Corporate Scandals: The Epilogue

Approximately a year ago, before the Bush administration made the Iraq war its major priority, the nation was riveted by corporate scandals. At the time, Congress passed the Sarbanes-Oxley Act to stiffen regulation of the accounting industry. The Bush administration threw a little extra money into the Securities and Exchange Commission so that it could, ostensibly, pursue the job of enforcing corporate compliance with basic accounting standards.

Of course, these were only palliative measures. Conservatives argued forcefully that nothing else really needed to be done, because the market would regulate itself. Corporate officers would see the damage sustained by Enron and Worldcom and be driven to clean up their balance sheets before the same terrible fate hit their own companies -- or so the argument went.

A year later, however, little has changed.

The Sarbanes-Oxley Act established the Accounting Oversight Board, whose purpose is to keep an eye on accounting firms and set new standards for auditing public corporations. Setting up a new agency can be a slow process, but the Accounting Oversight Board faces unique hurdles.

The funding issue is the most critical. The board is currently operating on money borrowed from the US Treasury, because the Sarbanes-Oxley Act set aside no public funding source for the Accounting Oversight Board. Instead, the Act specified that the board itself would bill accounting firms and use those funds for its operations. But the board has yet to finish registering all the public accounting firms in the US and the foreign accounting firms that do business with US companies overseas (a contentious issue with the European Union), much less figure out rules for how much to bill them and how often. Should they impose an annual fee? Bill only those firms they audit? What ratio should they use in order to avoid over-taxing smaller firms?

More importantly, this raises the issue of whether the Accounting Oversight Board can be truly independent of the accounting industry if its main funding source is the industry itself, particularly the big firms that are responsible for the most egregious abuses.

In the same vein, the board is having trouble recruiting members and drafting rules for inspection and enforcement. Naturally, the pay is not as good as in private industry. Chairman William McDonough, however, makes half a million dollars per year -- more than the chairman of the SEC and the President of the United States make combined. No one, so far, has pointed out that this classic corporate pay scale might be counterproductive for recruitment purposes. Currently, after a year of recruiting, the board has only 60 members, while its goal was to have 200 by the end of this year.

New employees are being drawn from large public accounting firms and the industry's own trade group, the American Institute of Certified Public Accountants, which has been attempting to influence the standards set by the Accounting Oversight Board. This increases the risk of the board becoming a revolving door for the very industry it's supposed to be regulating, like so many other government agencies.

At least the SEC is on the case, right? Well, the added funding from the Bush administration has made little difference in the SEC's ability to review the thousands of financial statements filed by public companies in the US every three months. It's a Herculean task, an insurmountable mountain of paper, and the SEC has been historically (and still is) chronically understaffed, only able to check selected financial statements on a spot basis and with little depth.

For example, last year the SEC issued a rule that requires corporate executives to personally sign and certify the accuracy of their companies' financial statements. In the months since then, there have been many companies whose executives have failed to comply, including some who have simply refused to comply on principle, like Intel Corp. Qwest Communications, Gemstar-TV Guide, Footstar, and others have broken this rule repeatedly but have not received any fines or other sanctions from the SEC. In fact, only one company has been punished under this rule: HealthSouth Corp., whose officers signed financial statements that were so clearly incorrect as to be impossible to ignore.