BILL ANALYSIS
AB 2970
Page A
Date of Hearing: May 7, 2002
ASSEMBLY COMMITTEE ON BUSINESS AND PROFESSIONS
Lou Correa, Chair
AB 2970 (Wayne) - As Amended: April 29, 2002
SUBJECT : Accounting.
SUMMARY : Prohibits an accountant from accepting employment
from an audit client or its affiliate within 24 months of
issuance of a financial statement when the employment permits
the accountant to exercise authority over accounting or
financial reporting. Specifically, this bill :
Prohibits licensees (accountants) from accepting employment from
a publicly traded corporation or its affiliate within 24 months
of issuance of a financial statement if the following conditions
are met:
1) The licensee had significant participation in the
corporation's audit engagement process from the levels of
the person in charge of field work up through positions of
being a partner on the engagement; and
2) The employment would permit the licensee to exercise
significant authority over accounting or financial
reporting, including authority over the controls related to
those functions.
EXISTING LAW establishes the California Board of Accountancy, in
the Department of Consumer Affairs (DCA), for the purposes of
licensing and regulating public accountants. In addition to
other requirements, a licensee is required to issue a report
conforming to professional standards upon completion of a
compilation, review, or audit of financial statements.
FISCAL EFFECT : Unknown
COMMENTS :
Purpose of the bill . According to the author, it is in the best
interest of consumers for an auditor's independence to be
protected by prohibiting employment by an audit client for a
period of 24-months when the auditor has significantly
participated in an audit engagement. Under this bill, auditors
AB 2970
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would be prohibited from becoming employees of the client for a
"cooling off" period of 24-months following the issuance of the
financial statement report.
Employment restrictions would apply only to those auditors who
are required to exercise significant judgment in the audit
process, and would include positions, however titled, where the
auditor was the person in charge of the fieldwork up through
partner on the audit engagement.
Employment restrictions would apply only when the auditor moves
to a position with the client that permits the auditor/employee
to exercise significant authority over accounting or financial
reporting, including authority over the controls related to
those functions. Such financial positions are often referred to
as controller or CFO, but would include any position exercising
significant authority over financial controls.
California Board of Accountancy . This bill mirrors the findings
and recommendation of the California Board of Accountancy
(Board). In developing its recommendations, the Board reviewed
existing professional standards and Securities and Exchange
Commission (SEC) rules. After careful consideration, the Board
concluded that additional restrictions would be appropriate.
The Board identified positions in the accounting firm and
positions with the audit client where the restrictions would
increase public protection without unduly restricting employment
opportunities for auditors. Also, the 24-month restriction is
consistent with pending federal legislation (H.R. 3818).
Conflict of interest . An independent auditor's job is to
determine whether or not a company's financial performance is
reported accurately. The word "independent" is important
because an auditor's duty is not to the audited company, but to
the shareholders and the public at large. In the words of the
United States Supreme Court, "by certifying the public reports
that collectively depict a corporation's financial status, the
independent auditor assumes a public responsibility transcending
any employment relationship with the client. The independent
public accountant performing this special function owes ultimate
allegiance to the corporation's creditors and stockholders, as
well as to the investing public. This 'public watchdog'
function demands that the accountant maintain total independence
from the client at all times and requires complete fidelity to
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the public trust ."<1>
It is common practice for large publicly traded corporations to
hire members of the team that has audited it into senior-level
financial or accounting positions-these audit team members have
experience with and knowledge of the corporation and its inner
workings. However, such employment can frequently come at the
expense of the independence of the auditor and at the expense of
the audit, the public trust function delegated by Congress to
CPAs in 1933, in several ways:
1)An audit team member can barely be expected to maintain
independence, objectivity, and professional skepticism toward
the audit client while currying favor in order to obtain
subsequent employment with the audit client.
2)A company executive who is a former member of the audit team
that continues to audit the company knows exactly how the
audit works, its processes and procedures, and its personnel.
This inside information about one's auditors may enable or
promote fraud or aggressive accounting practices that the
company knows will not be detected in the ordinary course.
3)The ability of an audit firm's personnel to be independent and
objective in auditing the work of someone who was previously
one of their peers is questionable. For example, even in the
case of the "whistleblower" at Enron, although the executive
did go to management and warn of fraudulent accounting
practices within the company, she kept in-house the damaging
information against her former employer, Arthur Andersen, as
she silently divested her own holdings of Enron stocks. She
did not go public with the information until after the
bankruptcy filing and subsequent national scandal.
"It is clearly a conflict of interest for an auditor to go to
work for the client," according to Michael Greenberger, a
professor at the Maryland School of Law and former director of
trading at the Commodity Futures Trading Commission. "It
completely undercuts the independence of the audit. It's a
serious problem and it's widespread."
"The suspicion is that the future employee might be currying
favor while on the audit team," said Stephen Lubet, professor of
---------------------------
<1> United States v. Arthur Young & Co., 465 U.S. 805, 817-18
(1984)
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legal ethics at Northwestern University School of Law. "It is
the well-known and often-discussed problem of the revolving
door."
The SEC has no prohibition against an auditor leaving his job to
work for a client, but it does require the auditor to sever any
financial ties to the auditing firm.
Federal preemption . A legal analysis issued by the Office of
the Attorney General on May 1, 2002, concluded that federal law
would not preempt California from enacting legislation to
restrict accountants from obtaining employment with a company
while performing, or for a certain amount of time after
performing, an independent audit of the company.
Federal legislation . There are several bills pending in
Congress addressing Enron-related reforms, ranging from auditor
conflicts of interest to a complete elimination of the private
sector's involvement in auditing publicly traded companies
(e.g., the government would make the decisions to assign
accountants to conduct specific audits). Because of the Big
Five's opposition to most, if not all, of these reforms, it is
unlikely Congress will provide the public with a remedy in an
expeditious manner. According a recent article in the Wall
Street Journal, "Don't look for a major overhaul of the
accounting industry soon?It remains uncertain if anything will
pass this year." And on April 12, 2002, the Washington Post
reported, "The accounting industry?has a long history of
successfully fighting off efforts to regulate it in the
aftermath of financial disasters, such as the savings and loan
crisis?. It is far from clear that significant change will
result."
As recently as the April 29, 2002, issue of Business Week
Magazine, an article, "Accounting: Congress Only Looks Like It's
Getting Tough" summarized the viability of any meaningful
accounting reform occurring, "But don't expect a White House
ceremony any time soon. House Republicans and Senate Democratic
leaders are poles apart on how best to curb auditing abuses."
In the same Business Week article, referring to the House GOP
leadership's stand on accounting reform, "They want to rattle
the legislative sword, but they don't want to take it out of the
scabbard," says John Endear, president of the American Business
Conference, which represents small and midsize companies.
AB 2970
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The SEC, the enforcement body for the accounting standards
already in place, requested
additional funds for 2003 in an attempt to increase its staff to
accommodate the growing demands placed on the agency since the
Enron/Andersen debacle and the plethora of corporate financial
restatements impacting the stock market. The White House
rejected the SEC's request.
REGISTERED SUPPORT / OPPOSITION :
Support
California Public Interest Research Group (CALPIRG)
Center for Public Interest Law (CPIL)
Congress of California Seniors
Consumer Attorneys of California
Consumer Federation of California
Consumers Union
Opposition
None on file.
Analysis Prepared by : David Pacheco / B. & P. / (916)
319-3301