oversight

GAO Forum on Governance and Accountability: Challenges to Restore Public Confidence in U.S. Corporate Governance and Accountability Systems

Published by the Government Accountability Office on 2003-01-24.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

               United States General Accounting Office

GAO            Comptroller General of the United States




January 2003
               GAO FORUM ON
               GOVERNANCE AND
               ACCOUNTABILITY
               Challenges to Restore
               Public Confidence in
               U.S. Corporate
               Governance and
               Accountability
               Systems




GAO-03-419SP
               a
                                                    December 9, 2002
              G A O
         Accountability Integrity Reliability
                                                    Governance and Accountability
Highlights
Highlights of GAO-03-419SP                          Forum Discussion

                                                    There was general agreement among the participants that the root causes of the
Why GAO Convened This                               accountability breakdowns are systemic in nature, complex, and will require
Forum                                               leadership and alterations to the current models in each of the four interrelated
                                                    areas to transition to an overall system that is more focused on protecting the
On December 9, 2002, GAO convened                   public interest and, in that regard, accountability. They also agreed that
a governance and accountability                     considerable actions have been taken and/or proposed towards achieving those
forum to discuss challenges facing                  objectives, but that having the “right people” and “stakeholders” involved was
regulators, the accounting profession,              critical to successfully achieve and effectively maintain the necessary reforms.
and boards of directors and                         Several other key observations follow:
management of public companies in
effectively implementing the
Sarbanes-Oxley Act of 2002 and                      •   Many boards of directors are reassessing their roles and responsibilities and
related regulatory actions to improve                   currently it is difficult to determine what is working and what is not
public confidence in U.S. corporate                     working.
governance and accountability
systems. Major accountability                       •   Participants agreed there is no “silver bullet” to enhancing the effectiveness
breakdowns in recent years,                             of boards of directors in their role of overseeing management and protecting
exacerbated in the last 2 years by the                  the public interest. However, for a board to effectively perform its
unprecedented massive breakdowns                        responsibilities, it must have the “right people” who possess an
and bankruptcy of Enron and                             “independent spirit” and are “knowledgeable” of the company/industry and
WorldCom, have contributed to the                       the company’s constituencies.
decline in investor confidence in U.S.
capital markets. The forum focused                  •   Little progress has been made moving toward a more comprehensive
on the four interrelated areas of                       financial reporting model that would include such information as operating
corporate governance, the financial                     and performance measures and forward-looking information about
reporting model, the accounting                         opportunities, risks, and management’s plans.
profession, and regulation and
enforcement that the accountability                 •   The impetus for changing the financial reporting model needs more
breakdowns have surfaced as critical                    involvement of investors and other users of financial information as the
areas to be strengthened.                               current model is too driven by those who have historically focused more on
                                                        the technical aspects of financial reporting, such as accountants, regulators,
Addressing these challenges will                        corporate management, and boards of directors.
involve the public, private, and not-
for-profit sectors. In general, there               •   An “artful blend” of principle-based and rule-based accounting standards, as
must be the proper incentives,                          well as a financial reporting model with different tiers of reporting that
transparency, and accountability                        provides full disclosure, are fundamental changes needed to improve the
mechanisms in place to ensure the                       financial reporting model.
effectiveness of any system. As a
result, these overarching principles                •   An “expectation gap” of what an audit is and what users expect continues to
were considered in connection with                      exist, especially with the auditor’s responsibility for fraud detection.
the issues discussed.
                                                    •   Supplementing the traditional financial statement audit with a “forensic
Forum participants included                             audit” as well as with a more informative auditor’s report could help to
individuals from federal and state                      narrow the “expectation gap.”
government, the private sector,
standards setting and oversight                     •   A strong, viable Securities and Exchange Commission is needed to maintain
bodies, and a variety of other                          investor confidence. Concern was raised that the Commission is not fully at
interested parties.                                     that status and that funding issues need to be resolved.

www.gao.gov/cgi-bin/getrpt?GAO-03-419SP.
                                                    •   The new Public Company Accounting Oversight Board needs to officially get
                                                        up and running with immediate priorities focusing on establishing policies
To view the full report, click on the link above.       and procedures for performing its disciplinary, inspection, and standard-
For more information, contact Jeffrey C.                setting functions.
Steinhoff, Managing Director, Financial
Management and Assurance, on (202) 512-
2600 or steinhoffj@gao.gov.
                                                                                                    United States General Accounting Office
Contents



Letter                                                                                                       1
                               Corporate Governance                                                          2
                               Financial Reporting                                                           3
                               The Accounting Profession                                                     4
                               Regulation and Enforcement                                                    5
                               GAO Observations                                                              6


Corporate Governance                                                                                        8
                               Defining the Roles and Responsibilities of the Board of Directors            8
                               Identifying the Right People to Serve on Boards                             10


Financial Reporting                                                                                        13
                               Little Has Changed with the Financial Reporting Model                       13
                               Current Financial Reporting Model Has Limited Value in Today’s
                                  Business Environment                                                     14
                               Considerations for Moving toward a Comprehensive Financial
                                  Reporting Model                                                          15


The Accounting                                                                                             18
                               An Expectation Gap Exists Concerning the Role of Auditing                   18
Profession                     More Attention Is Needed on the Quality of Audits                           21
                               Auditors Need to Strengthen Their Relationship with Others in the
                                 Corporate Governance Process                                              21


Regulation and                                                                                             23
                               Providing the SEC with Sufficient Resources to Restore Investor
Enforcement                      Confidence                                                                23
                               Reconsidering the Existing Approach to Enforcement Actions to
                                 Restore Public Confidence                                                 24
                               Establishing Priorities for the PCAOB                                       25


Appendixes
                 Appendix I:   GAO’s Governance and Accountability Forum                                   27
                               Participants                                                                27




                               Page i                         GAO-03-419SP Governance and Accountability Forum
A
United States General Accounting Office
Washington, D.C. 20548
                                                                                               Comptroller General
                                                                                               of the United States




                                    January 24, 2003                                                                      Leter




                                    The last 2 years witnessed major accountability breakdowns at Enron and
                                    WorldCom leading to significant restatements of financial statements and
                                    bankruptcy adversely affecting thousands of shareholders and employees.
                                    Unfortunately, such failures were not isolated instances as other
                                    accountability breakdowns in recent years included Qwest, Tyco, Adelphia,
                                    Global Crossing, Waste Management, Micro Strategy, Superior Federal
                                    Savings Banks, and Xerox. Although stakeholders of these companies were
                                    directly affected by the accountability breakdowns, these failures have
                                    cumulatively contributed to the general shaking of investor confidence in
                                    U.S. capital markets.

                                    Last year, on February 25, 2002, GAO held a forum to discuss systemic
                                    issues related to these accountability failures, such as corporate
                                    governance, accounting and reporting, and auditing.1 Since that time, major
                                    reform legislation has been enacted—the Sarbanes-Oxley Act of 2002—and
                                    regulators have proposed and/or finalized a number of new requirements to
                                    address issues related to the failures. However, much of the regulatory
                                    reform action is in process and experience will be needed to evaluate the
                                    effectiveness of the changes. Moreover, the changes to date do not address
                                    all the issues raised by the accountability breakdowns.

                                    On December 9, 2002, GAO convened a governance and accountability
                                    forum for the purpose of identifying past, pending, and proposed actions
                                    designed to protect the public interest by

                                    • identifying challenges to improving public confidence in U.S. corporate
                                      governance and accountability systems to assist regulators, the
                                      accounting profession, and boards of directors and management of
                                      public companies to effectively implement the Sarbanes-Oxley Act of
                                      2002 and other related regulatory actions and

                                    • placing special interest on steps designed to enhance independence of
                                      the corporate governance system and enhancing the
                                      accounting/auditing and attest/assurance models for the 21st century.




                                    1
                                     U.S. General Accounting Office, Highlights of GAO’s Corporate Governance,
                                    Transparency and Accountability Forum, GAO-02-494SP (Washington, D.C.: March 2002).




                                    Page 1                             GAO-03-419SP Governance and Accountability Forum
                       Specifically, the forum focused on four interrelated areas—corporate
                       governance, the financial reporting model, the accounting profession, and
                       regulation and enforcement.

                       The invited participants were from public, private, and not-for-profit
                       entities having extensive experience and subject matter expertise in the
                       accounting profession, corporate governance issues, financial reporting
                       and disclosure models, auditing, accounting, and related regulatory issues.
                       GAO also extended invitations to chairs and ranking minority members of
                       relevant Congressional committees. Over 40 invites attended. As agreed
                       with the participants, the purpose of the discussion was not to reach a
                       consensus, but rather to engage in an open, no attribution-based dialogue.
                       Therefore, this report summarizes the collective discussion and does not
                       necessarily represent the views of any individual participant or GAO.



Corporate Governance   The participants acknowledged that recent legislative and regulatory
                       reforms in response to issues raised by significant restatements of financial
                       statements and corporate failures were placing greater emphasis on the
                       roles and responsibilities of boards of directors. They noted that many
                       boards are reassessing their roles and responsibilities and, at this time, it is
                       difficult to determine what is working and what is not working.
                       Information on best practices of boards would be useful to help improve
                       board operations, for example in areas of improving communications with
                       management and using external advisors. However, participants generally
                       agreed that there is no “silver bullet” for enhancing the effectiveness of
                       boards of directors in their role of oversight of management and protecting
                       shareholders.

                       In discussing the role and responsibilities of boards of directors,
                       participants stated that it starts with having the right people on the board
                       who are independent, knowledgeable, and ethical and whose integrity is
                       unquestionable. The basic roles and responsibilities of the board were
                       defined as enhancing shareholder value, assessing and monitoring risk, and
                       ensuring management accountability. It was noted that boards need to do a
                       better job of identifying their constituencies and understanding and
                       addressing their concerns. In addition, board members have a
                       responsibility to educate themselves about the company’s operations and
                       plans and to seek advice of external experts, when and as appropriate.

                       Participants also focused on the roles of the nominating, compensation,
                       and audit committees noting that (1) nominating committees need to



                       Page 2                           GAO-03-419SP Governance and Accountability Forum
                      independently identify candidates for board membership rather than
                      “rubber stamp” management’s candidates, (2) compensation committees
                      need to focus more on achievements related to the company’s long-term
                      strategic objectives and less on short-term accomplishments, such as
                      meeting earnings projections, and (3) audit committees need to work more
                      effectively with the independent auditor as defined by the Sarbanes-Oxley
                      Act of 2002, and not get “tied up” in procedural matters concerned with
                      their legal liabilities as committee members.

                      Participants stressed that having the “right people” on the board was just as
                      important if not more so than having the right rules. In that respect, it was
                      noted that board members should possess an “independent spirit” to ask
                      the tough and probing questions of management. Participants stated that
                      the existing system for identifying board members might not always be
                      attracting the “right people.” For example, it was stated that some board
                      members are serving on too many boards to be effective, and that some
                      board members are serving for personal incentives that could adversely
                      affect their independence. Some participants believed that in today’s
                      environment, potential legal liabilities were adversely affecting finding
                      qualified board members. Other participants believed that there is no
                      shortage of qualified board members willing to serve and that the board
                      needed to look beyond the “list of usual suspects.”



Financial Reporting   The traditional financial statements, in terms of form and content, have not
                      changed much over the years. The financial reporting model uses a mixture
                      of historical costs and fair value to present a company’s transactions. This
                      model has value but fails to meet the broader range of information needs of
                      investors who want more forward-looking information and data that reflect
                      a company’s overall performance, risk profile, and expectations for future
                      performance.

                      Little progress has been made in moving toward a more comprehensive
                      reporting model that would include both financial information (financial
                      statements and related disclosures) and nonfinancial information (such as
                      high-level operating and performance measures used by management and
                      forward-looking information about opportunities, risks, and management’s
                      plans). Participants stated that the current model is too driven by
                      accountants, regulators, corporate management, and boards of directors
                      who have historically focused on the technical aspects of financial
                      reporting and are more likely to move slowly and cautiously in making




                      Page 3                          GAO-03-419SP Governance and Accountability Forum
                 changes. As a result, the current model has failed to get adequate “traction”
                 to move toward a more comprehensive reporting model.

                 Going forward, participants believed that the impetus for change to the
                 financial reporting model would have to come more from the investors and
                 other users of financial information who need timely, accurate, and useful
                 information to make value and risk judgments about publicly traded
                 companies. Also, a safe harbor for preparers and auditors of more forward-
                 looking information may be necessary to progress. Other suggestions by
                 participants included moving toward more principle-based accounting
                 rules to provide more substance versus form in reporting. There was
                 general agreement that (1) a combination of principle-based and rule-based
                 standards would be needed and (2) principle-based accounting rules were
                 not a panacea to solve financial reporting problems. In that respect, some
                 participants suggested that standard setters first needed to get the basics
                 right with the current financial reporting model, for example in areas such
                 as accounting for pensions, post-employment benefits, and pro-forma
                 financial statements, to help restore investor confidence. It was also
                 suggested that the financial reporting model have different layers of
                 reporting, while still having full disclosure, coupled with different levels of
                 assurances depending on users’ needs. Such layering would allow a user to
                 “drill down” to the level of detail needed.



The Accounting   An expectation gap between what an audit is and is not continues to exist,
                 especially with regard to the auditor’s responsibility for detecting fraud.
Profession       Some participants believed a periodic forensic audit may be needed to
                 supplement the traditional financial statement audit to assist in detecting
                 fraud. However, it was recognized that an audit cannot create precision or
                 certainty where such factors do not exist, as financial statements are not as
                 precise as users may believe. In addition, management and audit
                 committees have important roles and responsibilities for internal control to
                 prevent and detect fraud. The Sarbanes-Oxley Act of 2002 will help to close
                 the expectation gap concerning the effectiveness of internal control over
                 financial reporting by requiring management and auditor reporting on these
                 controls. Nonetheless, an expectation gap may still exist as users may be
                 expecting that an audit addresses internal control over the company’s
                 overall operations and performance. Educating users on the terminology of
                 internal control reporting, such as reportable conditions, was also urged so
                 that the users and capital markets do not over react in interpreting the
                 internal control reports.




                 Page 4                           GAO-03-419SP Governance and Accountability Forum
                 Participants suggested the need for a new reporting model for auditing, a
                 renewed focus on the quality of auditing, and building more effective
                 working relationships with the audit committee. It was recognized that the
                 standard auditor’s report could be made more useful to users who are
                 seeking greater information about what the auditor did and found, as well
                 as expanded assurances. Tiered reporting that would provide expanded
                 optional assurances was suggested. Participants stated that the quality of
                 audits can be adversely affected by “time and fee pressures” that lead to
                 less substantive auditing. Caution was also urged that rotation of audit
                 partners required by the Sarbanes-Oxley Act of 2002 does not have the
                 unintended consequence of adversely affecting the quality of audits
                 through loss of experience with a particular company’s operations and
                 financial reporting. It was recognized that confidence in audits needs to be
                 restored not only for investors, but also to attract and retain the best
                 people for the accounting profession over time.



