Keeping a Watchful Eye

Few of William Donaldson's decisions will come under more scrutiny than his choice to head the newly created Public Company Accounting Oversight Board. As of early March, the chairman of the Securities and Exchange Commission had yet to name someone to the post, but it's clear that Donaldson's tenure at the helm of the SEC will be judged by this critical appointment.

"It's important because of the impact it will have on investor confidence," says Sen. Richard Shelby, R-Ala., chairman of the Senate Banking, Housing and Urban Affairs Committee.

During his Feb. 5 confirmation hearing, Donaldson said picking someone to lead the board was his top priority. "We are a little behind the eight ball since there is no chairman in place," he said.

Created by the 2002 Sarbanes-Oxley Act, the board is charged with overseeing accounting firms such as PricewaterhouseCoopers and KPMG, as well as many smaller firms. It was created to replace the industry's failed self-regulatory system, including a peer review process in which the big companies periodically examined each other's work.

In the aftermath of financial scandals involving Enron, WorldCom and Arthur Andersen, lawmakers became concerned about the integrity and reliability of financial disclosures.

The board has sweeping powers to regulate and investigate auditing firms. Although it is borrowing startup money from the SEC, it eventually will be funded by fees assessed on auditing firms. An independent entity, the board's activities and rules are subject to SEC approval. The SEC also appoints the five full-time members.

The panel's first chairman, William Webster, resigned last November after only a couple of weeks on the job. Webster, former director of the CIA and FBI, was forced to step down when his connections to U.S. Technologies Inc., a nearly bankrupt Internet company under investigation for fraud, came to light. Webster was head of the company's audit committee when it fired its auditor after a report showed the company may be violating financial disclosure laws.

Webster's controversial appointment to the oversight board also forced Harvey Pitt to resign as chairman of the SEC. Pitt had been under fire for more than a year for a series of questionable decisions while at the helm of the agency.

The underlying problem was that the SEC did not establish a reliable process for appointing people to the oversight board. Both Pitt and former SEC Chief Accountant Robert Herdman knew of Webster's connection to U.S. Technologies, but did not disclose the information.

Based on Webster's credentials and the fact that there would be post-appointment vetting, Herdman didn't think the information would jeopardize Webster's nomination, according to a December 2002 General Accounting Office report (GAO-03-339).

GAO also found that SEC commissioners could not agree on the selection process. As a result, SEC staff had little direction on how to find candidates and screen them before submitting names to the commissioners. With a statutory deadline approaching to fill the board, the "SEC was ultimately forced to appoint members to the [board] that had not been adequately vetted."

Since board members serve five-year staggered terms, GAO recommended ways the SEC could fix the process. They include developing a systematic approach for finding and vetting candidates, and establishing a set of specific criteria for candidates.

The SEC provided only technical comments on GAO's recommendations, and refused to comment for this article.

Richard Boster, a special adviser to the oversight board, agrees with many of GAO's findings. "Clearly, the process was flawed," he says. But he says the board, which ironically is renting office space in Washington formerly occupied by Arthur Andersen, is moving forward with its work. It is on track to draft registration rules for public accounting firms by the end of April, he says. Only firms earning board certification will be allowed to audit public companies.