Q&A With SEC Chief Accountant Conrad Hewitt

California CPA magazine: October 2007

Protecting Investors An Important Task for SEC Chief Accountant

by Damien B.M. English

SEC Chief Accountant Conrad Hewitt has held one of the most visible accountancy jobs in the nation for more than a year. The pressure of his job is apparent: his office is involved in many difficult and unique accounting and auditing problems of SEC registrants and the external auditing firms—and is subject to congressional and press inquiries.

Simply put, Hewitt’s job is to “fulfill the mission as a regulator to protect the investor,” and includes responsibilities such as dealing with SOX implementation and related issues, FASB and PCAOB oversight, and international convergence of accounting standards.

Recently, California CPA caught up with Hewitt during his stop through the SEC’s San Francisco office to discuss the man, the job and the workload.

Q. Tell me about yourself and how you ended up becoming a CPA? How and when did you become involved with the SEC?
I grew up in Sheffield, Ill., a small farming community. I graduated from the University of Illinois, with a bachelor’s degree in finance and economics and did post-graduate work at the University of Southern California.

Career-wise, I started with a bank in Peoria, Ill., before I joined the Air Force. The Air Force didn’t know what to do with me, because I wanted to work in a bank. They said, “Lt. Hewitt, We don’t have banks in the Air Force, but we need an auditor.” I had never taken any auditing courses, but they said they would send me to auditing school, which they did. I became an auditor of Strategic Air Command Headquarters, which was a great duty, for about four years.

After that I decided to go into public accounting and joined Ernst and Ernst (a predecessor of Ernst & Young), in Los Angeles, and had my CPA license a year or two afterward. I stayed in public accounting for 33 years working up and down the West Coast doing various things. The firm had a mandatory retirement age for partners when I signed the partnership agreement in 1973. I thought that was a great way to go and was looking forward to it. The day came and the day after I retired, I became the Superintendent of Banks for the state of California.

Once in that job, I consolidated all the financial institutions in California into a new department called the Department of Financial Institutions. That took me about two years, and I became the first Commissioner for Financial Institutions, which I did for about four years. When the governor’s term was ending, so was mine, and I decided to go and play golf, but another company knew I was around and wanted me to join their board, which I did.

I ended up being on a number of different for-profit companies’ boards of directors. I was chair of all of those audit committees. I was on the boards of five companies at the end of that era before I accepted the Chief Accountant position.

Chairman Cox’s vision and strategy were in line with mine, and we both wanted to make some changes, so I decided to help for a few years. I thought it was a good way to cap my career in accounting.

Q. What are your responsibilities?
My main responsibility is to protect the investor. That involves a lot of different factors: oversight of FASB, oversight of PCAOB and international convergence situations. It involves a lot of different areas; my office works very closely with the enforcement, corporation finance, investment management and market regulation divisions. That’s enough to deal with.

Q. Policing the nation seems an insurmountable task. How big is the SEC’s budget and staff, and how does it go about prioritizing its agenda?
I have outstanding staff to help me. In addition to an extremely dedicated permanent staff, some are with me for two years as public accounting fellows; we have 10 of those who come and go. We then typically have about three academic professors in accounting that come and go every year.

The SEC’s budget is about $900 million and the organization has about 3,800 staffed positions. We have 11 regional offices throughout the United States, and we’re headquartered in Washington, D.C.—that’s where most of the staff is. We have about 100 people in our San Francisco office.

I’m responsible for setting my own priorities, and I discuss them with the Chairman. I didn’t know the Chairman when I took this position. When he indicated what his priorities were, in particular XBRL, I didn’t know much about it, but have always been a believer in technology, and that ended up being one of my responsibilities.

I also have taken on the complexity situation, and have formed the advisory committee to improve the usefulness and reduce the complexity of financial reporting in the United States.

That was a big item I was interested in, and the Chairman was, too.

He and I also discussed the PCAOB’s AS2, which was a very controversial standard that has been replaced with AS5. There has been a lot of interest in this area, and we wanted to see what could be done both at the SEC and working with the PCAOB.

