stock  exchanges to enhance listing requirements for public companies to  improve the effectiveness of audit committees and public company  auditors, including considering whether and to what extent:  audit committee members should be both independent of the company  and top management and should be qualified in the areas related to their  responsibilities such as accounting, auditing, finance, and the SEC  reporting requirements;  audit committees should have access to independent legal counsel and  other areas of expertise, such as risk management and financial  instruments;  audit committees should hire the independent auditors, and work  directly with the independent auditors to ensure the appropriate scope  of the audit, resolution of key audit issues, compliance with applicable  independence standards, and the reasonableness and appropriateness  of audit fees. In this regard, audit committees must realize that any  attempts to treat audit fees on a commodity basis can serve to increase  the risk and reduce the value of the audit to all parties;  audit committees should pre-approve all significant nonaudit services;  audit committees should pre-approve the hiring of the public  companies’ key financial management officials (such as the chief  financial officer, chief finance officer or controller) or the providing of  financial management services if within the previous 5 years they had  any responsibility for auditing the public company’s financial  statements, reports, or other documents required by the SEC; and  audit committees should report to the SEC and public on their  membership, qualifications, and execution of their duties and  responsibilities.
subsections: section_title: Responsibilities of Boards of Directors; Nominating, Compensation, Audit or Other Committees; and Management (Officers)
paragraphs: We also believe that the effectiveness of boards of directors and  committees, including their working relationship with management of  public companies, can be enhanced by the SEC working with the stock  exchanges to enhance certain other listing requirements for public  companies. In that respect, the SEC could be directed to work with the  stock exchanges to consider whether and to what extent:  audit committees, nominating committees, and compensation  committees are qualified, independent, and adequately resourced to  perform their responsibilities;   boards of directors should approve management’s code of conduct and  any waivers from the code of conduct, and whether any waivers should  be reported to the stock exchanges and the SEC;   boards of directors should approve the hiring of key financial  management officials who within the last 2 years had any responsibility  for auditing the public company’s financial statements, reports, or other  documents required by the SEC; and   CEOs should serve as the chairman of public company boards.
Also, to further protect shareholders and the public interest, the SEC could  be directed to report (1) within 180 days from enactment of legislation on  other actions it is taking to enhance the overall effectiveness of the current  corporate governance structure, and (2) periodically on best practices and  recommendations for enhancing the effectiveness of corporate governance  to protect both shareholders and the public’s interest.
section_title: Analyst Conflict of Interest Issues and Analyst Independence
paragraphs: We believe that the issues raised by Enron’s sudden failure and bankruptcy  regarding whether analyst’s independence from issuers’ of stock is  affecting their suggested buy and sell recommendations can be addressed  by requiring the SEC to work with the National Association of Securities  Dealers (NASD) in connection with certain requirements. Accordingly, the  SEC could be directed to work with the NASD to consider whether and to  what extent:  the firewalls between analysts and the business end of their firms  should be widened to enhance analyst independence and to report to  the Congress on the effectiveness of the regulations;  disclosure of (1) whether the analyst’s firm does investment banking,  and (2) whether there is a relationship with the company in question  should be improved, and whether to report to the Congress on the  effectiveness of the requirements; and   implementing regulations to be enforced through an effective  examination program should be required.
section_title: GAO Reporting on the above SEC Requirements
paragraphs: The Congress may wish to have GAO evaluate and report to it one year  after enactment of legislation and periodically thereafter on the (1) results  of the SEC’s working relationship with the stock exchanges to strengthen  corporate governance requirements, and (2) results of the SEC’s working  relationship with the NASD in developing independence and conflict of  interest requirements for analysts. Accordingly, we suggest that the  Congress provide GAO access to the records of the securities self  regulatory organizations, such as the New York Stock Exchange and the  NASD, that may be needed for GAO to evaluate the SEC’s working  relationships with these organizations.
section_title: Financial Reporting
paragraphs: Business financial reporting is critical in promoting an effective allocation  of capital among companies. Financial statements, which are at the center  of present-day business reporting, must be timely, relevant, and reliable to  be useful for decision-making. In our 1996 report on the accounting profession, we reported that the current financial reporting model does  not fully meet users’ needs. More recently, we have noted that the current  reporting model is not well suited to identify and report on key value and  risk elements inherent in our 21st Century knowledge-based economy. The  SEC is the primary federal agency currently involved in accounting and  auditing requirements for publicly traded companies but has traditionally  relied on the private sector for setting standards for financial reporting and  independent audits, retaining a largely oversight role. Accordingly, the SEC  has accepted rules set by the Financial Accounting Standards Board  (FASB)—generally accepted accounting principles (GAAP)—as the  primary standard for preparation of financial statements in the private  sector.
We found that despite the continuing efforts of FASB and the SEC to  enhance financial reporting, changes in the business environment, such as  the growth in information technology, new types of relationships between  companies, and the increasing use of complex business transactions and  financial instruments, constantly threaten the relevance of financial  statements and pose a formidable challenge for standard setters. A basic  limitation of the model is that financial statements present the business  entity’s financial position and results of its operations largely on the basis  of historical costs, which do not fully meet the broad range of user needs  for financial information. Enron’s failure and the inquiries that have  followed have raised many of the same issues about the adequacy of the  current financial reporting model, such as the need for additional  transparency, clarity, more timely information, and risk-oriented financial  reporting.
