Call for Better Tone at Top of Audit Firms

The top accountant at the Securities and Exchange Commission just fired a warning shot at the accounting industry, urging audit firms to do better at holding firm personnel accountable for misconduct and at developing a strong tone at the top overall. 

Said warning shot came from Paul Munter, chief accountant at the SEC, who released his 2,000-word missive to the audit industry Wednesday afternoon. He baldly said the SEC has seen multiple instances of firms brushing audit partner misconduct under the rug, and that firms must do better to fulfill their role as gatekeepers of investor protection in the capital markets.

“Given the accounting profession’s role of enhancing the public trust in corporate financial statements for the success of our capital markets, accounting is called to be a profession that holds its members to high standards of ethics and integrity,” Munter wrote. “To be an effective public watchdog, audit-firm leadership must set the right tone at the top by always placing the public-interest obligations of our profession ahead of business interests and profits.”

I mean, yes; the above sentiment is wholly correct — but why did Munter release this statement now? How does it fit into the previous statements he has released from time to time, urging audit firms and public companies alike to do better at risk assessments, fraud detection, and other financial reporting fundamentals? Let’s take a look.

Troubling Patterns at Audit Firms

Munter began his statement by describing the scenario of an audit firm engaging in a conflict of interest: to win lucrative audit business with a potential client, the audit partner quietly promises to include non-audit services at a reduced rate. (A big no-no under audit industry rules.) The SEC then discovers the illicit arrangement, imposes monetary penalties on the audit firm, and bars the audit partner from practicing before the SEC for several years. 

So what happens after such an enforcement action? What should the audit firm in question do?

Ideally, the audit firm would use the incident as a teachable moment — to “instill in all staff the critical importance of professional integrity, ethics, and serving the public trust,” as Munter said, perhaps by punishing or even firing the offending audit partner. 

Or the audit firm “may treat the independence violation as an isolated incident — an efficient breach or just the ‘cost of doing business’ — and wait things out by allowing the partner to focus on non-audit business development until being reinstated,” Munter said.

As you likely guessed by now, the above scenario is not hypothetical. The SEC has seen audit firms in exactly this predicament numerous times, Munter said, and too often the offending firm decided to keep quiet and squander the teachable moment.

That sends a terrible message, Munter continued, especially for younger accountants and staff in non-audit lines of business. “When firm leadership fails to set a strong tone at the top ­… they risk eroding the firm’s culture, professional skepticism, quality control systems, and public responsibility as gatekeepers of our capital markets,” he wrote. 

Ah, there it is — a reference to quality control! It so happens that the Public Company Accounting Oversight Board adopted a new standard for quality control at audit firms earlier this week. The PCAOB has also been on the warpath about audit firm deficiencies in the last year or so, ramping up its inspection efforts and fines for shoddy work. Clearly Munter’s missive about audit firms’ tone at the top fits into that larger frame.

His statement also comes after that cuckoo crazy story of the BF Borgers audit firm, permanently barred from SEC practice for fabricating audit work for hundreds of clients. Clearly the audit industry has a long road ahead to achieve the ethical ideals that Munter and the rest of us want to see — but hey, you have to start somewhere.

Instilling a Strong Tone at Top

OK, audit firms need a better, more ethical tone at the top. How should they go about achieving that? Munter minced no words.

“Senior partners in firm leadership across all service lines must lead by example, through their actions,” Munter said. “After all, almost all audit firms have a written code of ethics or code of conduct; and almost all audit firm leaders extoll the importance of ethics and integrity. However, all those words and policies can easily be diluted or undermined by leadership’s ‘tone,’ which is exhibited by actions.”

Munter went on from there, rolling out an homage to ethical leadership that would delight ethics and compliance officers everywhere:

Less-experienced staff watch what their managers do. If they see their managers bend the rules or make exceptions for profitable partners who engage in inappropriate conduct, less-experienced staff may assume that this behavior is the path to rise through the ranks. This is why firm leadership must make ethics and character a fundamental part of the firm’s hiring, retention, and promotion criteria for all professionals, regardless of service line within the firm—even at the expense of a more profitable bottom line in the short-term.

Sure, compliance professionals already know all this is true, but isn’t it invigorating to hear it? Print out all these words and staple them to your management team’s foreheads, I say. 

Munter also emphasized the importance of candor and transparency for an ethical culture. That can range from multiple channels to give honest feedback about corporate culture (whistleblower hotlines, workforce surveys) to policies requiring that employees report misconduct when they see it; plus strict policies against whistleblower retaliation.

Think about it: even if your organization has a stellar tone at the top, people elsewhere in the organization might work to thwart that tone because they are engaged in unethical practices themselves. In that case, your organization also needs mechanisms to let employees bypass those problematic managers and coworkers. You need mechanisms that let employees reach the top with their concerns, so the top can respond accordingly. That’s what hotlines, surveys, and the like can accomplish.

It’s a feedback loop, really. When senior executives committed to ethical conduct can receive that candid feedback about what’s really going on elsewhere in the org chart, they can act on that information. The rest of the organization sees that action, and takes the tone at the top seriously, so they speak up more often and more directly. 

That’s just as true for public companies as it is for audit firms. We’d all do well to consider Munter’s advice and how to put it into practice in our own organizations.