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Accountants' Cleanup Crew

April 21, 2003

Wall Street wants nothing more than to put the past behind it. But post-Enron accounting scandals and the New York Stock Exchange announcement Thursday about suspected cheating by the very people executing investors' trades show why investors stay wary.

The new watchdog agency established by Congress, the Public Company Accounting Oversight Board, is moving to clamp down on industry abuses, and the change can't come soon enough.

On Wednesday, the oversight panel voted to set rules for corporate auditors rather than allow an industry trade group to continue self-policing.

Under congressional guidelines, the panel could have stuck to the old rules. But with the Securities and Exchange Commission opening up 2,200 audit investigations and 330 companies changing their earnings statements in 2002, the panel rightly recognized that industry problems did not stop with a few bad apples.

Government responses to the scandals also include SEC and Justice Department investigations of America Online and its partners, Homestore and Bertelsmann. America Online is restating $190 million in profit because it engaged in a popular accounting trick called "round-tripping" -- selling a product to a company and buying similar goods from it, then counting the sold goods as new revenue. Presto, profit from thin air.

The oversight board has named someone well suited to help clean up this mess. Long-time accounting industry critic Douglas R. Carmichael, a professor and former auditor, will draw up new ethics standards for auditors, who had hoped the task would be delegated to them.

The accounting industry also faces a new look at an old problem. The SEC decided against restricting lucrative tax consulting work -- actually, tax-avoidance consulting. It's the companies' second-biggest source of income, after auditing. But the acting director of the accounting oversight board, Charles D. Niemeier, shocked the industry last week by announcing that the board would consider banning the practice. He brought up one painful example: Accountants at Ernst & Young created tax shelters for two executives at telecom giant Sprint that enabled them to avoid taxes on $288 million in stock options.

When William J. McDonough, the retiring president of the New York Federal Reserve, takes over at the accounting oversight board from Niemeier in several weeks, he should continue to aggressively crack down on auditors' conflicts of interest. His first move should be to eliminate the tax shelter loophole. Outside scrutiny is something auditors abhor for themselves, but McDonough should insist on overseeing the overseers.

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