H.R. 3970
THE TRUTH AND ACCOUNTABILITY IN ACCOUNTING ACT OF 2002

Title I -- Financial Accounting Standards Board Resolution of Accounting Standards Issues

Section 102 directs the Securities and Exchange Commission (SEC) to conduct an annual review of the Financial Accounting Standards Board’s (FASB) resolution of accounting standards issues. The SEC must submit an annual report to FASB and FASB’s Congressional oversight committees on the results of this review, including identification and prioritization of accounting standards issues that need to be resolved and an evaluation of FASB’s resource needs.

Section 103 directs FASB to submit a detailed response to each SEC report.

Section 104 requires the General Accounting Office (GAO) to conduct an ongoing evaluation of the process established by sections 102 and 103 for the timely identification and resolution of accounting standards issues, and to report to Congress GAO’s analysis and recommendations at designated intervals.

Background and Need:

Much of Enron’s erroneous financial reporting -- the hiding of debt and losses and the inflation of profits -- concerned transactions between Enron and related special purpose entities (SPEs). FASB’s FAS 57 requires disclosure of such relationships.

Enron’s compliance with FASB’s standards in this and other pertinent matters was at best selective. Enron publicly acknowledged that it failed to comply with existing accounting requirements in at least two areas. A subsequent report of a special investigative committee of the Board of Directors of Enron indicated numerous other failures of Enron to comply with the language or intent of existing standards. Even when compliance did occur, it often produced highly impenetrable disclosures. Improvements are needed to accounting principles in the areas of revenue recognition, intangible assets, consolidation of SPEs, and clearer disclosure of the fair values of financial instruments. The FASB has active projects to develop improvements in each of those areas.

There is strong support for the FASB as an independent, expert, private-sector body that sets accounting principles in an open and deliberative way providing due process for effected parties. But there is growing concern by some that FASB has been too slow in addressing a number of cutting-edge issues and that its rules are too complex and not forceful enough. Some of this is FASB’s fault, and the FASB has recently initiated several administrative projects to address those concerns. Much of it, however, has been occasioned by strong opposition to FASB proposals from some companies, accountants, and Members of Congress who have mounted lobbying efforts to delay and significantly water down FASB proposals.

Title I sets up a mechanism for identifying and resolving accounting standards issues in a timely and effective manner.

Title II -- Accounting and Financial Reporting by Certain Public Utilities

Section 201 adds a new section 320 to the Federal Power Act (FPA). Section 320 directs the Federal Energy Regulatory Commission (FERC) to promulgate a rule, within six months of enactment, establishing criteria for any exemption, waiver, or other reduced or abbreviated form of compliance with the requirements of FPA sections 204 (issuance of securities and assumption of liabilities), 301 (accounts, records, and memoranda), 304 (periodic and special reports), and 305 (officials dealing in securities, interlocking directorates). The criteria must ensure that any such action is consistent with the purposes of these provisions and will protect the public interest.

After enactment, FERC may not take any action permitting reduced or abbreviated compliance with these sections of the FPA, including any prospective blanket order, until the new rule has taken effect and unless they are in compliance. FERC actions taken before enactment continue in force and effect for 18 months after enactment, but will not continue past that date unless FERC reviews them and finds, by rule or order, that they are in compliance with the new criteria.

Section 202 directs FERC to submit a report, within 12 months of enactment, to its Congressional oversight committees on implementation of section 201. Section 203 directs FERC to submit an annual report on the financial and operating condition of power marketers.

Background and Need:

Title II requires FERC to justify two loopholes it created that exempt Enron and other electricity marketers from securities and reporting requirements that apply to utilities and other sellers. After the Enron scandal broke, the Commission requested comment on these practices, but it has not formally proposed any changes.

First, FERC is required to demonstrate why marketers like Enron should not have to comply with requirements relating to the issuance of securities and assumption of liabilities that could affect their financial soundness.

Second, FERC must show why marketers like Enron should not have to keep records on electric sales and related services, and make them available to the Commission. This type of information is relevant to a variety of FERC responsibilities, including its recently initiated review of whether Enron and others manipulated wholesale power markets to take advantage of California’s electricity crisis last year.

Title III -- Certification of Financial Statements by Corporate Officers

Section 301 directs the SEC to adopt rules to require public companies to include in their periodic reports a statement signed by the chief executive officer and chief financial officer. The statement shall attest that:

1. the financial statements (including the balance sheet, income statement, and cash flow statement) have been prepared by management of the issuer;

2. the signing officers believe and affirm that the financial statements fairly present to investors, with clarity and completeness, the issuer’s financial position and performance for the reporting period; and

3. the issuer’s internal controls and internal audit procedures are consistent with best practices and fully comply with section 13(b)(2) of the Securities Exchange Act (attached).

