Accounting reform legislation passed in United States

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29 Jul 2002

By vote of 99-0 in the Senate and 423-3 in the House, the United States Congress has approved legislation creating a Public Company Accounting Oversight Board (PCAOB) to oversee the accounting profession.

By vote of 99-0 in the Senate and 423-3 in the House, the United States Congress has approved legislation creating a Public Company Accounting Oversight Board (PCAOB) to oversee the accounting profession.

Key Features of the Public Company Accounting Reform and Investor Protection Act of 2002
  • Oversight Board. The Act creates the Public Company Accounting Oversight Board (PCAOB)
  • Organisation and administration. PCAOB will be organised as a nonprofit corporation. The SEC will provide administration and oversight.
  • Timing. The initial PCAOB members must be appointed within 3 months. The board must be organised to begin its work within 9 months.
  • Mission of PCAOB. PCAOB is charged with overseeing the audits of public companies and related matters.
  • Subpoena power. PCAOB will have subpoena power.
  • Funding. PCAOB will be funded by assessing public companies.
  • Board members. PCAOB will have five full-time members (maximum of two CPAs) appointed by SEC with approvals of Treasury Secretary and Chairman of the Federal Reserve Board. They will serve five-year terms, with one renewal term allowed.
  • Authority to establish or adopt standards. PCAOB must establish or adopt auditing, quality control, ethics, and independence standards. In doing so, the PCAOB may look to standards established by recognised professional organisations.
  • Auditor registration. All auditors of public companies must register with the PCAOB, identify public audit clients, identify all accountants associated with those clients, list fees earned for audit and non-audit services, explain its audit quality control procedures, and identify all criminal, civil, administrative, and disciplinary proceedings against the firm or any of its associated persons in connection with an audit report.
  • Disciplinary power. PCAOB can discipline or suspend auditors of public companies. Disciplinary proceedings will be confidential until completed.
  • Inspection of CPA firms. PCAOB must inspect all CPA firms that audit public companies to assess compliance with the law, SEC regulations, rules established by PCAOB, and professional standards. Firms that audit more than 100 public companies will be inspected annually. Firms that audit 100 or fewer public companies must be inspected at least once every three years. If violations are found, the board must take disciplinary action.
  • Engagement of auditors. Audit firms will be appointed by, and will report directly to, the audit committee which must be comprised entirely of independent (non-executive) directors.
  • Restrictions on non-audit services to audit clients. The law restricts consulting work auditors can do for their clients. Prohibited services include bookkeeping, financial systems design, appraisal and valuation, actuarial, internal audit, management functions, human resources, broker-dealer, investment banking, and legal. PCAOB may enumerate additional prohibited services. The registrant's audit committee must pre-approve engaging the auditor for any other non-audit services, including tax work.
  • Audit partner rotation. The law requires audit partner rotation after 5 years.
  • Mandatory audit firm rotation. The Comptroller General must study and report on this within one year.
  • Disclosures in financial reports. The law requires certain disclosures in financial reports, including information about off-balance sheet transactions, and orders the SEC to develop rules regarding pro forma disclosures.
  • Loans to company executives. The Act prohibits most personal loans to company executives.
  • Financial analyst conflicts of interest. Financial analysts cannot be involved in marketing securities (detailed rules to be developed by the SEC).
  • Rules of conduct for lawyers. The SEC must develop rules of professional responsibility for attorneys who represent securities issuers.
  • Principles-based accounting. The SEC must conduct a study on the adoption of a principles-based accounting system in the United States.
  • Corporate and criminal fraud. The Act provides for criminal penalties for corporate fraud and document shredding.
  • Accounting standards. The Act permits the SEC to recognise standards established by a private-sector accounting standard-setter, such as FASB or IASB, provided that the standard-setter: — has an independent and broad-based board of trustees; — is funded through the fees collected by the PCAOB; — is deemed acceptable by the SEC in terms of improving financial reporting and protecting investors, and reports annually to the SEC; — has adopted procedures to consider accounting issues promptly and to keep its standards current; and — "considers, in adopting accounting principles, ... the extent to which international convergence on high quality accounting standards is necessary or appropriate in the public interest and for the protection of investors".

A pending issue before the SEC, set out in its February 2000 Concept Release, is the extent to which the Commission should allow registrants to use IASB standards.

The President has indicated he will sign the bill into law. Click here to Download the Legislation (PDF 226k).

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