More than 30 organizations and individuals are pressing SEC Chair Gary Gensler to overhaul the financial reporting infrastructure, including the accounting standard-setter FASB, the audit regulatory board PCAOB, and the SEC’s Office of Chief Accountant (OCA). They urged the commission, which oversees the two boards, to make the three entities investor-centric because they have been too lenient towards businesses and the accounting and auditing industry, especially the Big Four firms, that serves the businesses at the expense of investors who provide the capital.
Accounting firm partners or corporate finance executives have been well represented at the FASB and the PCAOB, and partners of Big Four firms have dominated the top positions in SEC’s OCA while strong investor advocates have not been as well represented. And this has been reflected on their work especially in recent years, the 34 individuals and organizations said.
They are worried that weak implementation of Sarbanes-Oxley reforms—intended to prevent a repeat of big accounting scandals that toppled companies like Enron and WorldCom—is recreating the conditions that led to such scandals, which cost investors an estimated $85 billion two decades ago.
Separately, the Capital Group, which manages $2.2 trillion in assets, wrote a letter in April to Financial Accounting Foundation (FAF) Chair Kathleen Casey to express its concerns that the FASB has not put the views of investors front and center even though they are the ones who need accurate and reliable financial information to make informed investing decisions. FAF is the parent organization of the FASB. Currently, 7 of 18 FAF trustees and two of the seven FASB members have investor backgrounds.
Congress passed the Sarbanes-Oxley Act in 2002 in response to the scandals, which among other things, created the PCAOB to supervise accounting firms that audit public companies. Before the board was formed, the AICPA, which represents the accounting and auditing profession, wrote auditing standards for companies.
“Many of the root causes of that crisis – deeply flawed and outdated accounting standards, weak and ineffective auditor oversight, and auditors who lack both independence and professional skepticism – have reemerged as pressing issues,” 34 organizations and individuals wrote in a June 7, 2021, letter to Gensler, who is no stranger to Sarbanes-Oxley: he was senior adviser to Senator Paul Sarbanes in writing the law. The letter was also forwarded to senior members of the Senate Banking Committee and the House Financial Services Committee.
“For too many years, the Commission itself has been either complicit or passive in the face of these developments,” according to the letter. Among the signers are Barbara Roper, director of investor protection of the Consumer Federation of America; former SEC chief accountant Lynn Turner who is a member of the Alliance of Concerned Investors (ACI); Bartlett Collins Naylor, financial policy advocate of Congress Watch, a division of Public Citizen; Lisa Donner, executive director of Americans for Financial Reform Education Fund; and Jack Ciesielski, President of investment research firm R.G. Associates, Inc.
They said that Sarbanes-Oxley sought to fix the slow pace of accounting standard-setting dominated by industry interests and strengthen independence of auditors who had been too cozy with their public company clients.
“From the outset, however, SOX was hampered by weak implementation by an SEC that, too often, appeared to take its cues from the large accounting firms, rather than focusing on the needs of investors,” the investor advocates wrote. “The governance and funding reforms put in place at FASB were insufficient to counteract the dominance the auditing and issuer community were able to exert over the standard-setting process through their majority representation on the board.”
FASB Too Focused on Simplification?
ACI, in a separate letter to Gensler when he became the chair of the SEC, said in recent years, there has been “little or no evidence of investor considerations” in the FASB’s output or its agenda for the future. Of the 111 Accounting Standards Updates issued from mid-2013 to mid-2020, they said almost one third of them were related to simplification, accounting standard codification improvements, practical expedients, technical corrections, or implementation delays. Another 22 percent were adoptions of narrow scope changes recommended by its Emerging Issues Task Force (EITF) to address concerns of financial statement preparers.
At the same time, investors have asked the FASB for improvements to the cash flow statement for 33 years, but their calls have been ignored.
As for the PCAOB, the 34 organizations and individuals said that it never had the pro-investor majority during the Obama administration and was “decimated by leadership openly antagonistic” during the Trump administration to fulfill its mission, which is to protect investors and further the public interest.
