Ethics, maintaining true and fair statements, is a key part of financial reporting. In order for shareholders to trust a company with their money, they must feel confident in the company’s financial reporting. Financial reporting presents all data relating to an entity’s current, historical and projected health which means investors and shareholders rely upon the available financial data in order to make informed, educated decisions. In an effort to help entities comply with business regulations and maintain financial reporting shareholders can trust there exist organizations designed to watchdog different aspects of the accounting world. Primary among these are the Securities and Exchange Committee (SEC), the Financial Accounting Standards Board (FASB) and the Public Company Accounting Oversight Board (PCAOB). These three bodies work together to ensure financial reporting is fair, reliable, honest and available to all investors.
Ethics and Accounting
The importance of ethics in business, and specifically in financial reporting is to inspire and ensure public and investor confidence in entities. Without a strong code of ethics, and adherence to those ethics, individuals may not be certain their investments, often life savings and retirement, are protected and secure. Accounting professionals must have a strong grounding in ethical and moral reasoning as their decisions regarding financial reporting can have devastating consequences not just for individuals but also for corporations and entire nations. Ethics in business are more than just issues that relate to accounting, as ethical practices can and will cross boundaries from business practice in to what an entity may ask its accounting professionals to do in financial record-keeping and recording. The recent scandals involving accounting fraud generally began at the CEO and found their way down into the financial records.
Before the passage of the Sarbanes-Oxley Act wide-spread financial abuses such as WorldCom, Enron, and Adelphia Communications plagued the American public and delivered hard punches to the economic health of the entire nation. Many of these frauds stemmed from unethical accounting practices often instituted at the highest levels of the corporations themselves, but carried out in the financial reporting practices of public accounting firms. In December 2001, Enron, once one of the world’s leading energy companies, filed the largest bankruptcy in U.S. history, emptying the retirement accounts of thousands of American workers, while enriching those at the highest levels of the corporation. Using thousands of off-the-books partnerships to hide nearly $1 billion in debt and to inflate profits, the company had defrauded shareholders of billions. In the wake of these scandals, President Bush and Congress were forced to take a tough stance in the passage of the Sarbanes-Oxley Act in July of 2002.
Agencies and Oversight
When ethics seem to be failing a society, it is natural to turn to the government for guidance. In response to various crises in the history of the United States, several regulatory bodies and laws have been created. The three to be discussed work most closely together to ensure financial accounting is honest, fair and reliable: The SEC, the FASB, and the PCAOB. They are each separate entities, but often work in cooperation with one another and overlap in certain areas such as oversight and reporting.
The SEC, a five-member body created after the stock market crash of 1929, is a government commission within the United States with responsibility for regulation of the securities (investing) industry; it exists to protect investors as well as safeguard the reliability of investments made. The SEC has legal standing as a governing body, with members appointed by the President of the United States and approved by the Senate. Three of the five members may come from the same political party, so the body may have some political loyalty to the president who appointed them. The key interest of the SEC is to promote disclosure of financial information and oversee corporate takeovers. The SEC requires all “public companies to disclose meaningful financial and other information to the public, which provides a common pool of knowledge for all
investors to use to judge for themselves if a company’s securities are a good investment” (SEC, 2005). This kind of oversight can ensure all investors access to accurate, timely information so they can make informed, sound investing decisions. Each year the SEC makes several hundred enforcement actions against individuals and companies that are found to have broken securities laws, however, their small staff is often not enough to directly discover fraud and misdeeds, for this reason the SEC must rely on private-sector organizations (the FASB and PCAOB, for example) to investigate and uncover fraud. The SEC does not bring charges, although it is designed to punish and deter.
The FASB is a seven-member board made up of accounting professionals. It is a federal organization whose primary purpose is to develop Generally Accepted Accounting Principles (GAAP) in the United States; it is also responsible for maintaining independence standards in accounting. Unlike the SEC, it is not a governing body with official legal standing; however, the SEC does recognize their pronouncements and moves to enforce them (investopedia, 2005). The FASB is an independent part of the structure the SEC relies upon to aid in their mission. It also stands between the International Accounting Standards Board and US markets to make financial reporting easier for companies who operate in both the national and international markets.
The PCAOB’s mission is to develop controls over how an entity reports financial information to the public and try to identify fraud. It oversees the auditors of public companies. The PCAOB was created by the Sarbanes-Oxley Act (2002) and is responsible for ensuring the requirements of that act are adhered to by businesses and accountancy firms. It takes long strides toward correcting the shortfall left by the inefficiencies and limited staff of the SEC. The PCAOB is granted disciplinary and investigative authority by Sarbanes-Oxley and, while reporting to both the SEC and local regulatory agencies, is a private-sector, non-profit corporation. Created in the wake of a spate of high-profile accounting scandals, not least among them Enron and WorldCom, the PCAOB has been helpful in such cases as the case against Richard Scrushy, former CEO of HealthSouth for falsely inflating earnings. This body has more ability to directly analyze the public findings reported by a corporation, but must still come against the limited staff of the SEC for disciplinary action.
While these three bodies work together, they rely on cooperation from the member companies as well as from participation from “whistle-blowers” and public citizens. This can limit the reach and scope of their effectiveness as well as limitation upon available funds. Another limitation is that the SEC can not bring charges, but must rely upon the Justice Department to bring those charges. This adds a layer of bureaucracy that slows down prosecution and makes it somewhat less likely that a wrong-doer will be charged, let alone found. As the Enron collapse illustrated, there were systemic, catastrophic failures in the private-sector watchdog-groups (Report of the Staff to the Senate Committee on Governmental Affairs, 2002). The SEC and the PCAOB must work more closely together and include a way for them to fast-track criminal cases.
Wikipedia online encyclopedia. (2005) US Securities and exchange commission.
Accessed October 15, 2005.
Wikipedia online encyclopedia. (2005) Sarbanes-Oxley Act.
http://en.wikipedia.org/wiki/Sarbanes- Oxley_Act#Overview_of_the_PCAOB.27s_requirements, Accessed October 15, 2005
Securities and Exchange Commission website. (2005) What we do.
http://www.sec.gov/about/whatwedo.shtml Accessed October 16, 2005.
Investopdia online investment encyclopedia.(2005) Terms. http://www.investopedia.com/terms/f/fasb.asp , Accessed October 15, 2005
Report of the Staff to the Senate Committee on Governmental Affairs.(October 8, 2002)
Financial oversight of Enron: the SEC and private-sector watchdogs.
http://www.senate.gov/~gov_affairs/100702watchdogsreport.pdf, retrieved October