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SEC Chief Accountant Paul Munter released one of his insightful statements yesterday on the topic of fostering a healthy “tone at the top” at audit firms, and I think his guidance is applicable to other professional service organizations as well. Munter notes:

To be an effective public watchdog, audit-firm leadership must set the right tone at the top by always placing the public-interest obligations of our profession ahead of business interests and profits. Doing so is essential for educating and instilling in our young accountants the critical importance of acting ethically, with integrity and fidelity to the public trust in all our professional activities. These are core tenets of the accounting profession.

Munter highlights how tone at the top is particularly important in audit firms, noting:

For example, setting a proper tone at the top is critical in supporting auditors’ ability to exercise professional skepticism—having an attitude that includes a questioning mind and a critical assessment of audit evidence at all times. We understand that skepticism can prolong an audit by requiring auditors to obtain additional audit evidence and perform additional, but necessary, procedures to have sufficient appropriate audit evidence in support of the audit opinion. Such time pressures “can create an environment in which audit quality might be compromised if engagement team members, at any level, perceive that their individual performance is measured primarily by meeting time deadlines and budget estimates.” So in order for a less-experienced accountant on an engagement team to be empowered to exercise such skepticism, they need the unwavering support of engagement team and firm leadership, who should shield members of the engagement team from client pressure and resist the desire to wrap up an engagement quickly so that they can move on to the next book of business.

Tone at the top is also critical for having an effective quality control system. Leaders who understand and are dedicated to their role in protecting the interests of investors through adherence to professional ethics, values, and attitudes—and instilling those priorities in their employees—are the foundation of a strong quality control system.

So when firm leadership fails to set a strong tone at the top¬—for example, by sweeping mistakes and bad behavior under the rug, treating violations of law as isolated incidents or the “cost of doing business,” not holding wrongdoers throughout the firm and across service lines accountable, or changing their firm structures in ways that could pose future independence challenges for the firm with respect to its audit engagements—they risk eroding the firm’s culture, professional skepticism, quality control systems, and public responsibility as gatekeepers of our capital markets.

Munter’s statement goes on to recommend how to instill a healthy “tone at the top” into the organization, including taking appropriate actions rather than merely relying on a code of ethics, setting an appropriate example, integrating ethics and character into the firm’s hiring, retention, and promotion criteria, making professional integrity and an integral part of the promotion and compensation process, promoting candor and transparency and avoiding conflicts in the firm’s business structure (e.g., selling a portion of the firm to a third party).

If you are interested in the SEC Chief Accountant’s important role in shaping accounting and audit policy over the course of the SEC’s history, check out this exhibit that I curated for the SEC Historical Society.

– Dave Lynn