A Future That Matters

An exit interview with the Chief Accountant of the SEC.

s he packed up to leave his Washington office, Donald T. Nicolaisen shared some candid comments with the Journal of Accountancy on the profession, the politics and the people that have made up his world for the past two years.

JofA: Do you think regulation is dampening the growth of the small companies that could one day be the next Microsoft?

Nicolaisen: I don’t think so. From everything I can gather, our nation’s entrepreneurial spirit is still very much alive. People continue to pursue the American dream; new products and ideas are flourishing and being disseminated in the United States and abroad. That being said, with the new legislative and regulatory requirements, in certain cases it may take a bit longer to get to the public markets. The capital formation process has undergone change. Companies go public at a more mature stage and private capital has filled that gap and replaced early-stage IPOs.

JofA: The relationships between auditors and preparers have always been open as both sides look for the right answers. But today some people feel auditors are saying, “Well, you figure it out and we’ll tell you if it’s OK.” Do you think that’s true? And if so, does that approach produce the best results in our capital market system?

Nicolaisen: A great many people have raised this with me. The concern is that auditors are saying to their clients, “Finish all of your discussion, decide on what the proper accounting is, put it in a memo and then we’ll review it.” That’s not our intent and that certainly was not the intent of Sarbanes-Oxley. The objective is that the auditor be independent and not make management decisions. The auditor ought to be involved early on in helping preparers identify and understand issues. All we’re really seeking is the best answers.

I believe, though, that this concern has received sufficient attention recently and has begun to correct, even though the audit profession is more cautious than in the past. The pendulum is swinging in the right direction.

JofA: Do you think the new environment is causing the best and the brightest accountants to stop aspiring to the top positions in their firms and companies, where they’d be held accountable for anything that goes wrong?

Nicolaisen: There is a visible desire by the audit profession and the preparer community to have detailed guidance and rules, and many people are increasingly reluctant to exercise professional judgment. But I also see an ambitious and competent group of professionals who really do want to make a difference. What separate the good from the great are hard work and a willingness to stick your neck out and speak up for what you believe.

JofA: In your resignation letter to Chairman Cox, you said the past two years have been extremely challenging for the accounting profession, and now financial disclosure has strengthened the audit process and rebuilt investor confidence. You said a recent study revealed that the momentum created by these efforts will provide a platform for “future, broad-reaching global and national efforts to improve transparency, reduce complexity and enhance the relevance of financial reporting.” Can you expand on that?

Nicolaisen: The preparer community and the audit profession have been challenged, perhaps as never before, during the past few years. When I first joined the commission, I was surprised by the deep distrust of the audit profession, the preparer community, CEOs and CFOs. The bad actors in our capital markets had sullied the reputation for many, including those who attempt to do the right thing day in and day out. But I believe we’re making progress. The measures of improvement are clear.

Still, when I look at the complexity of financial reporting, some accounting standards have been written with a bias that someone will do the wrong thing. They sometimes are more focused on what to avoid rather than the objective. Some of that is unnecessarily over the top. There’s simply too much complexity for any one person to maintain expertise in all areas of accounting. That sometimes divides the national office from clients and from engagement teams in the field. Priority one should be to reduce that complexity. Competent professionals shouldn’t be regimented to follow excessively detailed rules and interpretations. Accounting and auditing is a profession.

Technology is undoubtedly part of the answer, and XBRL is one tool that can help. Young people entering the profession have grown up in an environment where Web-based research is the norm. I think they’ll be disappointed in how slowly we’ve embraced technology in certain areas of the audit and accounting professions. The advantage of tools like XBRL is quick retrieval, and the data always means the same thing—in every company and every country—so you can compare information and find what you need in a Web-based environment. I’m a firm believer that if it’s not XBRL, there will be some other way of tagging information that leads us to the next level of financial reporting.

I also should mention that I believe the number of restatements in financial statements filed with the SEC is unacceptably high, as is the number of material weaknesses companies have reported in this first year of 404. This is another area where less manual effort and better use of technology may help. Preparers know how to use technology, but when it comes to preparing financial statements, we still see information transferred from many different home-grown reporting systems, often with manual intervention and not fully integrated. So even when companies of like size merge, they often have to re-sort their data and systems in order to understand the real detail of what they’ve acquired and how to account for the acquisition. Technology can help us do better. It’s just a question of baking quality improvement—less complexity and more technology in financial reporting—into our everyday lives.

JofA: Have the efforts of the Enhanced Business Reporting Consortium and the Reporting Simplification Task Force contributed to improving the transparency or reducing the complexity of financial reporting?

Nicolaisen: They have, though more is possible. For the past couple of years we’ve been focused on ensuring compliance with existing standards, and putting internal control reporting into place. That pushed almost everything else to the back burner. So the efforts to simplify, to find better ways of measuring and reporting on corporate performance, have suffered. I believe now is the time to take a good hard look at this.

About half of SEC registrants use some sort of pro forma earnings to measure performance. That suggests to me that GAAP alone is not sufficient. If so many companies measure their performance their own way, it’s difficult for the average investor to compare one company to another. So I believe enhanced business reporting especially, to the extent that it identifies best practices, has a part to play in this effort.

JofA: What did you like most about the job of chief accountant and what was your biggest challenge?

Nicolaisen: The most fulfilling aspect was working every day with a group of highly talented professionals. I inherited a top-notch staff and then had the opportunity to build on that team by restructuring the Office of the Chief Accountant and more than doubling its size.

