Report Your Financials, Big Four Audit Firms Urged

Under one plan, a big audit firm could gain liability caps and tax deductions if it submits its own audited GAAP financial statements to the Public Company Accounting Oversight Board.

Like the philosopher Diogenes, who spent his days looking for an honest man, Donald Nicolaisen is still looking for a transparent audit firm.

Nicolaisen, a former chief accountant for the Securities and Exchange Commission, was the co-chair, with former SEC Chairman Arthur Levitt, of a committee named by Treasury Secretary Henry Paulson to advise him on the state of the auditing. In its final report, issued in early October, the committee proposed that the Public Company Accounting Oversight Board require the biggest audit firms to prepare and privately submit audited financials adhering to Generally Accepted Accounting Principles to the PCAOB by 2011.

But Nicolaisen and Levitt decided to go most of their colleagues on the 21-member committee one better. While they believe that the proposal “would be a significant improvement in providing insights into the auditing profession,” they wrote in the report, “we also continue to believe that at least the largest auditing firms should make audited financial statements available, including to audit committees and the investing public.” (The report defines the largest firms as those with more than 100 public company audit clients that the PCAOB inspects annually.)

For its part, the PCAOB is currently considering the proposal along with other committee recommendations. “This is one of many recommendations that we will look at seriously over the coming year,” said PCAOB spokesperson Lucy Harvey. In October, the board’s Standing Advisory Group said that a good starting point for a discussion on transparency was a European Union directive requiring audit firms to list on their websites such financial information as “total audit fees as a percentage of total revenues; and fees charged for other assurance, tax, and non-audit services” and the firms’ policies for paying their partners.

Barry Melancon, president and chief executive officer of the American Institute of Certified Public Accountants and a member of the Paulson advisory committee, said that he thinks that a transparency report containing such information “seems to be an appropriate first step.”

Currently, as private partnerships, the Big Four do very little in the way of public reporting of their financials. A quick check of the websites of their U.S. arms reveals KPMG reporting its total revenues through its 2006 fiscal year; Deloitte listing its revenues by business through fiscal 2008; PricewaterhouseCoopers listing aggregated revenues by service line through fiscal 2008; and Ernst & Young providing a 2008 annual report on global revenues. Requests for comment from the four firms were unanswered at presstime on Friday.

Speaking at an annual auditing conference held by the Zicklin School of Business at Baruch College in New York on Thursday, Nicolaisen said that while the big audit firms are “good at asking their clients for disclosures, they’re terrible themselves. They’re not transparent.”

In a conversation with CFO.com before his speech at the conference, the former SEC accounting chief appeared to favor the idea of an optional charter for audit firms. Under the plan, which was discussed by Paulson’s advisory committee, an audit firm opting to operate under such a charter would have to report its audited GAAP financials. But it would benefit from a cap on legal liabilities and from certain tax deductions available to public companies now.

But such a plan would have to be enacted by Congress, he told this website. In his remarks to the conference, Nicolaisen said that in the absence of requirements by legislators and regulators, he hoped that one of the big audit firms would “come up and take a leadership role” and start reporting regularly under GAAP.

Asked by an audience member what the connection is between fuller financial reporting by audit firms and safeguarding the quality of audits—one of the committee’s main goals—Nicolaisen replied: “If a firm is suffering financially, that affects its sustainability. That goes beyond protecting audit quality.”

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