WASHINGTON - Over the next few weeks federal regulators will decide whether to proceed with a plan to bar banks from hiring the same company to conduct their internal and external audits.
If the agencies move forward, banks would face higher auditing costs and be singled out among publicly traded companies for tougher auditing standards.
However, a consensus among the regulators has not been reached, reportedly because the Federal Reserve Board is concerned that Congress, considering legislation to enhance auditor independence, could make any action by the banking agencies moot.
Though banking and auditing industry sources said an interagency task force on internal auditing standards had already abandoned its work, regulators insisted in interviews this week that the proposed ban is still actively being considered. A decision - to proceed or wait until Congress acts - is expected by June 30.
"Nothing is off the table," said Doris Marsh, an examination specialist at the Federal Deposit Insurance Corp. who is leading the interagency task force. "Generally, we think two sets of eyes are better than one."
In fact, if the banking agencies cannot agree, the FDIC Improvement Act of 1991 gives the FDIC the unilateral power to impose stricter auditing standards on banking companies with more than $500 million of assets. Several regulators mentioned this option as a likely alternative if the agencies are unable to reach a common position. Any change would require that a proposal be issued for public comment.
A Fed spokesman denied Thursday that the agency favors a wait-and-see approach. "We have not taken a position yet," he said. The Office of the Comptroller of the Currency has long discouraged national banks from outsourcing their internal audits to the same firm that provides the external audit. Interest in the topic is high; some 1,400 bankers participated in a teleconference the agency sponsored this spring on outsourcing audit work.
FDIC Chairman Donald E. Powell is on record as supporting tougher auditing rules and this month complained about how much time it takes to get the four banking and thrift agencies to act in concert. The interagency task force on internal audits was formed in late 2000.
"Too many auditors are faced with conflicts of interest arising from providing multiple services to the same financial institution," Mr. Powell said in a speech March 5. "We have the authority to adopt more stringent requirements in this area, and we are looking into whether we should.
"One of the ideas we're discussing is whether accounting firms should be prohibited from providing both internal auditing and other consulting services to the same financial institutions they are auditing externally," Mr. Powell said.
An Office of Thrift Supervision spokesman declined to comment.
Critics claim the dual role presents a conflict of interest because the external auditors are essentially being hired to check their own work. But supporters contend the two jobs are quite different, with the internal audit more focused on a bank's systems to identify, monitor, and control risks and the external audit focused on verifying financial statements. Proponents claim auditors doing both jobs are better informed and therefore able to do a more thorough job.
Regulators said they do not know how many banks hire the same auditing firm to do both. But they argued that outsourcing the internal audit is a growing trend, and that many banks save money by hiring their internal auditors to conduct the external audit. Regulators use PNC Financial Services Group Inc. to illustrate their point.
Until this year, the Pittsburgh-based company used Ernst & Young to do both its internal and its external audit work. But twice after being forced to restate its earnings, reducing 2001 profits by nearly $200 million, PNC hired Deloitte & Touche to review this year's financial statements. The bank continues to outsource its internal audit to Ernst & Young.
PNC spokesman Jeep Bryant on Thursday said the company made the switch to comply with new auditing rules issued by the Securities and Exchange Commission - not because it felt Ernst & Young's objectivity was compromised by its dual role. Mr. Bryant noted that E&Y performed both functions for "more than a decade" without incident.
Mr. Bryant said he did not know whether hiring Deloitte & Touche drove up PNC's auditing fees. But James D. McLaughlin, the director of regulatory and trust affairs at the American Bankers Association, said banks will pay more if they are forced to hire separate accountants for internal and external audits.
A lot of banks use one single firm for both, he said "because it saves a heck of a lot of money. There is a double learning curve every time you hire [a new auditor], and time is money."
Asked whether bank regulators should forge ahead or wait to see what Congress does, Mr. McLaughlin said, "Prudence would probably suggest waiting."
The banking agencies are aware that auditing rules are the province of the Securities and Exchange Commission - which has been down this road before.
Public companies with more than $200 million of assets are required to obtain an "independent" external audit. But as the outsourcing trend took hold in the 1990s, many companies were hiring the same firm to do both their external and internal audit work.
Former SEC Chairman Arthur Levitt questioned the independence of auditors who check their own work. In June 2000 the commission proposed banning external auditors from also providing the internal audit.
After a bruising battle, industry criticism forced the SEC to compromise, so the final rule permits an external auditor to be considered "independent" if it does 40% or less of a company's internal audit work. That cap is defined as the number of hours spent on the internal audit - a measure that critics say is vague and easy to fudge.
The SEC's auditor-independence rules began taking effect in February 2001 and are scheduled to be fully phased in this August. The current SEC chairman, Harvey Pitt, has argued against making any changes until the rules have had a chance to work.
However, some bank regulators do not want to wait, and contend that stricter bank auditing standards could be justified to ensure the industry's safety and soundness. Using this basis would avoid a turf battle with the SEC.
"We might ban it on the basis of safety-and-soundness concerns," a senior regulator on the task force said. "We think internal audit is a very important aspect of bank safety and soundness."
In the aftermath of Enron Corp.'s collapse, Congress is considering legislation that would crack down on audits. The Houston-based energy concern, which declared bankruptcy in December, for a time hired Arthur Andersen to do both audits. Senate Banking Committee Chairman Paul Sarbanes' bill would ban external auditors from also doing a company's internal audit or designing its financial systems. The bill approved by the House directs the SEC to impose such a ban.
