OLSON: Red ink

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By Carl Olson

OP-ED:

The odds 10,000 to 1 are not good for the public's financial health. Every one of the well-known debacle companies had CPA auditors who said the financial statements were just fine. For AIG it was PricewaterhouseCoopers. Lehman Brothers (the largest bankruptcy in American history) had Ernst & Young.

Fannie Mae's fiascos were OK'd by Deloitte & Touche. KPMG was responsible for Countrywide. The $50 billion Madoff Ponzi scheme somehow could not be detected by numerous CPA auditors for its investors.

Is the loss to the investing public $1 trillion, $2 trillion, or more? How many life savings are destroyed? How many pension funds are imploding, including private and public? With the biggest state population California, has had the most to lose.

We all know that there is no good reason for an individual to believe and act on any financial statement of any company without a positive CPA auditor opinion. We all presume that these opinions are reliable and backed up with not just some ethics code but with some financial guarantee by the CPAs.

But wouldn't it be great if the errors in financial statements were detected by CPA auditors before they are issued and become egregious rip-offs? Lawsuits are after-the-fact remedies, usually taking many years. The public needs immediate and effective discipline and punishment for misbehaving CPA auditors. They need to be stopped before they can strike again.

CPAs and CPA firms are licensed by state government boards of accountancy. Without a license, they cannot conduct any auditing business. In a real sense, boards of accountancy are more important than medical boards. Doctors can injure patients only one at a time. Negligent CPA auditors can wipe out thousands with the stroke of a pen.

California has a typical, ineffective Board of Accountancy which is underfunded and dominated by the CPA industry. It has 15 members, seven of whom are CPAs and other licensees. Gov. Arnold Schwarzenegger appoints all seven of these plus four other non-licensee members. The other four are appointed two each by the Speaker of the Assembly and the Senate Rules Committee.

The board is funded by annual licensing fees from the 76,000 licensees in the state. The Accountancy Fund is supposed to ensure ongoing consumer protection functions without regard to the state government budget appropriation process, since it does not involve any tax dollars. However, this structure has not prevented the governor and legislature from recently borrowing $11 million from the Accountancy Fund. This is in addition to the $6,270,000 borrowed in 2002 and 2003 but not repaid. The Accountancy Fund would be about $31 million without these borrowings. The board's annual budget is about $12 million with the current staffing level for processing licensees and investigating complaints.

The statute requires that licensees submit to the board financial re-statements they have been involved in. Re-statements are very significant because they involve materially false or misleading information in the original financial statements. These original statements have been relied upon by the public with obvious misdirection until the re-statements are issued and distributed. For the 15,000 publicly traded corporations nationwide, there have been about 1500 restatements per year for the last few years. This is an astounding failure rate of 10 percent and it's not getting better. No wonder the CPA malpractice insurance rate runs about 15 percent of their revenues.

What does the board do with the re-statements? One would think they would be a key quality control measure that would be immediately used in enforcement actions. Every one of them is a confession of material error. The board has decided that it won't require re-statement submissions for all publicly traded companies even though all of them impact California investors. Instead, a very narrow selection has been imposed, such that only about 200 of the 1,500 annual re-statements are received by the board. The other 1,300 are ignored.

But it gets worse. The board has a check it and chuck it policy with re-statements by throwing them away six months after receipt. They are not maintained as a public document library for Californians to utilize. A revealing sentiment was expressed by past board President David Swartz CPA at the September 2007 board meeting when he opined that only 2 percent of re-statements were important, and that the other 98 were not.

As for enforcement against misbehaving and dangerous licensees, the public is on the losing end of the 10,000 to 1 odds. For the 76,000 licensees, there are only 7 board investigators. There is not even a Southern California office. It is next to impossible to recruit competent investigating CPAs because the state pay scale is so low. Competitive pay for experienced CPAs is at least $125,000 per year. The state currently pays only about $65,000. The board, its supervising Department of Consumer Affairs, and the Governors Finance Department have all been dragging their feet for years over correcting this crippling defect. Apparently, this is their intentional policy. It was recently expressed in Capitol Weekly by the current board president Robert Petersen, CPA: We've got all the positions we need.

Hope for Californians could come from a governor who has changed his mind about the ineffective board. Or by a legislature which takes command of the ongoing travesty. The board is in the jurisdiction of the business and professions committees. Each of 120 members of the legislature in either party could introduce a bill to fix the mess. Who will be first to be a hero for the financial health of Californians?

Carl Olson is chairman of the Fund for Stockowners Rights.