Section 301 provides that responsibility for signing this statement may not be delegated. The penalties for violation set forth in Section 32 of the Exchange Act (attached) will apply.

Background and Need:

Former Enron chief executive Kenneth Lay and other Enron officials contend they had no knowledge of the financial and accounting chicanery that brought the company down. They also claim the blame for any financial reporting problems should be placed at the doorstep of its auditors.

This section reaffirms management’s responsibility for the accuracy and completeness of the company’s financial statements, as well as the internal controls and internal audit procedures necessary to produce honest numbers and guard against illegal acts that lead to financial fraud.

The Bush Administration has called for greater corporate accountability in this area. The report of the audit committee (including Warren Buffett) in Coca Cola’s recent proxy statement expressly includes these matters as questions that the audit committee believes are particularly relevant to its oversight of the independent auditors. 

In order to restore public confidence in the integrity of the accounting profession and in the honesty and reliability of the financial reports that they audit, this title creates a new regulatory organization for public accounting firms, subject to SEC oversight and with adequate authority and resources.

This regulatory body is directed to:

1. register public accounting firms that furnish accountant’s reports with respect to documents required to be filed with the SEC under the securities laws;

2. promulgate and enforce compliance with quality control and auditing standards designed to improve the quality of audits;

3. administer a continuing program of inspection of the accounting and auditing practices of registered accounting firms; and

4. investigate and discipline appropriately such firms and the persons associated with them.

Title IV also addresses auditor rotation, the revolving door between auditor and audit clients, and the rendering of non-audit services (including tax shelter advice) to audit clients.

Section 401 contains the purposes (pp. 12-14).

Section 402 contains key definitions (pp. 14-17).

Section 403 provides for the creation of the Independent National Board of Accountancy (the Board) (pp. 17-22). The SEC must establish the Board within 180 days of enactment. Standards ensure that the Board will be expert and independent and serve the public interest. The Board must be composed of five members, no more than two of which may be present or former accountants who are not currently in public practice, have not been associated with a public accounting firm for at least three years, and do not currently share in the profits of or receive payments from such firm. Board members shall be appointed by the SEC from a list of recommended individuals provided by GAO. The Board shall be funded by registration fees and annual dues from each registered public accounting firm. The Board also may prescribe fees and collect costs incurred for inspections and disciplinary actions. The Board shall submit annual reports on its activities and finances to the SEC and to Congress.

Section 404 requires public accounting firms to register with the Board (pp. 22-26). Beginning one year from date of establishment of the Board, it shall be unlawful for any public accounting firm to furnish an accountant’s report with respect to any financial statement or report required to be filed with the SEC under the federal securities laws unless the firm (1) is registered with the Board and (2) has paid all applicable registration and annual fees. Section 404 spells out the minimum information requirements for applications for registration and grants the SEC general exemptive authority as well as the authority to delegate its authority to the Board.

Section 405 spells out the duties of the Board (pp. 26-31). It requires the Board to promote high professional standards among registered public accounting firms, to improve the quality of audit services, and to protect investors and promote the public interest. It requires the Board to adopt and enforce quality control standards that include monitoring for compliance with professional ethics, the professional development and advancement of accountants, assignment of personnel to engagements, and supervision of audit work. Mandatory standards are required on document retention (seven years) and on concurring or second partner review of audit work papers and approval of the issuance of the accountant’s report. It also requires the Board to conduct a continuing program of inspections of each registered public accounting firm, on an ongoing annual basis for the largest firms. It sets forth standards for these inspections and requires that the Board’s report of its findings and any response from the firm under review be made public. The Board is authorized to prescribe which records shall be maintained and for what periods and at what physical location to facilitate such reviews. The Board also is required to adopt and enforce compliance with necessary and appropriate auditing standards.

Section 406 mandates auditor independence (pp. 31-35). The section provides that the SEC will have authority and responsibility for adopting and interpreting auditor independence, and that a public accounting firm will not be deemed independent of an audit client if certain conditions exist. These conditions include previous employment by the issuer’s chief executive officer and financial officers with its auditor (two year cooling off period), the rendering of non-audit services (20 percent limitation and audit committee preapproval), auditor rotation (required every seven years), and the rendering of advice or consultation on the design or structuring of or the application of Federal tax laws to any transaction that is accounted for in the issuer’s financial statements (consulting for audit clients is banned). The firm is not considered independent if it is not hired by and does not report directly to the audit committee of the board of directors.