Regulation and   A strong, viable Securities and Exchange Commission (SEC) is needed to
                 maintain investor confidence in the markets. Participants recognized that
Enforcement      the SEC’s resources had not kept up with its increased workload over the
                 years. This situation has adversely affected the SEC’s ability to adequately
                 enforce the securities laws and also its ability to invest in technology to
                 more efficiently manage its workload. Some participants suggested that the
                 SEC may wish to consider pursuing the status to operate independently in
                 setting its own funding levels, as the Federal Reserve does. It was also
                 suggested that the SEC needed to explore how it is using its enforcement
                 powers, as civil penalties may ultimately be hurting shareholders more
                 than those who have violated the securities laws. In that respect, the SEC
                 should reexamine the amount and targeting of its civil sanctions, its use of
                 criminal statutes, and working effectively with the Department of Justice to
                 put violators behind bars when appropriate.

                 The new Public Company Accounting Oversight Board (PCAOB) needs to
                 officially get up and running. Suggested priorities for the PCAOB included
                 establishing policies and procedures for disciplinary actions and
                 conducting inspections of registered public accounting firms. Also,
                 decisions need to be made on the setting of standards for auditing, quality
                 control, ethics, and independence. It was also suggested that the PCAOB
                 should evaluate the recent events that have affected the public’s confidence
                 in auditors to consider what further actions may be needed beyond those
                 mandated by the Sarbanes-Oxley Act of 2002 and recent regulatory changes
                 and proposals. In addition, the PCAOB needs to work cooperatively with



                 Page 5                          GAO-03-419SP Governance and Accountability Forum
                   the SEC and state boards of accountancy. The fragmentation of the
                   regulatory system for the public accounting profession was not completely
                   dealt with by the Sarbanes-Oxley Act of 2002. At a minimum, the PCAOB
                   will need to effectively work with the other public regulators on
                   enforcement/disciplinary matters. Participants generally believed that the
                   provisions of the Sarbanes-Oxley Act of 2002 should be implemented and
                   assessed before the Congress should consider adding any new legislative
                   requirements; however, participants agreed that much can and should be
                   done by other responsible parties, such as by regulatory and self-regulatory
                   bodies, within their existing authority.



GAO Observations   Restoring public trust and confidence in a manner that can be sustained
                   over the long-term will require concerted actions by a variety of parties,
                   including accounting and auditing standard setters, regulators,
                   management and boards of directors of public companies. The Sarbanes-
                   Oxley Act of 2002 provides a strong framework for more effective
                   corporate governance and regulation of the accounting profession. The
                   SEC and the stock exchanges, along with the Financial Accounting
                   Standards Board, have also been actively making progress to address a
                   range of issues raised by the accountability breakdowns. However, the
                   fundamental principles of providing the right incentives, providing
                   adequate transparency, and ensuring appropriate accountability are even
                   more important and relevant as the new structure and reforms are being
                   established.

                   It is important to recognize that rules alone will not effectively resolve the
                   problems that resulted in massive restatements of financial statements and
                   ultimately bankruptcy of certain public companies. The Congress cannot
                   legislate nor can regulators establish by rule human behavior or integrity to
                   always do the right thing in protecting the public’s interest. Public company
                   management needs to set the appropriate “tone at the top” and that culture
                   needs to be carried throughout the company and exhibited by the board of
                   directors in its oversight of management and in its protection of
                   shareholder interests.

                   The accounting profession needs to vigorously work to rebuild its greatest
                   asset—public trust—in order to restore faith in the integrity and objectivity
                   of the profession. Accounting and auditing standards need to be
                   reexamined to provide enhanced value to users of financial statements,
                   related disclosures, and more comprehensive business reporting. Users of
                   these products will need to step forward to help ensure the value of an



                   Page 6                           GAO-03-419SP Governance and Accountability Forum
enhanced financial reporting model and related auditor assurances for the
effective functioning of U.S. capital markets. Accountants and regulators
who have historically driven changes to the financial reporting model do
not have the same set of needs as users of financial statements. In that
respect, a broader performance and accountability reporting model is
needed and should include not just financial statements but also
performance and other information necessary to better assess institutional
value and risk.

GAO will continue to play a professional, objective, nonpartisan and
constructive role in assisting the Congress, regulators, and the accounting
profession as initiatives are proposed, agreed upon, and become
operational. In that respect, the views of the participants in this forum
represent considerable experience in the matters discussed and represent
one way in which an independent party, such as GAO, can assist those who
define and/or implement policy.

The results of the forum are organized by the major areas of discussion and
reflect subsequent comments we received from the participants on a draft
of this report. Appendix I provides a list of the participants.

For additional information on our work concerning corporate governance,
the accounting profession, financial reporting, and related regulatory
matters, please contact Jeffrey C. Steinhoff, Managing Director, Financial
Management and Assurance, on (202) 512-2600 or at SteinhoffJ@gao.gov.


I wish to thank each of the participants for taking the time to share their
knowledge and to provide their insights and perspectives on the important
matters discussed during the forum. I look forward to working with them
on these important issues of mutual interest and concern in the future.




David M. Walker
Comptroller General
of the United States



Page 7                         GAO-03-419SP Governance and Accountability Forum
Corporate Governance



Defining the Roles and    Recent legislative and regulatory initiatives, such as the Sarbanes-Oxley
                          Act of 2002, Securities and Exchange Commission (SEC) proposals and
Responsibilities of the   rules, and proposed revised stock exchange listing requirements, have
Board of Directors        addressed weaknesses in corporate governance exposed by the major
                          financial reporting issues raised by restatements and corporate failures,
                          placing greater emphasis on the roles and responsibilities of boards of
                          directors. Although these reforms are not yet fully in place and not all
                          issues have been addressed, many corporate boards are reassessing their
                          roles. However, participants agreed that there is no “silver bullet” and that
                          it is difficult at this time to say what is working and what is not working.

                          Participants believed that it is important to continue working toward more
                          effective boards of directors and discussed the importance of clearly
                          defining and, in some cases, redefining, the roles and responsibilities of the
                          board of directors of public companies as a significant measure to help
                          restore investor confidence in the market. The board has a responsibility to
                          enhance shareholder value, assess and monitor risk, and ensure
                          management accountability. In that respect, the operations of the boards
                          should reflect a culture that embraces these responsibilities. In addition to
                          focusing on what accountants, regulators, and corporate management and
                          boards of directors (the “supply side”) should do, boards need to focus
                          more on what investors and other users of financial information (the
                          “demand side”) want from corporate governance.

                          In order to fulfill its responsibility of effectively overseeing management,
                          the board must have a thorough understanding of the company, its business
                          model and related risks, corporate culture, and the various interests the
                          board represents. Participants believed that the board has a responsibility
                          to educate itself through the use of external advisors or other means and
                          not rely solely on information provided by management. This will better
                          allow the board to raise difficult questions and probe issues to provide
                          input on strategy, assess and manage risk, and hold management
                          accountable for its actions. The time frame needs to be very clear, as
                          creating value is a long-term, not a short-term, process. Investors are not
                          looking for quick schemes that endanger the company.

                          In addition to its responsibility to oversee management, the board also has
                          a responsibility to shareholders and other stakeholders of the company,
                          such as employees, creditors, and the public. Participants believed that
                          boards need to do a better job of identifying their constituencies and
                          understanding and addressing their concerns. For example, from the



                          Page 8                           GAO-03-419SP Governance and Accountability Forum
Corporate Governance




shareholders’ point of view, many believe that board structures have not
been working properly to both protect shareholders’ interests and grow
share value. We have become a nation of investors, and boards need to
focus attention on the fact that there has been a shift from shareholders not
only being individual investors but also institutional investors, such as
pension plans and mutual funds, which are acting as fiduciaries for others.
Institutional investors may have concerns different from those of individual
investors regarding expectations for corporate governance and the role of
the board of directors.

