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Ethics in Accounting

of the accounting profession in the United States. Almost of financial reporting and hence to the operation of capi-
from the beginning, however, professional ethical stan- tal markets that he instituted a new regulatory body in
dards were not left to the individual CPAs to determine. 1997, the Independence Standards Board (ISB). The ISB
To protect the public, states instituted educational attempted to shore up audit firms’ independence from
standards and examinations, as well as admission stan- corporate management by instituting stricter regulation of
dards for CPAs and the rescindment of professional professional conduct. Unfortunately, the board received
licenses for breaches of professional standards. The Amer- little more than lip service from leading CPA firms and
ican Association of Public Accountants formed an ethics was abolished in 2001.
committee in 1906 to develop ethics standards for its The corporate scandals of 2001–2002 resulted in
members. Its modern successor body, the American Insti- major federal legislation and regulation not seen since the
tute of Certified Public Accountants (AICPA), is an 1933 and 1934 securities acts, principally the Sarbanes-
organization of all state societies of CPAs. Its Professional Oxley Act (SOX) of 2002. SOX transferred the regulation
Ethics Executive Committee (established in 1971) prom- of accountants auditing the financial statements of public
ulgates a code of professional conduct and investigates,
corporations from the AICPA to the Public Companies
threatens, and punishes AICPA members for infringe-
Accounting Oversight Board (PCAOB), a new private
ments of the code.
sector, not-for-profit body. The PCAOB is funded from
Consequently, for much of the twentieth century the fees paid by registrants. SOX requires accounting firms,
accounting and auditing profession was largely self-regu- including international firms and foreign firms that play a
lating, with a professional code of conduct and a mecha-
substantial role in the preparation of audit reports of U.S.
nism for investigating and punishing those whose conduct
public companies, to register with the PCAOB. As of
fell below professional standards. A separate investigation November 2005 more than 1,500 firms were registered.
might also be conducted by the state licensing organiza-
Section 103 of SOX directed the PCAOB to establish
tion (e.g., the Department of Education in New York
auditing and related attestation, quality control, ethics,
State).
and independence standards and rules for registered pub-
The federal legislation that ensued after the 1929
lic accounting firms. To meet this requirement for ethical
stock market crash (the Securities Act of 1933 and the
standards under rule 3500T, the board adopted the
Securities Exchange Act of 1934) set up a federal agency, AICPA’s Code of Professional Conduct Rule 102, and
the SEC, with broad powers of regulating public securities
passed interpretations and rulings (as Section 191) as of
markets. All public companies are required by these acts to
register with the SEC and to file annual audited financial April 16, 2003, as interim ethics standards, unless super-
seded or amended by the board. The board also adopted
statements. The SEC largely delegated accounting stan-
(under rule 3600T) the AICPA code of Professional Con-
dard setting to the private sector but retained enforcement
action. It may regulate the most powerful members of the duct Rule 101 as its interim Independence Standard,
profession who audit the financial statements filed with along with Standards 1, 2, and 3 and their interpretations
the SEC directly, by enforcement actions including bans issued by the ISB. It is the responsibility of users to deter-
on auditing or working for public companies; it can also mine if a particular rule has been amended or superseded.
ban trading in the securities of public companies. For the
most part though, throughout the twentieth century, the AICPA CODE OF ETHICS
audit profession continued to be self-regulating at the fed- The AICPA Code of Ethics covers general principles as
eral level, by agreement and cooperation between the SEC well as more explicit rules of conduct. It is based on six
and the AICPA.
principles, which are translated into a set of specific rules
that AICPA members must observe. The code is sup-
ETHICAL CONCERNS BEGINNING ported by interpretations and rulings that apply in specific
IN THE 1990S circumstances. The overriding objective of the six princi-
During the 1990s the growth of management consulting ples is to commit members to honorable behavior, even at
by audit firms caused many observers to question whether the sacrifice of personal advantage. The preamble states
those firms were sufficiently independent to conduct their that by accepting membership in the institute “a CPA
audits of public companies in the interest of the investing assumes an obligation of self-discipline above and beyond
public. Anecdotal evidence of an increasing willingness by the requirements of laws and regulations.”
auditors to agree with corporate management’s dubious The six principles to which the CPA must adhere are:
accounting treatments, strained the relationship between
the profession and the SEC. Its chairman, Arthur Levitt, 1. Commitment—to the public interest and honoring
was so concerned about the growing threat to the integrity public trust

262 ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION