Accounting firms and SEC hobble US audit watchdog

WASHINGTON, Dec 20, (RTRS): James Schnurr, just two months into his job as chief accountant at the US Securities and Exchange Commission, stood before a packed ballroom in Washington last December and upbraided a littleknown regulator.

The Public Company Accounting Oversight Board, or PCAOB, oversees the big firms that sign off on the books of America’s listed companies. And the board was “moving too slowly,” Schnurr said, to address auditing failures that in recent years had shaken public confidence in those firms.

These were fighting words in the decorous auditing profession, and they hit their target. PCAOB Chairman James Doty was among those attending the annual accounting-industry gala where Schnurr spoke. And Schnurr was Doty’s new supervisor.

“This is going to get ugly,” Doty said to a colleague afterward.

In his new SEC job, Schnurr now had direct authority over the PCAOB -- a regulator that just a few years earlier had derailed his C-suite ambitions at Deloitte & Touche. As deputy managing partner at the world’s largest accounting firm, Schnurr had commanded an army of auditors -until a string of damning PCAOB critiques of Deloitte’s audits led to his demotion.

Then, in August 2014, SEC Chair Mary Jo White named Schnurr to his SEC post. It was a remarkable instance of Washington’s “revolving door” for professionals moving between government and industry jobs.

Counted

Schnurr wasn’t the only one with a Deloitte tie. White had counted Deloitte among her clients while a partner at law firm Debevoise & Plimpton. White’s husband, John White, is a partner at law firm Cravath Swaine & Moore, which also counts Deloitte among its clients.

Schnurr’s speech was part of a yearlong campaign to oust Doty and thwart his efforts to implement rules that would increase auditors’ accountability to investors and their independence from the companies they audit. Doty’s proposals grew out of a broad consensus inside and outside government that the Big Four accounting firms had fallen down in the years leading up to the recent financial crisis.

Deloitte, Ernst & Young, PricewaterhouseCoopers and KPMG audit companies that account for 98 percent of the value of US stock markets. During the crisis, nine major financial institutions collapsed or were rescued by the government within months of receiving clean bills of health from one of the Big Four. While Schnurr was deputy managing partner at Deloitte, the firm signed off on the books of Bear Stearns, Washington Mutual and Fannie Mae. Each went bust soon after, costing investors over $115 billion in losses.

Doty’s efforts have floundered, in large part because Schnurr’s office has used its oversight powers to block, weaken and delay them, according to a dozen current and former SEC and PCAOB officials. Schnurr’s staff has also campaigned to have Doty removed from office, these people said.

Doty’s term ended on Oct. 24. He continues to serve as PCAOB chairman day-to-day, waiting for the SEC to decide whether or not to reappoint him.

The standoff is a test of who holds sway with regulators in Washington -- investors large and small who seek better disclosure of what really goes on inside companies, or the financialservices establishment that’s supposed to serve those investors.

Reappoint

In September, 29 people wrote to White urging her to reappoint Doty -- including two past SEC chairpeople, former Federal Reserve Chair Paul Volcker, and John Bogle, the founder of mutual fund giant Vanguard Group.

“The accounting firms have been letting corporations get away with reporting all kinds of funny pro forma earnings,” Bogle said in an interview. “The addition of Jim Doty to the PCAOB was a big upgrade. And if the firms are angry with him, he’s clearly doing something right.”

Deloitte spokesman Jonathan Gandal said his firm appreciated the “constructive feedback” it gets from the PCAOB. “We are proud of the excellent trajectory our inspection results have demonstrated over the past four years,” he said.

A spokeswoman for PricewaterhouseCoopers, Caroline Nolan, said PwC “is supportive of the PCAOB and efforts to increase transparency in the accounting profession.” KPMG and Ernst & Young declined to comment.

“US rule-making is a complex process that involves people with many different perspectives who care deeply about the issues,” PCAOB chief Doty said in a written statement. “I think this is the case with the PCAOB and SEC in the work we do together, including proposals to give more information to investors about who is leading the audits of the companies in which they invest.”

The SEC’s Schnurr and White declined to comment.

Though Schnurr’s career comeback as the SEC’s top accountant is striking, his ties to the industry are part of a pattern. Each of his predecessors, going back at least to 1992, came from senior partnerships at one of the Big Four accounting firms. Some returned to their firms when their stint as chief accountant ended.

Deloitte enjoys special influence. A former Deloitte partner has controlled the SEC Chief Accountant’s Office for 10 of the past 20 years. The five-person PCAOB board has two former partners from law firms representing Deloitte and the father of a Deloitte auditor. Deloitte declined to comment on its clout.

“The very people the PCAOB is regulating are the ones that are overseeing them,” said Lynn E. Turner, a former Big Four accounting executive who served as chief accountant of the SEC from 1998 to 2001.

SEC spokesman John Nester said Big Four experience isn’t a requirement to be chief accountant. “What’s required is deep expertise in financial reporting and public company audits, as well as knowledge and experience with the standard setting process to assist the Commission and the PCAOB in their investor protection mission,” Nester said.

The SEC’s defenders say its critics overstate the power of both the Office of the Chief Accountant over the PCAOB and of the Big Four firms at the commission. The Big Four, they say, are natural talent pools from which to recruit the SEC’s accounting czars, some of whom have been strict regulators.

Some Big Four accounting firm officials, meanwhile, say the tensions with the PCAOB stem from turf battles and personality clashes and aren’t part of any industry effort to undermine a tough watchdog. The Big Four say they don’t oppose regulations that improve standards, but believe the PCAOB would be more effective if it pushed rules focused on the nuts and bolts of auditing.

Controls

The US Congress created the PCAOB in 2002 by passing, with near-unanimous bipartisan support, the Sarbanes-Oxley Act. The goal was to tighten controls on the auditing industry following a string of colossal accounting scandals, most notably the 2001 collapse of energy company Enron Corp.

Lawmakers gave the new regulatory board powers to fight corruption and monitor accounting firms, and laid out tough criminal penalties for accounting fraud. The law’s drafters gave PCAOB board members and staff some of the richest salaries in government to insulate them from the allure of private sector payouts. Doty makes $672,676 a year -- 68 percent more than the US president and nearly three times as much as SEC Chief Accountant Schnurr.

The PCAOB would report to the SEC, which was given oversight of the board’s budget and its rule-making. The commission could appoint board members but had limited power to remove them. The bill’s coauthor, Senator Paul Sarbanes, wanted the new regulator to have some independence from the SEC, which, he told Congress, has “not adequately protected the public’s interests.”

The PCAOB began aggressive yearly inspections of audits by US accounting firms and published its findings in lengthy reports for each firm. It was a dramatic change from the pre-Enron days, when big firms chummily policed each other through an industry-run self-regulator.

“Many thought this new regulator was behaving a little aggressive,” said a former Deloitte partner.

In 2005, Deloitte promoted Schnurr to deputy managing partner, responsible for overseeing the firm’s massive network of auditors, determining how audits were conducted, and serving as the face of the firm in dealing with the new regulator.

After Schnurr’s promotion, Deloitte’s attitude toward the PCAOB hardened, according to former Deloitte executives and PCAOB officials. That view is supported by the public correspondence between Deloitte and the regulator. In the two years after Schnurr took over, Deloitte’s performance on annual inspections deteriorated. In both years, it led all big four accounting firms in audit failures, inspection reports show.