Participants also felt that boards needed to reexamine how they are
structured and how they operate. Many boards were not perceived to
function properly for investor protection, which is a negative reflection on
the entire corporate governance process. To some extent, deficiencies in
the functioning of boards may have been masked by the effect of a
flourishing market and may not have been readily apparent until market
downturns began to occur. It is incumbent upon boards to establish
processes that are appropriate and effective to restore investor confidence
rather than relying on a checklist approach to corporate governance.
Participants believed that information on best practices of boards would be
useful to help to improve board operations. Some best practices include
focusing on improving communications with management and using
external advisors. It was also suggested that boards should effectively use
the “gatekeepers” (auditors and audit committees) for help in the board’s
oversight of financial management and reporting activities of the company.

Independent committees of the board of directors, such as the auditing,
compensation, and nominating committees, play an important role in
effective corporate governance. Audit committees should not only oversee
both internal and external auditors, but also be proactively involved in
understanding issues related to the complexity of the business, and, when
appropriate, challenge management through discussion of choices
regarding complex accounting, financial reporting, and auditing issues. In
that respect, the role of the audit committee, which in some cases has not
been very active or effective in its oversight of management or auditors as
related to financial reporting, is evolving into not just financial
management oversight, but the overall aspects of the company’s financial
reporting, such as releases on earnings expectations and quarterly financial
reports. In addition, the Sarbanes-Oxley Act of 2002 defines a number of
audit committee responsibilities for the hiring, compensation, and
oversight of auditors. However, a serious concern exists over whether audit
committee members are focusing more on procedural matters to protect



Page 9                          GAO-03-419SP Governance and Accountability Forum
                        Corporate Governance




                        themselves from liability than on improving their competence and
                        effectiveness as a committee. Also, compensation committees need to
                        understand the implications of compensation to provide incentives for
                        management to do the right thing for the company and its shareholders
                        versus themselves. Compensation committees need to focus on executive
                        performance more related to the company’s long-term objectives rather
                        than just short-term business results. In addition, nominating committees
                        need to ensure that they identify the right mix of talent to do the job and
                        make it clear to candidates what is expected of them as a board member
                        rather than merely approving candidates identified by management. In that
                        respect, some participants stated that boards are often made up of
                        consensus builders and, in that case, a dominant member of the board
                        could effectively control the board’s agenda.

                        Participants also discussed the importance of providing reasonable
                        transparency of key information, with regard to both financial information
                        of the company and board operations. Boards need to focus on enhancing
                        the quality and reliability of financial reporting, identifying key elements of
                        disclosure, and ensuring that such information is appropriately disclosed to
                        investors and the public. Participants also believed that there is a need for
                        better transparency of board activities to help restore investor confidence,
                        such as reporting on the board’s progress against best practices of leading
                        companies2 noted for the effectiveness of their boards. If the board is not
                        following best practices, it should report why it is not following these
                        practices. The point was also made that successful companies have
                        reinvented themselves through two fundamental focuses—ethics/integrity
                        and respect for people. These behaviors have been demonstrated by long-
                        term successful companies.



Identifying the Right   Participants stressed the importance of independence, both in fact and
                        appearance, as essential for the board to be able to fulfill its
People to Serve on      responsibilities. Participants expressed the belief that having the right
Boards                  people on the board is just as important if not more so as having the right
                        rules under which the board operates. Nominating committees need to
                        identify competent individuals who possess an “independent spirit” which
                        allows board members to raise difficult questions and probe issues related


                        2
                          One source of information on best practices of leading companies is the 1999 Report and
                        Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of
                        Corporate Audit Committees.




                        Page 10                               GAO-03-419SP Governance and Accountability Forum
Corporate Governance




to management’s decisions to ensure that the company operates honestly
and effectively in the shareholders’ interest. Even if board members are
independent, they can be ineffective as directors if they lack expertise or
knowledge relevant to the company and its business. Therefore, board
members must also be willing to educate themselves about the company
and the risks it faces rather than relying on a checklist mentality of
corporate governance requirements issued by the stock exchanges.

Participants also noted that unfortunately, as a result of the recent major
financial reporting issues leading to restatements and, in some cases,
bankruptcy, board members have focused on the rules and may be
concerned more about their personal reputation and financial liability
rather than focusing on protecting shareholders’ interests and adding
shareholder value. Participants expressed concern that disincentives such
as legal liabilities, including financial and reputation risks, may limit a
board’s ability to attract the right people to serve over time.

Participants raised the question whether the current system of selecting
directors needs to be reexamined because the existing system from a
shareholders’ point of view has not been working to get the right people on
boards. For example, it was viewed that individuals who serve on
numerous boards at the same time and/or who serve for personal
incentives, over time lose the “independent spirit” needed to be an effective
board member. Participants also stated there is some evidence that the
recruiting of directors is being adversely affected by the current
environment that is placing ever-increasing demands on board members.
Examples were cited of increased premiums for finding qualified board
members and such searches needing to identify 15 candidates for a board
position just to get one who is willing to serve. Other participants
commented that there is no shortage of qualified people to serve on boards
of directors. Many people are willing to serve higher goals and the selection
process needs to go beyond “its usual pool of suspects.” Some participants
suggested that perhaps serving as a director on a board should be a salaried
position if shareholders were willing to bear the cost. Other participants
noted, however, that having salaried board members could be problematic
because shareholders would have to be able to hire and fire the directors
that would cause great instability and salaried board members may also
lack an “independent spirit.”

Participants also discussed the appropriateness of the chief executive
officer (CEO) serving as chairman of the board of directors, which could
present potential conflicts resulting from a single individual functioning in



Page 11                         GAO-03-419SP Governance and Accountability Forum
Corporate Governance




these dual roles. Some participants believed that separation of the CEO and
chairman of the board positions recognizes the differences in their roles
and eliminates conflicts in functions. For example, management is
responsible for the operations of the company and members of the board in
their oversight function should have the ability to challenge the CEO in
managing the company. Although the corporate governance community in
the United States may not currently be receptive to requiring the separation
of the CEO and the chairman of the board, such a practice does exist in the
United Kingdom, where apparently there is more receptivity. Therefore,
regulators may need to look beyond the United States to consider the merit
of whether these positions should be held by different individuals.

Other participants pointed out that not allowing the CEO to also serve as
the chairman of the board of directors does not guarantee that problems
will be avoided if the board lacks an independent spirit to question
management, citing such examples as Enron, Global Crossing, and
WorldCom, all of which had a separate CEO and chairman. Some
separations of the CEO and chairman functions are successful and others
are not. A CEO may lose authority when the position is too diluted. United
States firms have been successful because they have had strong leaders
running them, and an effective and strong board of directors can
counterbalance a strong executive.




Page 12                         GAO-03-419SP Governance and Accountability Forum
Financial Reporting



Little Has Changed   Participants commented that traditional financial statements, in terms of
                     their form and content, have not really changed over the years. The model
with the Financial   we have today can be traced all the way back to the early 1970s (back to
Reporting Model      the Trueblood Committee).3 Participants attributed this lack of change to
                     the financial reporting model being largely driven by the supply side, that is
                     accountants, regulators, and corporate management and boards of
                     directors. Participants referred to a landmark study on financial reporting
                     by the Jenkins Committee4 as evidence that little has changed. Participants
                     acknowledged that accounting standards have changed to capture fair
                     value in addition to historical value, resulting in a model that is now a
                     mixture of the two, whereas the original financial statement model was
                     based solely on historical costs. However, the majority of the Jenkins
                     Committee’s recommendations never got any “traction” to move them
                     forward. The Financial Accounting Standards Board (FASB) has many of
                     these items on its agenda. At the same time, there are many other items on
                     FASB’s agenda. Participants felt that if stakeholders were serious about
                     improving the financial reporting model, a group would be established and
                     funded specifically for this purpose. Participants stated that such a group
                     was proposed by the Jenkins Committee, but it was never established.
                     There needs to be a sense of urgency in order to make the investment,
                     commitment, and ultimately change the model. However, one participant
                     questioned that since almost 10 years have gone by since the Jenkins
                     Committee made its recommendations, is there really a demand for
                     change?




