Accounting firm CEOs: review the financial reporting environment.

Establishment of the Securities Act and the U.S. Securities and Exchange Commission in 1933-4 sparked the beginning of the regulated audit, to help protect average people--the investors--and not the companies. The auditing profession has gone through much change, including the establishment of the Public Company Accounting Oversight Board (PCAOB), in response to the Sarbanes-Oxley Act of 2002. The PCAOB now regulates the audit firms in lieu of prior self-regulation, and dictates which services they can perform for clients.

As a special report for FEI's 75th anniversary, Executive Editor Ellen M. Heffes spoke with the current CEOs of the largest U.S. audit firms about their perspectives on changes in the nature of the relationships between their firms and CFOs. They were also asked to discuss significant changes in the profession, how they view the changes and what they expect in the future.

Each of the large audit firm CEOs has gone through the ranks--starting in audit and moving up the ladder to become the chiefs of their firms. So, they speak from their personal history and much quality experience.

Timothy P. Flynn, Chairman and Chief Executive, KPMG 

There are some fundamental principles that have always existed in the relationship with the CFO and the auditing partner or audit firm. One is that they both have an aligned interest in getting it right. And the second is they both have a responsibility to the shareholders of the business [and] the capital markets to do their job in a professional way.

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Clearly, Sarbanes-Oxley and some of the changes that took place in the environment in 2002 caused all to look at the relationship and make sure that there was a proper independence and the proper healthy skepticism on the part of all the parties involved. It took some time to work through that changed environment. We've always had a great relationship based on mutual trust with the CFO. As things evolved over 2002-04, that trust never wavered, but auditors had to bring a healthy degree of skepticism to the job. The relationship is still based on trust, but it is now what I would call "trust and verify. I trust you, but my job requires that I verify this fact."

As a profession, there was a time when we might have relied more on representations made by CFOs ... Today's "healthy degree of skepticism" may have put some short-term stress on the relationship, [yet] it has never impacted the mutual respect and trust that both parties have for the rules and responsibilities and the need to have the right level of independence.

There have been a lot of changes in business in the last 25 plus years that have impacted the roles of the auditing firm and the CFO, and we've worked together to tackle those changes and strengthen the roles we have in organizations. We now work for the audit committee, and with the CFO and management. This is a change in mindset brought about by regulatory change. There's no question about it.

Businesses have gone through different stages, and more complexity in accounting regulations has increased the need to have good, strong communications. As globalization and more decentralization of business have happened [along with] a stronger need for full internal control environments, there has been an even greater need to work together.

For the future of the auditing profession and relationships with clients, we will continue to have the aligned interest to get it right. There will be stress points on relationships as we deal with complex issues and complex global transactions that involve a great deal of judgment and experience. But the mutual respect will stay, and that will allow for transparent and open communication to achieve our objectives to get it right, on behalf of the audit committee, management, shareholders and the capital markets.

Looking at the trends of the last two decades--the globalization of businesses and the world--I believe that, over time, [they] will lead to a globalization of the auditing and accounting standards and the regulatory framework. It's inevitable, and we need to all work to shape that in the most constructive way. I am optimistic that it will happen in a constructive way.

Dennis M. Nally, U.S. Chairman and Senior Partner, PricewaterhouseCoopers LLP 

In terms of corporate governance, and the roles of boards and audit committees, Sarbanes-Oxley has brought about more cumulative change than during the prior 20 years. That's had a real impact on how independent auditors carry out their work.

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Historically, the reporting relationship was between the audit firm and the CFO, and "dotted-line" to the audit committee. Sarbanes-Oxley changed that dramatically. The reporting relationship is now directly to the audit committee. This doesn't say we don't have a fundamental working relationship with the CFO or management. The best way I can describe it is: auditors work with management, and for the audit committee.

Fifteen, 20 years ago the audit partner was the overseer of a lot of different types of services, not only the audit, but tax, consulting or financial advisory services. The changes in what audit firms can and cannot do for a client put a spotlight on the audit in a much more prominent way. In the past, the audit was viewed by some as a "loss leader." We were providing audit service, but we were also providing these other services. Every one of the firms was providing significant IT consulting services to our audit clients; we're now precluded from doing that, and rightly so, from an appearance standpoint.

This has forced the audit service to stand on its own. It has put a spotlight on the audit, on the quality of what we do. That has been positive. Part of the change we're all experiencing is the increased emphasis and focus on enhanced financial reporting and making sure that not only the registrants are getting this right, but the audit firms are getting it right. That's good, and that benefits the investor community well for the long term.

I believe CFOs and audit firms are aligned, even more so than five or 10 years ago, in terms of what we are collectively trying to accomplish--providing the right type of information to the investor community. Given the complexity of the rules, we all have a very strong incentive to get it right the first time; there's a huge penalty to pay when a company has to restate financial statements or correct things that were not done correctly the first time.

Sarbanes-Oxley is the most significant change to corporate reporting/corporate governance since the Securities Acts of the 1930s, and we ought to give it a chance to work. [Thus] I don't think we need more changes tomorrow. That doesn't mean that all the things that were addressed in Sarbanes-Oxley and some of the other rules that came out of the law are 100 percent right.

But, we ought to get some experience with it and then have meaningful discussions with the key constituents around what we have learned, what's working and what's not working--and what should change. It's important that external auditors and CFOs continue to work in a collaborative way, meaning that our interests are aligned, providing high-quality information to the capital markets that will ultimately benefit investors.

Edward E. Nusbaum, CEO and Executive Partner, Grant Thornton LLP 

The impact of Sarbanes-Oxley--particularly on internal controls--is as groundbreaking as the 1933 and '34 Securities Acts were in changing the way companies look at financial disclosure aimed at meeting investor and user needs.

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Because Sarbanes-Oxley requires the audit committee to take a greater role in the audit--one with increased independence--the interaction between the audit committee, the auditor and the CFO has changed significantly. This mandate can cause tension between the CFO and the auditor. Now the auditor works more for the audit committee than it does for the CFO; however, the day-to-day relationship between the auditor and the CFO is still critical for getting the audit done. We've been successful at minimizing that tension because we help the CFO understand his or her heightened level of responsibility and what that means in relation to financial reporting.

Although the new relationship and increased scrutiny elevates every issue, it also enhances the role of the CFO, because CFOs today have much greater authority and ability to influence what's happening within a company than they did before. Now, the CFO can put more teeth in his or her position to enable that CFO to get good accounting communicated to the audit committee and the CEO and avoid related pressures felt in the past.

Another change has been accounting-firm concentration. There used to be eight--I would argue 10, 15, 20--large, national firms. Now, we have seven or eight national firms, and the number continues shrinking. Concentration dramatically affects choice. Fortunately, we've seen other firms expand, and that's healthy for the profession. Grant Thornton has grown dramatically--we've run at a growth rate in excess of 20 percent for over four years, and that puts our firm and others in position to address some problems created by market conditions.

Still it's a problem to find the right firm, and by that, I mean the firm with the required skills, industry expertise and size to match a company's needs. Companies today don't just use accounting firms for audits. New independence rules preclude firms from providing both the audit and certain types of financial consulting. The result is a shortage in the number of quality firms from which companies can choose (that's the perception, anyway).

Another change has been the rise in litigation. We've seen big failures with litigation fallout. The reality is that every accounting firm is facing major litigation, and at such magnitude as to raise serious doubts about the survival of the network. It's essential that expert accountants be able to apply judgment in accounting and auditing issues. To do so, our rules-based environment must be replaced by one based on the principles behind the rules.

I'm optimistic about the profession and the future. Movement towards global accounting and auditing standards is essential because the market is already global. We must look at the capital market system, the accounting, the auditing and the profession on a global basis.

James H. Quigley, CEO, Deloitte & Touche USA LLP

We have seen a dramatic evolution in our relationship with the CFO and the office of the CFO as a whole. Previously, the CFO was the focal point of the relationship with the external auditor. Now, the audit committee has center stage with respect to engaging an auditor and approving the services that an auditor performs. That said, the relationship with the CFO continues to be critical.

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I have said many times that I believe effectiveness in financial reporting actually sits on a platform--it's a three-legged stool with an auditor, financial management and an audit committee. Each has a different but crucial role to play in the financial reporting process.

In recent history, the audit committee seat has been balanced with those other two seats, and is today very much a key player in the process. Yet, the CFO is still at the center of much of this activity and manages the relationship with the auditor as well as, in many cases, the interaction with the audit committee.

A report released in 1999, Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees, caused me to consider that in the future the audit committee would be a key client. Both this report and the Treadway Commission report had the goal of trying to improve the efficacy of financial reporting and advocated a stronger role for the audit committee. Everybody agreed these were good ideas--but few saw the need to implement them themselves. Then Sarbanes-Oxley made an enhanced role of the audit committee a matter of law.

Changes in the regulatory environment over the last two or three years have certainly put some unusual stress in the auditor/client relationship--but this is improving. Today, we have an appropriate and constructive relationship with our clients. Some of the tension that was so evident in the initial implementation of Sarbanes-Oxley has been mitigated by our progress along the learning curve and the comfort we now have with our respective roles within this new corporate governance model.

James S. Turley, Chairman and CEO, Ernst & Young

In some ways, the profession has changed greatly in the last 75 years; in other ways, it's somewhat similar. One of the firm's earliest surviving employee manuals from the 1920s said: "providing confidence to others is the heart and soul of our work." It went on to say that "it's not so much what we say as what we think, and do and are." In many ways, that says a lot about the profession today as well--what we do matters a great deal to many people. It matters to investors. It matters to regulators. It matters to our people. That is something that was true 75 years ago and is true today--and it's even more true today than it was five years ago.

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Without a doubt, the profession has experienced many significant changes. In the past five years, we have gone from being relatively unregulated to being one of the most scrutinized professions in the world. Personally, I would rather be both very scrutinized and very relevant than neither. I think that really defines where the profession is today.

Another key change is our relationship with CFOs. In the recent past, in the audit business, our client was primarily the CFO and management. Now, we are hired and evaluated by the audit committee, and that's been a fundamental change. I talk often with my Ernst & Young colleagues about the triangular relationship between our firm, the audit committee and management, and how this triangle's been turned on its head.

Sarbanes-Oxley put much more responsibility in the hands of audit committees, as the agents of investors. The audit committee is now on top, as it should be, whereas management sat on top of the triangle in the past. We're communicating a lot more directly with audit committees, and there is also more communication with CFOs, CEOs and others, so that there is healthy tension and clarity across the three sides of the triangle.

The other big issue that has changed significantly in the last decade is the globalization of economies. It is having a fundamental impact on businesses and societies. It is incredibly important that we commit ourselves to what I call "delivering on our promise"--to deliver seamless, consistent, high-quality client service worldwide.

I think the changes are all very positive. In many ways, it has been a refreshing reminder that what we do really matters to a lot of people who rely on our work. Investors don't necessarily know how we do what we do, but they care deeply that we do it well. Sometimes the relevance of any profession is seen when things may not go perfectly. The world now cares even more deeply about what we do--and the stakes are high in us doing it well.

Our people realize that others are relying on us. What we do creates the environment for investors to invest with confidence. They rely on us to help ensure that playing fields are level, that people are playing by the rules and that transactions are executed appropriately. That sense of purpose has been a strong wind in the sails that guide our people.