Securities and Exchange Commissioner Paul Atkins Dec. 5 urged that in its accounting enforcement actions, the agency is legally bound to rely only on formal rules and standards--not on informal accounting guidance.

Formal rules and standards, he said, are those that have been subject to the due process of notice and comment.

Failure of Self-Policing.

Speaking to the annual meeting of the American Institute of Certified Public Accountants in Washington, Atkins noted that an enforcement action can act as a "damper" on accountants in exercising their judgment. The commissioner also cautioned that the views of the staff accountants speaking at the conference or elsewhere should not be viewed as "binding law" unless they have been formalized by the commission.

The commissioner also spoke of the problem of "exploding" liability and costs for accountants and auditors. Atkins noted that it is possible for auditors to be "duped," and that it is not always the auditor who is at fault for a corporate fraud. "[C]ollusive fraud is so difficult to detect," he suggested at one point. "The problem that was decades in the making is susceptible to no easy solutions," he said of the liability issue. Litigation, Atkins said, "threatens to make this country a less attractive place to invest and to do business."

On the other hand, regulators stand ready to ensure that the law is enforced against accountants and auditors, he said. The PCAOB was created because the accounting profession "fell down on the job" of self-policing, Atkins reminded the AICPA gathering. He also cautioned, "The SEC will not shy away from taking enforcement action against accountants when their behavior warrants it."

Impact on Market.

Speaking of informal SEC guidance, Atkins said that the pronouncement of SEC accounting staff can have a significant impact and can affect the market. He pointed to Staff Accounting Bulletin (SAB) 101, on revenue recognition, as an example of staff guidance that was not formalized by the commission through a notice and comment process. Atkins suggested to reporters after his speech that the substantive issues of SAB 101 should have been handled by the commission as a rulemaking. There is a need for notice and comment because of litigation risk as well as to provide a basis for an enforcement action, he said.

Even if a regulation is formalized through the notice and comment process, Atkins told the large audience of accountants, "overly prescriptive standards can rob you of the ability to exercise your professional judgment." He suggested that Public Company Accounting Oversight Board Accounting Standard 2 (AS 2), on internal controls over financial reporting, may be an example of an overly prescriptive regulation. Atkins noted that a recent PCAOB report on the implementation of AS 2 found problems, including a "tendency to employ a bottom up approach," resulting in "more time than necessary to complete the audit" (37 SRLR 2011, 12/5/05).

Noting that in some instances outside auditors have claimed to find 20,000 or more key internal controls in a company, Atkins questioned whether that many internal controls could, in fact, be "key." Corporate executives and the outside auditor should be working "hand in hand" and not be in "hand-to-hand combat" in implementing Section 404, Atkins urged.

PCAOB Relationship.

Atkins also said that the SEC needs to continue to develop ways to oversee the PCAOB, with which it has a strong working relationship. The PCAOB must be monitored as a quasi-governmental agency and one with "de facto taxing authority," he said. Last March the SEC reviewed and approved the PCAOB's 2005 budget at a public meeting, and the commission expects to take up the 2006 PCAOB budget in a public meeting as well, he said (37 SRLR 429, 3/7/05).

In remarks to reporters, Atkins said that Bill Gradison, who has been named acting chair of the PCAOB, is not ruled out as a candidate for permanent chairman [See related report in this section]. In the process for choosing a successor to former PCAOB Chairman William McDonough announced by the SEC, the commission is likely to consult the chairmen of the SEC's oversight committees in Congress as well as the Federal Reserve Board and the Treasury Department, Atkins said.

In response to a question from the audience, Atkins said that the question of whether the SEC should defer or exempt nonaccelerated filers from Section 404 compliance is one being taken up by the SEC's Smaller Public Company Advisory Committee. He noted that the costs of Section 404 implementation for accelerated filers have been significantly greater than expected. "We cannot repeat those same mistakes with these smaller companies," he said. "We do have to get it right."

By Rachel McTague