Among other actions to address the Enron-specific accounting issues, the  SEC has requested that the FASB address the specific accounting rules  related to Enron’s special purpose entities and related party disclosures. In  addition, the SEC Chief Accountant has also raised concerns that the  current standard-setting process is too cumbersome and slow and that  much of the FASB’s guidance is rule-based and too complex. He believes  that (1) a principle-based standards will yield a less complex financial  reporting paradigm that is more responsive to emerging issues, (2) the  FASB needs to be more responsive to accounting standards problems  identified by the SEC, and (3) the SEC needs to give the FASB freedom to  address the problems, but the SEC needs to monitor projects on an ongoing  basis and, if they are languishing, determine why.
We generally agree with the SEC Chief Accountant’s assessment. We also  believe that the issues surrounding the financial reporting model can be  effectively addressed by the SEC, in conjunction with the FASB, without  statutorily changing the standard-setting process. However, we do believe  that a more active and ongoing interaction between the SEC and the FASB  is needed to facilitate a mutual understanding of priorities for standard- setting, realistic goals for achieving expectations, and timely actions to  address issues that arise when expectations are not likely to be met. In that  regard, the SEC could be directed to:  reach agreement with the FASB on its standard-setting agenda,  approach to resolving accounting issues, and timing for completion of  projects;  monitor the FASB’s progress on projects, including taking appropriate  actions to resolve issues when projects are not meeting expectations;  and  report annually to the Congress on the FASB’s progress in setting  standards, along with any recommendations, and the FASB’s response  to the SEC’s recommendations.
The Congress may wish to have GAO evaluate and report to it one year  after enactment of legislation and periodically thereafter on the SEC’s  performance in working with the FASB to improve the timeliness and  effectiveness of the accounting standard-setting process. Accordingly, we  suggest that the Congress provide GAO access to the records of the FASB  that may be needed for GAO to evaluate the SEC’s performance in working  with the FASB.
The FASB receives about two-thirds of its funding from the sale of  publications with the remainder of its funding coming from the accounting  profession, industry sources, and others. One of the responsibilities of the  FASB’s parent organization, the Financial Accounting Foundation, is to  raise funds for the FASB and its standard-setting process to supplement the  funding that comes from the FASB’s sale of publications. Some have  questioned whether this is the best arrangement to ensure the  independence of the standard-setting process. This issue has been raised  by the appropriateness of certain accounting standards related to  consolidations, that the FASB has been working on for some time,  applicable to Enron’s restatement of its financial statements as reported to  the SEC by Enron in its November 8, 2001, Form 8-K filing. However, the  issue has previously been raised when the FASB has addressed other  controversial accounting issues, such as accounting for stock options.  Therefore, the Congress may wish to task the SEC with studying this issue  and identifying alternative sources of funding to supplement the FASB’s  sale of publications, including the possibility of imposing fees on  registrants and/or firms, and to report to the Congress on its findings and  actions taken to address the funding issue.
section_title: The SEC’s Ability to Fulfill Its Mission
paragraphs: Over the last decade, securities markets have experienced unprecedented  growth and change. Moreover, technology has fundamentally changed the  way markets operate and how investors access markets. These changes  have made the markets more complex. In addition, the markets have  become more international, and legislative changes have resulted in a  regulatory framework that requires increased coordination among financial  regulators and requires that the SEC regulate a greater range of products.  Moreover, as I have discussed, the collapse of Enron and other corporate  failures have stimulated an intense debate on the need for broad-based  reform in such areas as oversight of the accounting profession, accounting  standards, corporate governance, and analysts conflicts of interest issues,  all of which could have significant repercussions on the SEC’s role and  oversight challenges. At the same time, the SEC has been faced with an  ever-increasing workload and ongoing human capital challenges, most  notably high staff turnover and numerous staff vacancies.
Our recent report discusses these issues and the need for the SEC to  improve its strategic planning to more effectively manage its operations  and limited resources, and also shows that the growth of SEC resources  has not kept pace with the growth in the SEC’s workload (such as filings,  complaints, inquiries, investigations, examinations, and inspections). We  believe that the SEC should be provided with the necessary resources to  effectively discharge its current and any increased responsibilities the  Congress may give it. And finally, we believe that the SEC should be  directed to report annually to the Congress on (1) its strategic plan for  carrying out its mission, (2) the adequacy of its resources and how it is  effectively managing resources through a risk-oriented approach and  prioritization of risks, including effective use of information technology,  and (3) any unmet needs including required funding and human resources.
section_title: Closing Comments
paragraphs: The United States has the largest and most respected capital markets in the  world. Our capital markets have long enjoyed a reputation of integrity that  promotes investor confidence. This is critical to our economy and the  economies of other nations given the globalization of commerce. However,  this long-standing reputation is now being challenged by some parties. The  effectiveness of systems relating to independent audits, financial reporting,  and corporate governance, which represent key underpinnings of capital  markets and are critical to protecting the public’s interest, has been called  into question by the failure of Enron and certain other events and practices.  Although the human elements can override any system of controls, it is  clear that there are a range of actions that are critical to the effective  functioning of the system underlying capital markets that require attention  by a range of key players. In addition, a strong enforcement function with  appropriate civil and criminal sanctions is also needed to ensure effective  accountability when key players fail to properly perform their duties and  responsibilities.