                     3
                       The Trueblood Committee (named after the chairman), a group formed by the American
                     Institute of Certified Public Accountants (AICPA) to study the objectives of financial
                     reporting, recommended financial statements that set forth the objectives of financial
                     accounting and reporting and provided a conceptual framework for deliberations about
                     accounting matters. (See the AICPA’s Objectives of Financial Statements, Report of the
                     Study Group on the Objectives of Financial Statements, October 1973.)
                     4
                      The Jenkins Committee (named after the chairman), a group formed by the AICPA in 1991
                     to address concerns over the relevance and usefulness of financial reporting, recommended
                     in its 1994 report that standard setters develop a comprehensive reporting model that
                     includes both financial information (financial statements and related disclosures) and
                     nonfinancial information (such as high-level operating data and performance measures used
                     by management, management’s analysis of changes in financial and nonfinancial data, and
                     forward-looking information about opportunities, risks, and management’s plans). (See the
                     AICPA’s Improving Business Reporting—A Customer Focus: Meeting the Information
                     Needs of Investors and Creditors, Comprehensive Report of the Special Committee on
                     Financial Reporting, 1994.)




                     Page 13                              GAO-03-419SP Governance and Accountability Forum
                      Financial Reporting




Current Financial     Some participants agreed that financial statements are an important aspect
                      of overall business reporting, but were concerned that the existing model
Reporting Model Has   focuses too much on financial statements rather than on the broad range of
Limited Value in      information that is needed by investors to make good financial decisions.
                      Other participants commented that financial statements that exist today,
Today’s Business      while they may be useful to some, are not used very much by investors.
Environment           Financial statement disclosures are difficult to understand, as though
                      written in a “foreign language.” Participants stated that the disclosures
                      must be made more understandable.

                      However, there is a lot of dialogue taking place today concerning business
                      reporting. For example, regulators are asking what should be disclosed,
                      what is the purpose of financial statements, and how useful are they? What
                      are analysts doing with financial statements? What do analysts use to value
                      stock? Are they using financial statements? If so, what information in the
                      financial statements are they using to value stock? What additional
                      information would assist them in more accurately valuing stock?
                      Participants noted the need to report information about the business
                      model, as users of financial reports first must better understand the entity’s
                      business model in order to comprehend financial and nonfinancial
                      information about the entity.

                      Financial statements today focus on reliability much more than on
                      relevance. Historical information is reliable, but not necessarily relevant.
                      Fair value information is evolving but improvements in reliability are
                      needed. Participants agreed that reliability is fundamental to useful
                      business reporting; however, participants felt that financial reporting
                      would be much more useful if it were expanded to include key
                      performance indicators and measures (including disclosures on how the
                      key measures were chosen). Participants raised questions about the gaps in
                      reporting of intangibles. For example, in a knowledge-based economy, one
                      could argue that the most important assets are people (human capital);
                      however, current financial reporting records investments in people as an
                      expense and liability. Participants agreed that it would be useful if financial
                      reporting recognized people as assets, but raised the difficulty in valuing
                      human capital. Participants generally agreed that there is a demand for
                      both historical and fair value reporting. However, participants felt that
                      FASB needed to better differentiate between the two. In that respect, some
                      participants felt that FASB is marching toward a “fair value” path and
                      cautioned that the fair value reporting model is not always good and needs
                      to be used only where it really makes sense.



                      Page 14                          GAO-03-419SP Governance and Accountability Forum
                      Financial Reporting




                      Participants acknowledged that financial reporting, in addition to being
                      largely driven by the accounting profession, also has been driven by the
                      legal system, resulting in an overload of information that is too complex
                      and not easily understood. Disclosures that run on for pages are not
                      understandable. Experts are needed to interpret the disclosures and
                      sometimes even they cannot decipher what is being reported. However,
                      participants understand that accountants are taking a risk when they issue
                      an opinion on the financial statements. The litigious environment has also
                      led to a “check box” mentality where it is more important to follow the
                      accounting rules when preparing financial statements than actually
                      reporting the economic substance of the transaction.



Considerations for    Participants generally agreed that financial statements are not designed to
                      serve all business needs and that other types of business reporting are
Moving toward a       needed to assist investors and other users in making decisions. Participants
Comprehensive         also generally agreed that the demand side (investors and other users of
                      financial information), has not been as involved as it needs to be to make
Financial Reporting   financial reporting more meaningful and understandable. More needs to be
Model                 done to convince investors and other users to demand different reporting.
                      Voluntary disclosures are rare and only in industries that demand this type
                      of information. The voluntary process has resulted in some movement
                      toward better reporting, but it is very slow moving. Change is going to have
                      to come from the demand side and is going to require a lot of leadership
                      from very influential people. Input from advisory councils may also be
                      beneficial for developing a broader business reporting model. While it is
                      essential that a new model not be driven totally by the supply side
                      (accountants, regulators, corporate management, and boards of directors),
                      there cannot be a disconnect between the supply and demand sides.

                      Participants also cautioned that we need to move forward patiently toward
                      a new comprehensive reporting model. It was viewed that forward, real-
                      time, qualitative information, all of which would be helpful in predicting
                      future cash flows, may require a safe harbor from liability. It is also
                      important to keep in mind the role of the regulator in this process since the
                      public needs to have confidence in the regulators to enforce rules.
                      Regulators may not be totally supportive of a more comprehensive
                      business model because they are concerned that the information would be
                      based on a lot of judgment and, therefore, lack of precision, which could
                      make enforcement of reporting standards difficult.




                      Page 15                         GAO-03-419SP Governance and Accountability Forum
Financial Reporting




Participants discussed the lack of investor confidence in the current
financial reporting model and the need to first improve the reliability of
financial reporting before adding any new reporting. First, get the basics
right, that is, the “blocking and tackling” of financial reporting. Participants
cited accounting for pensions, postemployment benefits, and pro-forma
financial statements as examples of accounting treatments that need
attention before building on any new reporting requirements. Issuers of
financial statements who are inappropriately bending the current
accounting rules need to know they cannot get away with this anymore.

Participants discussed the merits of replacing accounting rules with
principle-based standards to promote more substance versus form in
reporting. However, some participants cautioned that principle-based
standards should not be viewed as a panacea to solve the problems with
financial reporting and could lead to an undesirable situation where you
would not have comparability or agreement as to the treatment of similar
transactions. Also, stakeholders may not interpret principles consistently,
and it is important for stakeholders to have the same conceptual
framework as preparers when interpreting a principle. In addition, you
would need the right kind of implementation guidance to carry out a
principle. Participants agreed that while accounting rules are also needed,
there should not be such blind adherence to accounting rules to result in
reporting form over substance. Participants offered that an “artful” blend of
both principles and rules would be useful. The Employee Retirement
Income Security Act (ERISA) was cited as an example of an approach that
blended both a principles-based (general fiduciary standards) and rules-
based (prohibited transactions) approach to an important issue (retirement
security).

