The Enron collapse has given new meaning to the word “partnerships” and has brought to the fore somewhat controversial accounting procedures which helped the multinational company look more profitable than it actually was. The failures happened erosion of the public confidence. As a result, billions of dollars in market value disappeared. Investor losses caused a public outcry.
The U.S. Congress responded to declining public confidence by passing the Sarbanes-Oxley Act. The law made four fundamental changes in the relationship between auditors and public companies.
First, it sharply restricted the auditor’s ability to render consulting services to audit clients. The law separating consulting and accounting work, dividing investment banking from analysts and making disclosure of stock holdings and investment banking ties more prominent in research reports, potentially term limiting auditor contracts for individual companies, requiring outside entities be incorporated into financial disclosure statements so as not to understates liabilities and overstates earnings, and encourages diversity by employees with 401Ks.
Second, it made the company’s audit committee, composed of independent directors, rather than management, responsible for hiring the auditor. External accounting oversight cannot be fully effective if the company itself is not committed to fair and accurate financial disclosure. In that regard, the relationship between the company’s auditor and its independent audit committee is key.
Third, the Sarbanes-Oxley Act required both management and the auditor to report to the public on the effectiveness of the company’s internal control over financial reporting. To make that new responsibility work, Congress required the PCAOB to issue an auditing standard on this new aspect of the auditor’s responsibilities.
Finally, the new law ended the accounting profession’s long tradition of self-regulation. In its place, the Sarbanes-Oxley Act created the Public Company Accounting Oversight Board. An auditing firm or an individual auditor is acting in good faith and is willing to conduct audits in accordance with the PCAOB’s standards, we will generally seek to improve practice quality by making inspection recommendations, rather than by taking disciplinary action.