“The result is that, today, FASB remains both glacially slow and unresponsive to investor concerns, and the PCAOB seems to have become more focused on protecting audit firms than protecting investors,” the letter states.
The letter said that the audit regulatory board in recent years advanced an agenda that weakens auditor independence rules even though its audit firm inspections has repeatedly found a lack of independence and professional skepticism. On June 4, the SEC removed Trump-era PCAOB Chairman William Duhnke and said it would be seeking to fill all five board seats in response to heavy pressure by progressive groups and senators. Before Duhnke was removed, four have been industry-leaning and one pro-investor. But the lone investor advocate member, Jay Brown, resigned earlier in the year because his wife, Allison Herren Lee, served as acting chair of the SEC.
The SEC OCA “has aided and abetted their abandonment of their investor protection mission, undermining reform efforts and weakening auditor independence rules,” the letter states. “As a result of these institutional failures, we are recreating the conditions that led to the massive wave of accounting scandals that rocked the markets two decades ago. It will take bold action now to reverse that degradation of the financial reporting infrastructure, and to do so before we see catastrophic results resembling those of the Enron area.”
Recommended Reforms
They asked the SEC to:
- reconstitute FASB and the FAF to include a majority of investor members;
- increase the PCAOB’s budget, restore staff expertise, increase the frequency and rigor of inspections that is backed up by strong enforcement, and reinvigorate standard-setting process; and
- appoint investor representatives as OCA’s chief and deputy chief accountants.
Gensler, who assumed the chair position in mid-April has yet to name permanent heads of divisions and offices, including the chief accountant, which is arguably the most powerful accounting position in the world.
The SEC did not immediately respond to a request for comment. The FASB declined to comment. The PCAOB had no comment.
Capital Group Concerns
In response to the FAF’s December 2020 solicitation for feedback, Capital Group said having more investor representation on the FAF, the FASB, and the board’s Emerging Issues Task Force (EITF) is one of the most effective ways to improve the current financial reporting system.
The investment managing firm said without the highest quality accounting standards, investors would be at greater risk of losing money and capital allocation would not be optimal for the economy.
“We do not see the FASB to be effective in setting standards that meet investor needs for timely, complete, and relevant financial information,” Capital Strategy Research’s Elizabeth Mooney and Dane Mott wrote on April 9 to FAF Chair Casey. “Our conclusion is that the Board will never be a highly-effective standard setter until investor users of financial statements are significantly represented on the FAF and FASB.”
Mooney and Mott, who over the past decades have participated as members of the various committees of both the FASB and the IASB—which sets international financial reporting standards (IFRS)—said that the investor perspective often does not get reflected in the final standards or in the basis for conclusion of the standards.
“As licensed Certified Public Accountants and professional analysts alongside investors, our experience is that investors and accountants tend to think differently,” they wrote. “It is important to ensure that the financial information sought by investors from financial statements, is captured and communicated through the standards and provides critical insight.”
Turner, in an interview, said that he fully agrees with the points of the letter since Capital Group must rely on financial statements for its stock analysis; it does not do index investing like BlackRock or Fidelity does.
“You have to go find people who are making investment decisions and who use the financial statements to make those [accounting rule] decisions,” Turner said. “The auditors don’t; they don’t make investment decisions. The CFOs don’t. Quite frankly, the accounting academics don’t.”
In a statement issued before the June 7 letter in response to ACI’s letter, the FASB said that its mission is to write standards to provide investors with useful information while also considering the costs to preparers and investors.
“The FASB and its technical staff focus on obtaining input from all stakeholders, including investors, at every stage of the standard-setting process,” a spokesperson had said. “This includes soliciting investor input on what projects to add to the FASB agenda, carefully considering investor views while standards are in development, and meeting with investors after standards are issued as part of the FASB’s post-implementation reviews.”
This article originally appeared in the June 8, 2021 edition of Accounting & Compliance Alert, available on Checkpoint.
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