Participants also discussed the idea of exploring different levels or layers
of reporting while still having full disclosure. Such layering will allow users
to get only the information they need. For example, the basic level of
reporting would include performance and risk data, an industry layer could
include benchmarking information, and a company specific layer could
include information management feels it is appropriate to disclose that is
not contained in other layers of reporting. Along with this idea is the need
to explore different levels of verification or assurances by independent
parties based on the users’ need for such verification or assurances. For
example, what type of assurances are needed for nonfinanical information
and can auditors provide such assurances? Overall, it is critical to get the
demand side (investors and other users of financial information) to weigh
in on what information they need and want. It is not realistic to only expect



Page 16                          GAO-03-419SP Governance and Accountability Forum
Financial Reporting




the supply side (accountants, regulators, and corporate management and
boards of directors) to come up with the best solutions for improving the
financial reporting model.

Although time did not permit its discussion, financial literacy was raised as
an important issue that needs addressing. Participants agreed that there
clearly is a need for more education and for investor assistance in this area.




Page 17                          GAO-03-419SP Governance and Accountability Forum
The Accounting Profession



An Expectation Gap      The participants discussed the auditor’s responsibility for detecting fraud
                        and the meaning of the assurances provided by the auditor’s report on the
Exists Concerning the   financial statements. These issues have continued to plague the accounting
Role of Auditing        profession since the 1970s despite actions taken by the profession to
                        narrow the so-called “expectation gap” between what the public expects or
                        needs and what auditors can and should reasonably be expected to
                        accomplish.5 Users often equate a clean audit opinion with a seal of
                        approval that fraud does not exist and annual reports are both complete
                        and accurate. However, auditors do not provide absolute assurance and the
                        scope of the opinion is limited to certain financial-related information. One
                        participant explained that there are a lot of things an audit cannot do. For
                        example, an audit cannot create certainty in an environment where there is
                        no certainty. An audit cannot guarantee precision in an environment where
                        estimates are made. An audit cannot ensure that stock prices will be
                        achieved. We cannot lose sight of the fact that in a risk-taking environment
                        businesses do fail. Auditing is not the “be all” and “end all” to solve the
                        problems in the business place. However, participants generally agreed that
                        while the accounting profession needs to take additional steps to address
                        any misunderstanding as to the limits of an audit, there is room to improve
                        the audit process and auditor reporting.




                        5
                        We reported on this issue in The Accounting Profession: Major Issues: Progress and
                        Concerns (GAO/AIMD-96-98, Washington, D.C.: Sept. 24, 1996).




                        Page 18                              GAO-03-419SP Governance and Accountability Forum
The Accounting Profession




Participants recognized that management has the responsibility for
preventing and detecting fraud. At the same time, they agreed that it is fair
to expect auditors to provide “reasonable assurance” of detecting any
material fraud. Participants discussed the need to mitigate the opportunity
and risk for fraud by educating boards of directors and ultimately changing
the tone at the top of the company. Some participants liked the idea of
auditors periodically performing more of a “forensic-type” audit6 in which
auditors would be more skeptical of management, but cautioned that this
approach could have a negative effect on audit quality because
management and the auditor might not work as actively together on an
ongoing basis. Participants agreed that an adversarial relationship between
the auditor and management would not be constructive in that the
cooperation of management is critical to both an effective and efficient
audit. However, participants agreed that auditors should be more skeptical
and should say no and walk away from clients more often than they
currently do. The participants applauded the deterrent put in place by the
Sarbanes-Oxley Act of 2002, which sends a signal that persons who prepare
or attest to fraudulent financial statements can go to jail. This deterrent has
raised awareness and conscientiousness within all levels of the financial
reporting and auditing process as to the significance of their job in
preparing financial statements.




6
  The concept of forensic auditing was recently suggested by the Panel on Audit
Effectiveness to improve the likelihood that auditors will detect fraudulent financial
reporting (see The Panel on Audit Effectiveness Report and Recommendations, Aug. 31,
2000). Forensic auditing, as explained by the Panel, would require that auditors undertake
an attitudinal shift in their degree of skepticism and presume the possibility of dishonesty at
various levels of management, including collusion, overriding of controls, and falsification
of documents.




Page 19                                 GAO-03-419SP Governance and Accountability Forum
The Accounting Profession




Participants generally viewed the new internal control reporting
requirements of the Sarbanes-Oxley Act of 2002 as a good requirement. A
participant added that earlier mandatory internal control reporting
probably would have surfaced problems with ineffective boards of
directors and audit committees.7 However, participants cautioned that
reporting only on internal controls over financial reporting could lead to
more of a gap in what investors perceive as the scope of the auditor’s work.
For example, users of financial reports are interested in a company’s
overall performance and outlook and, accordingly, would be interested in
the effectiveness of internal control over the process that produces that
data. In that respect, participants also discussed the need for auditors to
expand their focus on internal control to include controls over
performance data in order to better meet the needs of investors for
assurances on financial statements and for understanding all business
risks. Also, new information not only needs to be useful, but also needs to
be understood by investors. For example, investors do not understand
terminology such as “reportable conditions,”8 which could result in
investors over- or under-reacting to problems. Participants also suggested
that the one-page audit opinion should be replaced with “tiered” reporting
of audit results, where firms can obtain the level of assurance they desired.
For example, in today’s environment, audit committees would most likely
ask for the deepest “tier” of audit reporting to better carry out their
responsibilities.

Participants generally agreed that the profession needs a new reporting
model for audits to eliminate the misunderstanding as to what an audit of
financial statements is and what its limits are. The participants
acknowledged that the financial audit process is largely driven by the
accounting profession and suggested that the profession needs to spend
more time understanding what the demand side (investors and other users
of financial information) needs and wants from auditors. However, the
participants recognized that one of the big obstacles for innovation in


7
  This comment was based on the standards and guidance contained in Internal Control-
Integrated Framework, published by the Committee of Sponsoring Organizations (COSO)
of the Treadway Commission, for reporting on the effectiveness of internal control, which
addresses a company’s control environment including boards of directors and audit
committees.
8
 The AICPA’s Generally Accepted Auditing Standards defines a reportable condition as a
significant deficiency in the design or operation of internal control that could adversely
affect the entity’s ability to record, process, summarize, and report financial data consistent
with management’s assertions in the financial statements.




Page 20                                 GAO-03-419SP Governance and Accountability Forum
                        The Accounting Profession




                        reforming the audit process and auditor reporting is the auditor’s fear of
                        legal liability. One participant added that the current regulatory structure
                        has dampened the profession’s spirit for innovation.



More Attention Is       Participants commented that there are good solid audits being performed;
                        however, some participants expressed concern that overall, time and fee
Needed on the Quality   pressures both from company management and from within the auditing
of Audits               firms have resulted in less and less auditing, particularly less substantive
                        testing of transactions. In that respect, the financial audit is considered the
                        “loss leader” in many audit organizations with a focus on cutting hours and
                        costs and as a means to obtain consulting engagements. Some participants
                        also pointed out that most of the auditing is currently being performed by
                        inexperienced auditors. Further, several participants cautioned that the
                        auditor rotation rules currently being developed by the regulators could
                        further reduce audit quality by resulting in a loss of continuity, experience,
                        and technical knowledge on an audit.

                        Participants felt that the profession needs to elevate and restore the
                        importance and the quality of the financial statement audit. Participants
                        stated that the accounting profession needs to candidly discuss what it is
                        doing to improve the audit process to restore public trust. Further, a
                        growing concern for the profession is its ability to attract and retain the
                        best people over time. It was stated that auditors frequently leave the
                        profession early in their careers to join clients, and that over half of CPAs
                        are not practicing public accounting. One participant added that the
                        interest in the profession over the past 10 years has dropped by half,
                        although the recent publicity stemming from Enron and WorldCom, albeit
                        negative, has actually sparked increased interest in the profession.
                        Participants generally agreed that the profession needs to aggressively
                        address the issue of attracting the best people to the profession.



