Be Careful What You Wish for: How Accountants and Congress Created the Problem of Auditor Independence
64 Pages Posted: 10 Sep 2004
The independence of auditors from the publicly traded clients whose books they inspect is one of the most vexing problems in the financial world today. The effects of corporate fraud unchecked by the audit process are felt far outside Wall Street in the form of devastated retirement plans and lost jobs. Numerous attempts to fix this problem have failed. This article analyzes the history of auditing to argue that the imposition of a mandatory audit system through the federal securities laws created the problem of auditor independence. The laws' drafters erred in emulating select portions of the British Companies Acts, which was itself a comprehensive set of provisions for corporate and securities laws. Accountants advocated for the system as a way to elevate their profession to the status of other learned professions such as law or medicine. But in seeking this prestigious government franchise, the profession got more than it bargained for. It traded a lucrative premium service for a commodified cost of doing business, even while incurring an impossible obligation to an unspecified "investing public." At the same time, this investing public neither hires, fires, nor controls the auditors. Instead, the audit relationship is managed by the company being audited. The resultant conflict of interest has proven to be insurmountable even after multiple reform efforts. The author argues that the problem will only be resolved by returning to its origins in the 1930s federal securities laws and restructuring the role and relationships involved in public company audits. The article also gives extensive detail about the legal and business environment for public accountants and auditors before passage of the 1930s securities laws. This environment has been inadequately documented in the current legal scholarship. Thus, the article provides a valuable historical resource for those interested in reform of the audit system.
Keywords: Auditor independence, Accountants, Accounting, Audits, Arthur Andersen, Corporate Governance, Enron, Non-audit services, Securities regulation, Gatekeepers, Reputational intermediaries, Professional services, Commodification, Worldcom
JEL Classification: M49, G38
Suggested Citation: Suggested Citation
By John Coffee