Issue Date: September/October 2004
U.S. Federal Regulations
Former SEC Chief Accountant: Systemic Problems
Need Fixing
By Cynthia Harrington, Associate Member, CFA
Lynn Turner says there's still arrogance in the public business world, more should be spent on
enforcement, and higher education accounting should be taught in a “framework of making ethical
decisions.”
Sarbanes-Oxley and SAS 99 may help cleanse some firms and make CFEs' jobs easier but little has
changed – unethical, arrogant companies still try to beat the system. So says Lynn Turner, CPA, the
former chief accountant for the U.S. Securities and Exchange Commission (SEC) during the height of the
major accounting scandals – 1998 to 2001.
Since he left the SEC, Sarbanes Oxley and SAS 99 forced dramatic changes in the way companies and
their auditors do business. Some parts of the new rules make the CFE's job much easier. The penalties
for document destruction and the more restrictive definition of materiality are two examples. “But fraud
professionals work in a shifting tide,” says Turner. “Despite all the changes we still continue to see a
record number of restatements. Even with the certification requirement and stiff penalties we still see
people lacking the ethical foundation to comply with the rules,” he says.
We caught up with Turner, 50, recently in his Denver office at Glass, Lewis & Co. LLC to get his thoughts
about the effects of the sweeping U.S. legal and regulatory changes in the last few years. He is director of
research at Glass, Lewis – an independent research firm providing investors proxy, corporate governance,
and financial research – and a senior advisor to Kroll Zolfo Cooper in New York City, which specializes in
corporate advisory and restructuring and forensic and litigation consulting. Turner is a member of the
board of directors of Sun Microsystems and recently was on the faculty of Colorado State University
where he had been a professor of accounting in the College of Business , and director of The Center for
Corporate Financial Reporting.
Critical components of the SOX legislation adds both tasks, and liabilities for not complying. A public
company's CEO and CFO must certify by personal signature that the financial statements are truthful and
fairly represent the financial condition of the company. Despite a potential 20-year jail term, the SEC still
called on Nortel, Bristol Myers, and HealthSouth after all three firms restated financial reports that had
executive certification. “There's still a level of arrogance out there and not enough resources spent on
enforcement,” says Turner. “Until there's a level playing field, people will game the system if they feel they
can do it profitably.”
Turner's efforts at the SEC to improve financial reporting and achieve auditor independence paralleled the
mission of then-chair Arthur Levitt. Levitt, whose top priority was investor protection, wrote the book “Take
On Wall Street” about the epidemic of cooked books. He repeatedly called for accounting reform, pointing
to five major areas. He prompted lawmakers to tighten up rules on “big bath” restructuring charges,
creative acquisition accounting, “cookie jar” reserves, “immaterial” misapplication of accounting principles,
and premature recognition of revenue.
SOX contains one item that Turner believes will greatly improve the fraud examination process. Auditors
must now retain and possibly release audit manuals, work papers, and all documents relating to their
work. Additionally, the new definition of materiality under SAS 99 makes it much easier for a fraud
examiner to make his or her case. “Now companies are held to the standard that they must reveal all
information that would cause an investor to think differently about the financial condition of the company,”
says Turner. “This has caused companies to record entries that they wouldn't have done earlier.”
But SAS 99 like SOX has its limitations. The requirement to ask management if they are committing or
know about fraud may perhaps be less effective than the standard authors intended. “Eighty percent of
the audit work is done by fairly inexperienced people,” says Turner. “And we expect someone right out of
school to grill this powerful charming guy with two dozen also powerful people on his board about whether
he's committing fraud?”
Concentrated power in the executive suite foments a positive fraud environment in Turner's opinion. The
chair and the CEO should be separate positions. “When the top guy has that much power and wants to
cook the books, he can put such pressure on the CFO that the CFO may have one of two choices: go
along or walk out the door,” says Turner.
Turner also believes that the mood has fundamentally shifted in the last six months in the U.S. Congress.
He points to the mid-July vote in the U.S. House of Representatives to block the expensing of stock
options. “Two years ago it would have been inconceivable for them to vote against the FASB (Financial
Accounting Standards Board),” says Turner, “Today Congress sees things differently and as a result,
there is no way could we get something like SOX passed today.”
In fact Turner believes that the sweeping legislation got passed in a very narrow window of opportunity.
The debate on the U.S. Senate floor of a draft of the bill had been pushed from a spot on the agenda in
July to September. Scandals at Enron and Qwest heightened awareness but hadn't sparked investors'
interest. The frauds were big but the accounting treatments hard for the public to understand. Then
WorldCom hit the headlines. They understood the misallocation of expenses to capital spending and the
market tanked. Investors called their representatives and senators. Congress found the political will to act.
While many worried about the speed of passage of SOX, Turner points out that almost everything in the
omnibus bill had been keyed up in the previous three years or earlier. For example, the SEC in June 2000
had proposed almost word for word the provisions on auditor's independence included in SOX. The
provisions in SOX creating a new Public Companies Accounting Oversight Board had come from
legislation introduced in Congress in the 1970s and which had been reworked by the staff of the SEC in
1999 as the Panel on Audit Effectiveness prepared its report on the topic.
Events in the late 1990's helped set the stage for SOX. Waste Management executives with the support
of the external audit firm Arthur Andersen knowingly reported misleading financial information. As part of
the settlement in 2001, Andersen agreed to not violate securities laws again. That agreement set up AA's
downfall along with Enron.
Auditor independence had also been brewing for some time, according to Turner. Then in 1998 KPMG
approached the SEC for help in selling off their consulting practice. Coincidentally, an anonymous letter
pointed to massive conflicts of interest in a Florida office of PricewaterhouseCoopers. These two events –
combined with inaction on the part of Andersen to the fraud at Waste Management while collecting $50
million in consulting fees – were drivers behind the changes to come, he says.
Turner credits his varied education with preparing him for the SEC job. He holds a master's in accounting
from the University of Nebraska and a bachelor's in business administration, with a concentration in
accounting, from Colorado State University . “The professors at Colorado State provided me with all their
practical experience as an undergrad,” he says. “And then I was lucky to also have teachers who were all
theoreticians at grad school.”
Turner states that accounting programs today need to teach not only what is between the covers of a
book but also include an increased focus on the practical application of what is taught. In addition,
accounting should be taught in a framework of making ethical decisions. “Take something as simple as
revenue recognition,” he says. “Professors should teach the rules but then also discuss what's likely to
happen in reality and how to make judgments when items fall in the grey area.”
Turner believes that schools should prepare young students for the eventuality of being asked to do
something wrong. “What they need is a method to evaluate the request and how to respond in a manner
that allows them to survive by doing the right thing,” he says.
After all of the changes, the red flags for signs of fraud haven't changed, he says. An arrogant, powerful
CEO backed by a lax board with extensive personal relationships should still cause flags to fly and a
board that's willing to go along with insider transactions should still raise eyebrows, he says. Accounting
should be down the middle of the fairway and not too aggressive nor too conservative. “I wish I could
really say that the changes made to date such as documented internal controls and certified financial
statements will get the job done,” says Turner. “There are some positive changes in the accounting
profession, but quite frankly the process is very slow and there remains a lot to do before the systemic
problems we have are fixed.”
Cynthia Harrington, Associate Member, CFA, is a freelance writer for Fraud Magazine. Her e-mail
address is: cynharrington@mindspring.com.
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