Auditors Need to        Participants generally agreed that improvements in corporate governance
                        will bring about improvements in auditing. It was viewed that one of the
Strengthen Their        more positive outcomes of the Sarbanes-Oxley Act of 2002 is the
Relationship with       relationship the act establishes between the auditor and audit committee
                        by making the audit committee in essence the client, versus company
Others in the           management. Historically, participants felt that auditor communication
Corporate Governance    with audit committees has been variable. Participants generally agreed that
Process                 auditors should be able to speak more freely, openly, and honestly with



                        Page 21                          GAO-03-419SP Governance and Accountability Forum
The Accounting Profession




audit committees on risks facing the company and on the appropriateness
of the company’s accounting policies. Audit committees should be
demanding more information from auditors and asking auditors if they
have sufficient resources, both in number and expertise, to adequately
perform the audit. Audit committees and auditors together can become
good safeguards for investors. A point was also made that the role of the
internal auditors, specifically their cooperation and coordination with the
external auditors and the board of directors, should be improved, which
ultimately could improve the quality of financial reporting and the external
audit. In addition, disclosures, such as those required to be reported to the
SEC on Form 8-K,9 should be improved to be more transparent and helpful
to regulators in determining the reasons and circumstances surrounding
auditor changes.




9
 An SEC registrant must file a Form 8-K when its external auditor resigns, declines to stand
for reelection, or is dismissed.




Page 22                                GAO-03-419SP Governance and Accountability Forum
Regulation and Enforcement



Providing the SEC with    Participants uniformly agreed that the nation needs a strong, viable SEC to
                          instill investor confidence in our markets. The SEC plays an important role
Sufficient Resources to   through its responsibilities to regulate activities of public companies and
Restore Investor          their auditors and to conduct related enforcement actions, as well as to
                          establish and sustain the new Public Company Accounting Oversight Board
Confidence                (PCAOB) established by the Sarbanes-Oxley Act of 2002 until the PCAOB is
                          certified by the SEC as ready to operate. However, participants noted the
                          SEC may not have been provided with sufficient resources to achieve such
                          results. For example, participants stated that the SEC has recently been
                          operating on a budget of about $450 million.10 It was noted that although
                          the Senate authorized about $750 million for the SEC for fiscal year 2003,
                          an amount that the Senate believed would be sufficient to implement
                          provisions of the Sarbanes-Oxley legislation to restore investor confidence,
                          the Office of Management and Budget only proposed a funding level of
                          about $500 million.

                          Participants believed that a lack of sufficient funding provides constraints
                          in two areas that are vital to the SEC—staffing and technology. To carry out
                          its important function of restoring investor confidence, the SEC may not
                          always be able to attract the right people and retain them under the existing
                          structure. In addition, to effectively conduct its reviews of public
                          companies, the SEC will require a large technology investment and related
                          training of SEC staff. Participants questioned whether, given the current
                          funding restraints, existing models for generating revenues for the SEC
                          were workable. Participants believe that models that provide temporary
                          resources to SEC, such as through fellowships from the accounting
                          profession, are not the answer to its funding and staffing problems and can
                          raise conflict of interest issues. Accordingly, some participants believed
                          that it is time to think about having the SEC operate independently in
                          setting its own funding levels, like the Federal Reserve, and to let the SEC
                          determine and set its own fees, with industry participation, for the
                          activities it conducts. If the SEC were able to establish its own annual
                          budget and collect fees, the SEC would be better able to conduct its


                          10
                           Prior GAO reports and testimonies discuss SEC resource issues and the need for the SEC
                          to improve its strategic planning to more effectively manage its operations and limited
                          resources. See U.S. General Accounting Office, SEC Operations: Increased Workload
                          Creates Challenges, GAO-02-302, Washington, D.C.: Mar. 5, 2002) and U.S. General
                          Accounting Office, Protecting the Public’s Interests: Considerations for Addressing
                          Selected Regulatory Oversight, Auditing, Corporate Governance, and Financial Reporting
                          Issues, GAO-02-601T, Washington, D.C.: Apr. 9, 2002).




                          Page 23                             GAO-03-419SP Governance and Accountability Forum
                       Regulation and Enforcement




                       activities, attract the best people, and enhance its technology to more
                       efficiently and effectively operate. Participants noted that even if the SEC
                       were independent regarding its funding, the Congress could still oversee
                       the SEC.



Reconsidering the      Participants discussed the importance of effective SEC enforcement
                       actions as a means of restoring investor confidence in the markets. The
Existing Approach to   SEC tries to create deterrence and be measured in imposing sanctions. If
Enforcement Actions    there are no clear negative consequences to securities violations or
                       wrongdoing, investors may perceive that the system is not working
to Restore Public      properly. Although the SEC has an array of sanctions available, all SEC
Confidence             enforcement actions are civil based, which ultimately results in
                       shareholders bearing the burden of the costs of legal proceedings and
                       sanctions. Some participants believed that shareholders were benefiting
                       from litigation and questioned the appropriateness of civil-based
                       enforcement actions, citing the fact that shareholders have already been
                       financially hurt by the actions that lead to the sanctions. Participants also
                       discussed whether the right people were being held accountable and
                       whether the SEC’s civil-based enforcement actions were sufficient to
                       discourage the bad actors.

                       Participants raised questions about whether the SEC should reconsider the
                       amount and targeting of its civil sanctions and more frequently use other
                       types of remedies, such as criminal sanctions, to hold people accountable
                       for wrongdoing. In that respect, participants noted that the SEC should be
                       effectively using the option of referring cases when appropriate to the
                       Department of Justice for investigation for possible violation of criminal
                       statues. Participants questioned how well that process was working.

                       The Sarbanes-Oxley Act of 2002 provides for additional enforcement
                       authority for both the SEC and the newly created PCAOB. In response to
                       the question of whether the Sarbanes-Oxley Act of 2002 should be revisited,
                       participants believed that although ultimately some technical changes to
                       the act may be necessary, the SEC and the PCAOB needed to move forward
                       to implement the act. Also, the SEC and the PCAOB should explore
                       integrating their activities to get the new enforcement mechanisms in place
                       to determine how well they may address some of the issues discussed.




                       Page 24                          GAO-03-419SP Governance and Accountability Forum
                          Regulation and Enforcement




Establishing Priorities   Participants believed that the PCAOB needs to be quickly set up and
                          establish its priorities so it can begin the difficult task of restoring public
for the PCAOB             confidence. Many participants believed that the PCAOB's most immediate
                          priority should be implementing a disciplinary process to let the public
                          know that failed auditing will be dealt with and trust can be restored. The
                          disciplinary process needs to have the necessary incentive measures to
                          serve as preventative measures before problems can become more serious.
                          Other immediate priorities should be setting up an inspection function of
                          auditors that audit SEC registrants and determining how standards that
                          govern the work of the accounting profession, such as auditor
                          independence rules and standards for conducting audits, should be set.
                          Some participants believed that the existing inspection process could be
                          improved by looking less at the accounting firms’ internal systems for
                          quality control and more at the quality of the judgments that were made by
                          the auditors in conducting the audit.