My office also was charged with producing a document called “Management Guidance,” which is for all public companies to use in their assessment of internal control over financial reporting  required by SOX 404.

Q. What’s been the most challenging—and rewarding—part of being the SEC’s Chief Accountant?
It’s all challenging. I do so many other things besides the major initiatives I mentioned. When I first got here, I immediately became involved with addressing backdating and stock options accounting issues. I ended up publishing a letter affecting all the public companies registered with the SEC last September, reiterating the accounting for about seven different scenarios we had received many questions about. The issues primarily dealt with how to account for options historically in accordance with APB 25.

I also get involved with many registrants’ accounting problems. I get referrals from the enforcement and corporation finance divisions, and some of them lead to big restatements, which can be challenging.

However, if I find things to be challenging, I also find them to be rewarding at the same time. If we come to a good solution on the issue, one way or another, I find that very rewarding.

Q. What have you learned about the SEC’s regulatory proceedings? Any surprises in terms of how regulatory bodies operate?
There are many operations and parts of the SEC. We’re responsible for many different things: brokers, dealers and investment advisers, to name a few. All the registrants we have, about 15,000 of various sizes and types, contain a great diversity. As a government agency, we’re not that large. But our responsibility is extremely great: to protect investors and make sure the capital markets run smoothly.

Q. What sort of dealings does the SEC specifically have with California, and specifically the CPAs therein?
We work with the California State Board of Accountancy regarding CPAs who have problems with the SEC, due to fraud or other issues, and are barred from appearing  and practicing before the SEC. We make referrals to the CBA, alerting them to these actions for their consideration. We do that with all 50 states actually.

We also get involved with the many public companies that are in California. We have registrants in the state of various types, many of them technology driven in Silicon Valley.

Q. Why was the decision made to eliminate AS2 and start fresh with AS5?
I had real practical experience with this because I had been chair of four audit committees for public companies, and those companies found it very expensive to implement AS2. For almost two years, management devoted its efforts to internal controls—and had less time to devote to efforts for customer service, new products and other important business needs. Personally, I believed the relative cost/benefit there slowed down our economy and something needed to be done.

We have what we call non-accelerated filers (primarily $75 million market cap or less). Presently, these companies are deferred until 2008 to have a 404(b) audit on their internal control system. This year will be the first time for management to evaluate their internal controls under 404(a), and we want to make sure the benefits are commensurate with the cost for those 5,000 companies.

Prior to the introduction of AS5, I believe this was a real concern. And there have been a lot of studies done that have guided our efforts to change that. Congress has really wanted to make sure that for these small companies the benefits are commensurate with the cost.

Q. How is AS5 different?
I believe AS2 was a very rule-based standard—there were a lot of steps required for auditing firms. AS5 is more principles-based. AS5 is what we would call in auditing a top-down, risk-based approach. I didn’t feel AS2 was written that way at all. I believe this created a lot of unnecessary auditing and did not help the costs of auditing in relation to the benefits.

Using the work of others is another area in which AS5 clarified AS2. Under AS2, there was a lot of unnecessary duplication of work. AS5 clarifies the ability for the external auditor to use the work of others.

It’s those types of things that are embedded in AS5 that should make it work better. If it doesn’t, I’ll be disappointed.

Q. What issues are you and the SEC still dealing with in regards to auditor independence?
I have people on my staff devoted to independence. We get a lot of independence questions and cases. When a company changes accounting firms, there can be independence issues.

In recent years, independence became a larger issue.

SOX also highlighted a lot of independence issues regarding whether a company can use an external auditing firm for certain types of counseling and those types of things. We’re taking a look at how the rules are playing out in practice and whether perhaps some additional guidance or rule amendments might be appropriate to help clarify what can and can’t be done.

Q. Can you explain the issue of “complexity” and what the SEC is doing to address it?
Complexity can take on many forms whether it relates to accounting standards, auditing standards, independence rules, and so forth.
This was a subject that I was deeply interested in before I became Chief Accountant. As a result, my staff and I, with the assistance of the chair of the FASB and PCAOB and their staff, worked to establish a Federal Advisory Committee on this subject. This committee was established July 17 and is called the Advisory Committee on Improvements to Financial Reporting. It is chaired by Robert Pozen, chair of MFS Management, and has 16 other members representing a cross-section of preparers, users and others.