There have been a lot of challenges. The obvious ones are those that deal with individual preparer or auditor issues, but I’ll save that for a book to be written sometime in the distant future! That being said, I believe the biggest challenge we face is often just communicating with each other.

I realize that preparers feel particularly imposed upon over the past three years because of the change section 404 has brought in regulatory practice, financial statement certifications, the relationship with the auditor and audit committees. But I have found that when the various groups communicate, the distance between their points of view isn’t as great as it first seems. It’s been challenging to try to keep the level of dialogue among investors, the preparer community, standard setters, the auditor community, Capitol Hill and other interested parties focused on what we’re doing right, what’s working and what’s not.

JofA: How do you communicate in an organization the size of the SEC?

Nicolaisen: You just keep working at it. For example, each week in my office we talk about our priorities and how we’re doing in achieving them. I do this in a weekly written update to my staff that also is shared more broadly within the commission. I’ve found such communications to be a good discipline because they force me to think, “OK, are we making progress? Are we doing the right things? Did I spend my time in the right areas this week?” It really does help me stay focused and accountable.

JofA: Looking to the future, can you define the relationship between the SEC and the PCAOB?

Nicolaisen: The PCAOB has a very clearly defined mission in oversight of the audit profession as it relates to public reporting entities. It registers, inspects and disciplines firms, and also has responsibility for setting audit standards. The role of the SEC is oversight. The SEC approves the PCAOB budget, rules and standards and entertains any appeals of PCAOB inspection reports and of its disciplinary actions. The SEC also has the authority to appoint or remove PCAOB board members.

In a practical sense, we work with the PCAOB in partnership, where our contact with the preparer community allows us to see things the PCAOB might not see and vice versa. We work issues through with them, but in general we try not to do their job and they try not to do ours. [PCAOB Chairman] Bill McDonough and I have communicated with each other just about every week that I’ve been at the commission and that too has been important.

JofA: What challenges and opportunities lie ahead for companies small and large?

Nicolaisen: Small companies still have SOX 404 awaiting them, at least in the public arena. The SEC recently deferred the reporting requirement for one more year to allow our Small Business Advisory Committee to complete its work and for COSO, which is developing a framework for small businesses, to obtain public input on its efforts. It’s tough in this complicated world for smaller businesses, whether they’re private or public, to get all the right information at the right time, so that they can prepare their financial statements accurately and so that auditors can audit them with confidence. Smaller businesses generally have more limited resources. Additionally some things the FASB is doing—working to codify and reformat access to its information to get it all in one place—are especially helpful. When I first entered the profession many years ago, there had been a codification of the accounting standards issued to date (Accounting Research Bulletin 43). That effort pulled together 30 or 40 years of information in about 40 pages. That was extremely helpful. We need to do that from time to time. But, obviously, the current codification will be a bit more lengthy!

JofA: If you had it all to do again, would you do anything differently?

Nicolaisen: Of course I would. In hindsight I know I sometimes let my zeal get ahead of the practicalities and that caused some frustration, but I don’t regret it. What happened is that we did advance the ball a lot. If we had been more methodical and focused only on all the things that could go wrong and all the handicaps to what we wanted to achieve, we would have accomplished far less. I think all of us in this office feel as though we’ve run a two-year marathon and that we’ve been stretched to the maximum.

JofA: What do you want the accounting profession to take away from this interview?

Nicolaisen: I’d say that the focus on accounting and auditing we’ve had for the past three or four years ought to reinforce that what you do every day is incredibly important and that you should approach your job with that attitude. The audit profession matters immensely. And, the preparer community has the awesome responsibility of providing useful, accurate and candid information to investors. Perhaps accountants should think of their responsibilities more as the medical profession does. We’re both dealing with life-and-death situations on a daily basis. In our case we’re protecting the financial lives and well-being of many, many investors. Our country is unique, with so much of our population invested in our capital markets. It does matter an incredible amount that we serve investors well and do our best to avoid causing them any harm. That ought to be at the forefront of our thinking every day.

JofA: What lessons have you learned?

Nicolaisen: I’ve learned that not everyone does what they should be doing, and strong enforcement and strong support functions are critical. I’ve also learned a lot about how to reach out to people and ask the right questions to get to the heart of issues rather than debate at the fringe those matters that aren’t particularly important.

I’ve also acquired a deep appreciation for Washington and for our regulatory environment, for the strength of the SEC, and especially for the intellect that’s gathered here. I have a better view of our political world. I know many people have become disillusioned with politics, but I have to say that in my experience if something made sense for the American public, it didn’t matter which party I talked to on the Hill. It was about doing the right thing. We enjoyed much support to get things done.

JofA: So what’s next for Don Nicolaisen?

Nicolaisen: I want to do one more challenging assignment someplace. It’s the future that matters. I certainly will serve on a board or two and, perhaps, take on another full-time role and continue to support our profession. In the past I’ve taken every opportunity I could possibly get to work with and talk to young people, because they’re not disillusioned. They’re optimistic. They have strong ethics. I’m really excited about the generation that’s just now entering this profession. There’s a real opportunity to embrace their skill sets and their values and to couple that with the deep wisdom that already exists within this profession. We need to work together to do things better than what we have accomplished up to this point, but I remain very optimistic about the profession and its role in American society and in protecting our global capital markets.

—Geoffrey Pickard