                          Participants also believed that the PCAOB also needs to evaluate the events
                          that have lead to the lack of public confidence in the markets and take a
                          fresh look going forward. For example, the PCAOB should consider the
                          reasons the accounting profession is organized the way it is, including
                          federal/state regulation such as the licensing structure, reasons accounting
                          firms practice as partnerships, the effects of private litigation, and the
                          structure and role of the state boards of accountancy. Participants also
                          noted that the PCAOB should take advantage of the fact that under the
                          current environment no one has more motivation for getting “bad auditors
                          off the street” than the accounting firms themselves. The accounting firms
                          do remove “bad auditors,” but this is accomplished without publicity so
                          that their efforts are not well known.

                          Participants also believed that a challenge facing the new PCAOB will be
                          dealing with the complex relationship between federal and state
                          governments involved in regulating the accounting profession.11
                          Participants identified the need for better communication and sharing of
                          information between federal entities such as the SEC and the new PCAOB
                          and the state licensing and regulating entities. For example, states are often
                          hampered in their ability to take appropriate regulatory actions because

                          11
                           Our report, The Accounting Profession: Status of Panel on Audit Effectiveness
                          Recommendations to Enhance the Self-Regulatory System (GAO-02-411,
                          Washington, D.C.: May 15, 2002) discusses the various bodies that regulate the
                          accounting profession.




                          Page 25                          GAO-03-419SP Governance and Accountability Forum
Regulation and Enforcement




they do not get referrals from the SEC and the AICPA, or because those
organizations have made the information confidential. Also, ongoing
litigation impedes information flow. In addition, participants stated that
some states have been independently trying to address accountancy reform
and, in some cases, have proposed reforms that have gone further than the
Sarbanes-Oxley Act of 2002 because they feared that the federal
government would not act. This has led to additional inconsistency in
requirements between states.

Participants encouraged the SEC and the PCAOB to work closely with the
states in taking actions to restore public confidence and ensure an
appropriate degree of consistency needed for viable interstate commerce.
Some participants suggested that the PCAOB consider the banking industry
to provide examples of the integration of federal and state regulation and
lessons learned about that structure from the savings and loan and banking
crises. Participants noted that with increased globalization of businesses’
operations and the need for harmonization of accounting and auditing
standards, as well as the need for preemptive measures, there may be more
federal involvement such as the Sarbanes-Oxley Act of 2002.




Page 26                        GAO-03-419SP Governance and Accountability Forum
Appendix I

GAO’s Governance and Accountability Forum                                           AA
                                                                                     ppp
                                                                                       ep
                                                                                        ned
                                                                                          n
                                                                                          x
                                                                                          id
                                                                                           e
                                                                                           x
                                                                                           Iis




Participants   Tom L. Allen             Chairman, Government Accounting
                                        Standards Board

               Lawrence F. Alwin        President, National Association of State
                                        Auditors, Comptrollers, and Treasurers

               Raymond L. Bromark       Partner, Pricewaterhouse Coopers, LLP

               Roel C. Campos           Commissioner, U.S. Securities and
                                        Exchange Commission

               Richard E. Cavanagh      President and CEO, The Conference
                                        Board

               Peter Clapman            Senior Vice President and Chief
                                        Counsel
                                        Corporate Governance, TIAA-CREF

               James L. Cochrane        Senior Vice President, Strategy and
                                        Planning
                                        New York Stock Exchange

               J. Michael Cook          Retired Chairman and CEO, Deloitte &
                                        Touche, LLP

               Jackson Day              Acting Chief Accountant, U.S.
                                        Securities and Exchange Commission

               Daniel Dustin            Executive Secretary, New York State
                                        Board for Public Accountancy

               Michael Emen             Senior Vice President Listing
                                        Qualifications, NASDAQ

               William Ezzell           Chairman, Board of Directors,
                                        American Institute of Certified Public
                                        Accountants

               Stephen R. Ferrara       Assurance Practice Leader, BDO
                                        Seidman, LLP




               Page 27               GAO-03-419SP Governance and Accountability Forum
Appendix I
GAO’s Governance and Accountability Forum




Randy G. Fletchall                     Vice Chairman, Professional Practice
                                       Ernst & Young, LLP

Timothy P. Flynn                       Vice Chairman-Assurance Services,
                                       KPMG, LLP

Carl R. George                         CEO, Clifton Gunderson, LLP

Gaston L. Gianni, Jr.                  Vice Chairman, President’s Council on
                                       Integrity and Efficiency

G. William Graham                      Partner, Grant Thornton, LLP

Holly Gregory                          Partner, Weil, Gotshal, and Manges, LLP

Barbara Hafer                          Treasurer, State of Pennsylvania

Steve Harris                           Staff Director/ Staff Director/Chief
                                       Counsel Committee on Banking,
                                       Housing and Urban Affairs

Robert H. Herz                         Chairman, Financial Accounting
                                       Standards Board

Janice Hester-Amey                     Principal Investment Officer, CalSTRS

Wayne A. Kolins                        National Director of Assurance, BDO
                                       Seidman, LLP

Robert J. Kueppers                     National Managing Partner of
                                       Professional Practice, Deloitte and
                                       Touche, LLP

Congressman John J. LaFalce            Ranking Minority Member, Committee
                                       on Financial Services, United States
                                       House of Representatives

Phillip B. Livingston                  President and CEO, Financial
                                       Executives International




Page 28                            GAO-03-419SP Governance and Accountability Forum
Appendix I
GAO’s Governance and Accountability Forum




Robert Mednick                         Retired Managing Partner—
                                       Professional and Regulatory Matters,
                                       Andersen Worldwide

Barry C. Melancon                      President and CEO, American Institute
                                       of Certified Public Accountants

Jack Miller                            Vice Chairman, KPMG, LLP and
                                       Chairman, Comptroller General’s
                                       Advisory Council on Government
                                       Auditing Standards

Charles D. Niemeier                    Acting Chairman, Public Company
                                       Accounting Oversight Board

Nell Minnow                            Co-Founder, The Corporate Library,
                                       Former Partner, Lens Investment
                                       Management

Robert A.G. Monks                      Founder, Institutional Shareholder
                                       Services, and Former Administrator,
                                       Pension and Welfare Benefits
                                       Administration, U.S. Department of
                                       Labor

Aulana L. Peters                       Retired Partner, Gibson, Dunn and
                                       Crutcher, Former Commissioner, U.S.
                                       Securities and Exchange Commission

Gary John Previts                      Associate Dean, Undergraduate
                                       Programs, Department of Accounting,
                                       Case Western Reserve University

Charles J. Schoff                      Chairman, New York State Board for
                                       Public Accountancy

Navid Sharafatian                      President, California Board of
                                       Accountancy

A.W. “Pete” Smith Jr.                  President and CEO, Private Sector
                                       Council




Page 29                            GAO-03-419SP Governance and Accountability Forum
           Appendix I
           GAO’s Governance and Accountability Forum




           Stanley Sporkin                        Former Director of Enforcement, U.S.
                                                  Securities and Exchange Commission
                                                  and Former Judge for the U.S. District
                                                  Court of the District of Columbia

           Mike Starr                             Managing Partner, Assurance and
                                                  Advisory Services, Grant Thornton, LLP

           Richard Steinberg                      Senior Partner and Corporate
                                                  Governance Leader,
                                                  PricewaterhouseCoopers, LLP

           F. Michael Taylor                      President, National Association of Local
                                                  Government Auditors

           William D. Travis                      Managing Partner, McGladrey & Pullen

           James S. Turley                        Chairman and Chief Executive Officer,
                                                  Ernst and Young, LLP

           Paul L. Walker                         Board of Center for Continuous
                                                  Auditing Research Fellow and
                                                  Associate Professor, University of
                                                  Virginia




(194184)   Page 30                            GAO-03-419SP Governance and Accountability Forum
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