Section 407 requires the Board to establish fair procedures for investigating and disciplining registered public accounting firms and their associated persons for violations of the Truth and Accountability in Accounting Act, the rules adopted by the Board thereunder, the federal securities laws and the rules and regulations thereunder, or professional standards (pp. 35-44). Grants the Board broad power to conduct an investigation of any act or practice or omission to act by such firm or associated person that may constitute such a violation. Includes incidental authority to require testimony and the production of documents and the power to sanction failure to comply, as well as provision for the confidentiality of investigations, investigative immunity, and referrals to the SEC. Provides the Board with broad disciplinary powers subject to notice and hearing. Available remedies include temporary or permanent revocation or suspension of registration with the Board; temporary or permanent limitation of activities, functions, or operations; civil money penalties (per violation, $100,000 individuals, $2 million entities but if fraud, $750,000 individuals, $15 million entities); censure and, in the case of an individual, temporary or permanent suspension or bar from being associated with any registered public accounting firm. The Board’s imposition of any disciplinary sanction shall be reported to the SEC, State or foreign licensing boards, and shall be made publicly available.

Section 408 facilitates SEC oversight of the Board (pp. 45-57). Provides for public comment on and SEC review of rules proposed by the Board. Authorizes the SEC by rule or order to amend the rules of the Board after notification and public notice. Provides for SEC review of final disciplinary actions taken by the Board, upon the SEC’s own motion or upon application of an aggrieved party. The SEC may affirm, modify, or set aside any such sanctions. Under certain circumstances, the SEC may censure or impose limitations on the activities, functions, and operations of the Board.

Section 409 addresses the application of this title to foreign public accounting firms (pp. 57-58). In general, provides that the Act shall apply in the same manner and to the same extent as to a domestic public accounting firm. The Board may grant exemptions or impose additional qualifications as it deems consistent with the public interest and the protection of investors.

Section 410 provides transition periods and effective dates for the independence requirements (p. 58).

Background and Need:

The Committee on Energy and Commerce’s Subcommittee on Oversight and Investigations held over 30 hearings on the accounting profession and a number of failed audits (see list below). The hearing and investigative records documented an inadequate governance system and a number of acts and practices that posed potential threats to the independence and integrity of the profession. The accounting industry met calls for reform with denials, promises of better self regulation, and intense lobbying campaigns to ward off SEC or Congressional action.

Enron is only the latest of a string of corporate scandals involving appalling audit failures. At the heart of these audit failures lies a set of business relationships (such as revolving doors between auditor and audited, and the increasing focus on providing big-ticket consulting services to audit clients) that are bedeviled by financial incentives and conflicts of interest.

A new study by the Investor Responsibility Research Center, based on an analysis of 1,224 large U.S. companies, found that fees for nonauditing services, usually consulting, were two and a half times greater than the fees for audits. Nonauditing fees exceeded $4 billion last year, while audit fees totaled $1.58 billion. Given that nearly 20 percent of the nonaudit fees earned by accounting firms were related to the design of financial systems, the potential for a compromised audit becomes greater.

This title establishes a regulatory structure to provide for better accounting and auditing practices and to restore faith in the basic integrity of the audit function.

Title V -- Preservation of Authority

Section 501 clarifies that nothing in this Act shall be construed to impair or limit the SEC’s existing authority.

Accounting Hearings
Subcommittee on Oversight and Investigations
Committee on Energy and Commerce
1985-1992

	Serial No.	Hearing Title	Dates
99-17	SEC and Corporate Audits--Part I	Feb. 20, Mar. 6, 1985
99-34	SEC and Corporate Audits--Part II (ESM)	April 2, 17, 1985
99-63	SEC and Corporate Audits--Part III (Beverly Hills)	June 19, July 15, 19,      Sept. 11, 1985
99-115	SEC and Corporate Audits--Part IV	Nov. 4, 7, Dec.16, 1985
99-144	SEC and Corporate Audits--Part V	Apr. 10, 24, 28, 1986
99-150	SEC and Corporate Audits--Part VI	June 19, 23, 1986
100-83	Financial Reporting Practices	July 10, 22, 27, 1987
100-115	Failure of ZZZZ Best Company	Jan. 27, Feb. 1, 1988
100-194	Financial Reporting Practices--Part 2	May 2, 1988
100-227	Insurance Company Failures	Sept. 14, 15, 1988
101-38	Insurance Company Failures	April 5, 11, 19, 1989
101-147	Insurance Company Failures--Part 2	March 12, 19, 1990
101-204	Insurance Company Failures--Part 3	June 18, Sept. 14, 1990
102-159	Insurance Company Failures	April 9, Sept. 9, 1992

Note 1: The insurance hearings included investigation of the role of creative accounting and misleading financial reports in insurance company failures.