The committee will cover five areas: substantive complexity, standard setting process, audit process and compliance, delivery of information and international coordination. It will exist for a year and will provide recommendations where necessary. It will look at the issues of complexity and how the current financial reporting system can be made more useful to investors.

Q. What’s going on with these hot topics on the SEC’s plate:
• XBRL
Everything I’m saying today only represents my view, and, in regards to XBRL, I do hope we can be moving in this area soon. It will make a huge difference with interactive data for business throughout the world. Other countries are working on it and the International Accounting Standards Committee Foundation is working on it.

The FDIC uses XBRL in their call reports, but it was very limited coverage. Ours is very expansive. We started with taxonomies for financial statements, footnotes and accountant reports. That’s a lot of tagging to do—a lot of defining of data to make it equal. We’re going to end up somewhere around 15,000 taxonomy elements, which I think is a lot.

It’s a big project and will allow investors to compare numbers easily and understand it more. Analysts and companies themselves will use taxonomies for their own internal reports. To me it’s going to be like when IBM developed the punch card system—I went to school on that stuff. It reminds me of that: it’ll be a revolutionary thing.

• International convergence
We have put out a proposal to allow our international foreign private issuers that are registered with the SEC to remove the reconciliation requirement, which has existed for a number of years. That requirement is for the foreign private issuers to take international standards and reconcile them to U.S. GAAP. The comment period ends Sept. 24, and we look forward to studying the comments in the near future. On Aug. 7, we also put forth a concept release on allowing U.S. public companies the option to use IFRS instead of U.S. GAAP. The comment period for that ends Nov. 13, and I’m also going to be very interested in the comments on that.

Take a large multinational company where a percentage of their revenue worldwide is pretty high. They may have adopted IFRS in all their worldwide operations outside the United States. A company like that may find interest in switching over from U.S. GAAP, but in the meantime we want the two to converge as close as possible.

They will not be perfectly married, but they’ll be close enough so investors receive the benefits of global accounting standards.

Q. What are some of the SEC’s accomplishments during your term?
We managed to get our 404 management guidance and PCAOB’s AS5 accomplished. I believe we have provided useful guidance on the accounting issues around backdating and stock options. We do not have international convergence accomplished, but we’ve made progress.

On an annual basis we have to review the budgets of FASB and the PCAOB, and we inspect the PCAOB regularly. We’re looking at materiality. For example, we’re trying to look at issues around materiality on a quarterly basis.

We’ve accomplished a lot, but we still have more work ahead of us.

Q. What issues are coming down the road?
You never know. It could be anything. You just don’t know. Something always comes up.

Q. Do you have any advice for California CPAs?
I’ve been a California CPA for many years. My advice: I’ve always believed very strongly in continuing education, and California CPAs need to keep up. We’re in a fast-changing accounting and auditing environment, and it’s going to be that way for the foreseeable future. It won’t be easy to keep up, but you have to go through the CPE courses, reading and studying to make sure you’re current.

Q. How can California CPAs get involved with the SEC? And why do you think they should?
That’s a good question. At the Office of the Chief Accountant, we always encourage input from anybody involved with accounting and auditing. If they have a problem with something, or need some help, we’re there to help.

We probably don’t advertise that enough, but we do have a website that’s easy to access (www.sec.gov).

We’re always looking for public comment on our proposals and concept releases during the comment period. California CPAs can really help us here. We read all the comments; we study them before making a recommendation to the Commission regarding what to do. That’s very important.

The other thing I’d like to see California CPAs do more of is that when FASB or PCAOB comes out with an exposure draft or proposes a new standard, practitioners really need to comment.

That would help our job, because we get very involved in these standards.

Damien B.M. English is CalCPA’s managing editor. You can reach him at damien.english@calcpa.org.