In the Wake of Enron: Accountant Rules for Banks

The Enron scandal has effects in the world of banking. The failure of the independent audit system for a company such as Enron can only heighten concerns about how those same accounting firms approach their evaluation of banks and other financial institutions. In the case of Enron, the accounting firm showed both failure to maintain competence and failure to maintain independence. The results were disastrous.

When it comes to banking, the concerns exceed the possible rise or fall of stock value. The concerns are about safety and soundness, the federal deposit insurance program, and the public's faith in the banking system.

The financial regulatory agencies are taking steps to guard against an Enron disaster in the banking world by strengthening the agencies' ability to supervise and evaluate the adequacy and accuracy of auditing by accountants and their firms. In the proposal, the agencies express concern about the quality of audits and internal controls for financial reporting.

The agencies are jointly publishing proposed changes to their rules governing the standards for independent audits for financial institutions having total assets of $500 million or more. The proposal would also implement provisions of the Sarbanes-Oxley Act of 2002. In the joint proposal, the agencies are also proposing changes that would make the regulations more uniform from agency to agency.

While this is a safety and soundness issue, the proposal has clear ramifications for every profession in the financial institution, including compliance. The existing rule and the proposed changes establish standards for performance and professionalism in the arena of banking.

The basic element of an independent audit is to determine whether the organization has adequate internal controls and whether those controls work.

A core element of the regulations would be the documented ability and willingness of the auditor to stand behind his or her work and conclusions. Unlike Enron, there may be no finger-pointing or passing the buck. This is about taking accountability for one's work.

Cause for Removal
The most significant addition to the rules would be the addition of provisions for removal, suspension, or debarment of accountants or accounting firms from performing audit services under Section 36 of the FDIA for financial institutions.

The rules would define "good cause" for removal or suspension. These standards would include such measurements as "knowing or reckless conduct that results in a violation of professional standards." Good cause may also result from a single instance or a pattern of highly unreasonable conduct violating professional standards when the accountant knew or should have known that scrutiny was warranted. Providing false or misleading information to the regulatory agencies would constitute good cause for removal or suspension.

It is noteworthy that the conduct giving rise to suspension or removal does not have to occur in connection with audit services or with services to depository institutions. The conduct may occur in another environment that causes the agencies to suspend the accountant. In short, the rule establishes expectations and standards for professional conduct for whatever work the accounting profession does. To the extent that conduct in a non-banking client is deemed reckless or unprofessional, the financial agencies could use that conduct to suspend the accountant or firm from serving financial institutions. This is a giant, but pragmatic step. While the shortcomings of the accounting firm's work for Enron may not directly relate to banking, what faith does the public or a regulator now place in that firm's work for a bank?

Who is removed?
The proposed rules give the agencies broad discretion in the removal of individuals, firms, or offices of firms. The agencies may name an individual, or name a firm by naming each member of the firm or office in the order.

In determining the scope of suspension or debarment, the agencies will consider the gravity or scope of the act, repetition, and the extent to which professional standards and procedures were followed.

The agencies will also consider the role of managers and senior members of the firm in hiring, training, and supervising the work of firm members. If senior members of the firm are believed to have participated in or tolerated the conduct, the agencies may suspend the entire firm on the basis that the firm does not have adequate management and controls to prevent similar behavior.Perhaps the most ominous aspect of these rules for the accountants is the public notice process. When an individual or firm is removed or suspended, the agencies will give public notice. You can bet that news reporters will pick up on that and go looking for stories!

ACTION STEPS

Review your work papers and audit reports. Consider whether they meet the standard for accounting firms.
Review the reports from outside firms. Consider whether these meet the new standards. If not, begin the process of asking for better performance.
Look over reports to the Board and evaluate the quality of information that board members receive. Can they carry out their responsibilities based on what they are told?
Consider where compliance violations occur and then consider whether the audit procedures you have in place are adequate for identifying problems.
Now evaluate internal controls. Are they adequate?
Look at other work done by your accounting firm. Do they adhere to professional standards in other industries?
Evaluate the contacts your institution has had with senior members of the firm. Are these individuals adequately informed and aware of the audits conducted in your institution?