Remarks to the Panel on Audit Effectiveness of the Public Oversight Board
by Chairman Arthur Levitt
U.S. Securities & Exchange Commission
Public Oversight Hearings
New York, N.Y.
October 7, 1999
Mr. Chairman, members of the Committee, thank you for giving us the opportunity to present our views on this very important issue. I would also like to thank the PublicOversight Board for their sponsorship of this endeavor.
Today, America's capital markets are the envy of the world. Our efficiency, liquidity and resiliency stand second to none. That hasn't happened by accident. For a good part of this century, our system of financial reporting has come to be characterized by its high quality and transparency. This has instilled an unparalleled degree of confidenceand trust.
But that confidence and trust can become all too fleeting if the public interest suffers under the weight of financial pressure. A year ago, I expressed concern that the motivation to satisfy Wall Street earnings expectations may be overriding long established precepts of financial reporting. While the problem of inappropriate earnings management is not new, it has risen in a marketunforgiving of companies that miss Wall Street's consensus estimates.
The dynamic nature of today's capital markets creates issues that increasingly move beyond the bright line of right and wrong. New industries spurred by new services and new technologies are creating new questions and challenges that must be addressed. More often, these issues fall under a gray area where there are no easyanswers. It is in this realm where judgment, experience and integrity are indispensable to high-quality and transparent financial reporting.
In light of this environment as well as recent industry trends, I fear that the audit process, long rooted in independence and forged through professionalism, may be diminished – perhaps even sacrificed in the name of more financial and commercial opportunities.In recent years, the amount of revenue generated by accounting firms in areas of business other than traditional auditing services has increased exponentially. Some firms – perhaps preferring to distance themselves from the roots that have given them such opportunities – prefer to think of themselves as "multi-disciplinary organizations."
Public accounting firms and business competitors outsidethe traditional public accounting firm structure have taken different approaches to handling this market driven growth in non-audit services. For example, some new arrivals – which offer other financial services – are acquiring accounting and auditing firms. As we all know, some accounting firms have even considered floating IPOs as part of their consulting practices. And, some have even gone so faras to question whether the traditional public accounting firm structure is still relevant in an environment where the revenue streams are so diverse.
As firms increasingly have branched out to generate other sources of revenue, the basic audit model, not surprisingly, has undergone changes. In an era that calls for greater risk management, the industry has migrated to what they call the"risk-based" model. It sounds right on target. Because of the challenges of executing these new standards well, I wonder if the public interest is being better served. We cannot permit thorough audits to be sacrificed for re-engineered approaches that are marginally more efficient, but significantly less effective.
Public companies operate uniquely through the separation of ownership and control. Withoutthe ability to independently measure performance through high-quality financial reporting, both the aggressive oversight of that reporting and the commitment to the shareholder interest fall by the wayside. The fragile asset of investor confidence wanes; liquidity dries up; and opportunities disappear.
As I look at some of the audit failures today, I can't help but wonder if the staff in the...