April 14, 2011

Financial Crisis: Senate Hearing Examines the Role of Accounting and Auditing

Last week, the Senate Banking Securities subcommittee held a hearing on the Accounting and Auditing Profession (here is all the written testimony; here’s archived video of the hearing). Jim Hamilton covered some of the proceedings in his blog – and here are some thoughts from The Center for Public Integrity.

Lynn Turner testified at the hearing and below are some of his thoughts about it:

I have been attending and/or testifying at these hearings since 1985. What caught my attention is how similar some of the testimony was to what one might have heard back then with respect to standard-setting, albeit the numbers on the standards have changed. There was almost no retrospective review of what had gone wrong – e.g., why had the FASB not fixed its broken standards for things such as off balance sheet and risk disclosures – before things ended up as they did? Senator Reed, who chaired the hearing, asked: why weren’t there any warning signals from auditors and – why were the problems with financial reporting allowed to go on for so long? He pressed the FASB for a response as to why – after Enron and Sarbanes-Oxley – did the FASB not get the problem with off-balance sheet debt fixed?

Anton Valukas stated during his oral remarks that accountants and auditors need to quit hiding behind materiality and start doing financial reporting based on ensuring transparency. It was noted the FASB has been urged to adopt a standard, similar to what the SEC has, that would require disclosure of material information if it is needed to keep the financial statements from being misleading. Senator Reed asked the Executive Director of The Center for Audit Quality if she would support that and in her response, she skipped around the question without providing an answer – so much for audit quality.

In addition, she was asked if she would support Congress permitting the PCAOB to make their enforcement proceedings public, similar to what the SEC does today. Again she did not respond to the question, saying the PCAOB enforcement process that goes through the SEC is public, which is absolutely not correct. Needless to say, any of the audit firms could make public their Part II of the PCAOB inspections but have refused to do so. Here is my own testimony.

As a sidenote, check out this letter to the SEC from the Institute for Management Accountants about the IASB due diligence process.

How Secrecy Undermines Audit Reform

As the NY Times’ Floyd Norris covered well in his recent column, new PCAOB Chair Jim Doty delivered this speech before the CII recently and said that the PCAOB had gone back and inspected the audits of many companies that later failed or were bailed out. Specifically, he stated: “In several cases — including audits involving substantial financial institutions – PCAOB inspection teams found audit failures that were of such significance that our inspectors concluded the firm had failed to support its opinion.”

Here is an excerpt from Floyd’s column:

That is, it should be noted, not the same as saying the financial statements were wrong. It is possible that the audit firm did not do enough work to know if the statements were accurate but that they would have been acceptable even to a proper audit. Moreover, as Mr. Doty noted, “Auditors were not charged with enforcing good risk management practices at financial institutions.” But they were supposed to make sure the statements reflected the conditions at the time. That appears not to have happened at Lehman Brothers, at least when it came to leverage, and it might not have happened at other banks.

Foreign Corporations: Subject to California Law Requiring Disclosure of Voting Results

From Keith Bishop of Allen Matkins and his “California Corporate & Securities Law” Blog:

In 2009, the Securities and Exchange Commission amended Form 8-K to require reporting companies to report shareholder voting results within four business days. How do shareholders in private companies get access to this information? While it seems likely to me that most states would allow shareholders to obtain this information pursuant to general common law or statutory inspection rights, California statutorily requires corporations to provide this information.

California’s Requirement

For a period of 60 days following a shareholders’ meeting, a corporation must upon the written request of a shareholder “forthwith” inform the shareholder of the result of any particular vote. Cal. Corp. Code § 1509. This requirement applies to both annual and special meetings. The corporation must disclose:

- The number of shares voting for,
- The number of shares voting against, and
- The number of shares abstaining or withheld from voting.

In the case of election of directors, the corporation is required to report the number of shares (or votes in the case of cumulative voting) cast for each nominee.

Foreign Corporations

Foreign corporations (i.e., corporations not organized under the California General Corporation Law) that are qualified to transact intrastate business in California are required to provide this information at the request of a shareholder resident in California. Cal. Corp. Code § 1510(a). According to the California Secretary of California, there are more than 80,000 foreign corporations qualified to transact business in California.

In addition to natural persons residing in California, a shareholder will be considered resident in California if it is a state bank, national bank headquartered in California or any retirement fund for public employees established or authorized by California law. Cal. Corp. Code § 1510(b). Even if the foreign corporation is not qualified to transact business in California, it can be subject to the disclosure requirement if it has one or more subsidiaries that are domestic corporations or foreign corporations qualified to transact intrastate business in California. Finally, California has expansive provisions for determining who is a shareholder for purposes of this requirement. Cal. Corp. Code § 1512.

- Broc Romanek