The Colonel Carter myth and the Securities Act: Using accounting history to establish institutional legitimacy

Introduction

Several papers have examined specific episodes in accounting history to document the use of myth by both the accounting profession and its regulators (Arnold and McCartney 2003; Bealing et al., 1996; Robson et al., 1994). This article follows these authors’ model to demonstrate how a seminal event in American public accounting history, the enactment of the 1933 Securities Act, and particularly the role that Arthur Carter and other accountants played in the creation of the audit provisions of the act, has been portrayed inaccurately by both the American profession and its regulators as a means to legitimate the CPA’s role as the “public watchdog” of big businesses’ financial communications to the public. ¹

Myth-making is a well-worn tool for organizations to establish and maintain their legitimacy (Ritti and Silver 1986: 28). As Robson et al. write: “Ideological narratives are linked to the discourses of legitimation: stories and histories surrounding the development of particular practices that contrive to portray particular forms of social practice as worthy and legitimate. Accounting has not been short of its own accounts of its origins and development” (Robson et al. 1994: 533). The necessity of a legal requirement that an independent public accountant audit the financial statements of publicly traded companies has never been seriously challenged in the eight decades since the Securities Acts and Securities and Exchange Commission (SEC) regulations mandated it. This is, despite the fact that alternatives exist; some of them radical by American standards, like a government takeover of the audit function, and some seemingly viable, like introducing a third-party payer into the auditor-client relationship. The American accounting profession and its regulators, the SEC and Public Company Accounting Oversight Board (PCAOB), have successfully used the Colonel Carter myth to silence debate on the efficacy of the public accountant audit.

The testimony of Colonel Arthur Carter before the U.S. Senate Banking and Currency Committee on 1 April 1933 has been recounted by accounting historians, practitioners, and regulators for generations. The story often takes on iconic proportions: “Colonel Carter … whom many in accounting consider to be a hero because he ‘saved the day for the profession by appearing before a Senate committee and persuading them that audits performed by private accountants were essential for the proper functioning of the [Securities] Act’” (Hendrickson, 1998: 502–3). Many of these sources write that Congress was leaning towards a government takeover of the audit function until Carter and others from the American Institute of Accountants (AIA, the predecessor of the American Institute of Certified Public Accountants (AICPA)) convinced them to trust the accounting profession with this role. This is the version of events recounted in standard academic reference works (Previts and Merino, 1998: 273; Zeff, 2003: 192), popular histories aimed towards students and general readers (Brewster, 2003: 9, 79; Clikeman, 2009: 37), critical accounting journals (Bealing et al., 1996: 324), and in practitioner journals, most recently by the Journal of Accountancy in June 2012 (Tysiac, 2012: 62). Of particular importance, this is how the story is told by the profession’s regulators, including the PCAOB (2011: 30), and on at least a half-dozen other occasions by representatives of the SEC. In 1966, the then-Chairman of the SEC, Manuel Cohen, wrote:

Colonel Arthur H. Carter, as a representative of the profession, was persuasive in his assertion that independent public accountants familiar with their clients’ affairs would be able to make the examination more quickly and economically than an army of government accountants. Colonel Carter’s suggestion was adopted in the Securities Act of 1933. (Cohen, 1966: 56)

No evidence exists that the creation of a government bureaucracy to handle financial statement audits was seriously considered by anyone in Congress or the Roosevelt administration, let alone that Carter persuaded them against it. After discussing the impact of the Colonel Carter myth on the regulation of the accounting profession, the article provides a narrative of the significant events during the months when the Securities Act was debated and written, drawing from publicly available archives.

Hypothesis development: Myth and accounting regulation

The accounting profession would not be the first to aggrandize the role it played in its own creation, and the SEC would not be the first to employ an engaging narrative to justify a controversial decision it does not wish to revisit.

Myths are prose narratives which, in the society in which they are told, are considered to be truthful accounts of what happened in the remote past. They are accepted on faith, they are taught to be believed, and they can be cited as authority in answer to ignorance, doubt, or disbelief. (Bascom, 1965: 7)

While the term is commonly used to refer to anything that is untrue, folklorists require myths to involve a story, and “myths necessarily serve a purpose” (Dundes, 1984: 1; Ritti and Silver, 1986: 27). Richard Hofstadter’s agrarian myth portrayed Americans’ idealization of the independent yeoman farmer as a reaction to the growth of big business in the late nineteenth century (Hofstadter, 1955: 24). Meyer and Rohlinger, studying the exaggerated impact credited to such esteemed works as Rachel Carson’s Silent Spring and Michael Harrington’s The Other America, described the “big book myth” that “provides a simple origins story for social movements” and concluded that these accounts “omit the initiating efforts of government and political organizations” and emphasize instead the role that an individual can play in social reform (Meyer and Rohlinger, 2012: 136). And in the field of accounting history, Arnold and McCartney (2003: 228, 250) analyze:

One of the most widely held views in accounting history: that the published accounts of early British railway companies were subject to pervasive manipulation by their directors, in order to exaggerate reported profit figures and justify higher dividends … Prevalent views of the defective nature of early railway accounting have helped to construct a particular view of the way accounting evolved … Instead of being a rigorous and reliable form of academic enquiry, the process of referencing and citation in this area appears to have functioned instead more as a form of ‘myth’ creation. Although the authors have no evidence that the flaws in the conventional wisdom identified in this paper are pervasive in accounting history, equally there is no reason to believe that the area examined should be unique or even atypical. Instead, given the newness of the accounting history sub-discipline it is a reasonable working hypothesis to suppose that these flaws may well be symptomatic of a widespread, even generic, problem.

For the accounting profession, it is much easier to speak of an idealized past where the plain-spoken declaration of a CPA persuaded skeptical congressmen of the accountant’s essential role and unimpeachable integrity than to concede that the independent audit was an afterthought in the writing of the Securities Act.

But while the accounting profession clearly has a stake in the Colonel Carter myth, the primary culprit in the myth’s perpetuation seems to have been the SEC. In addition to SEC Chairman Cohen and the PCAOB (above), speeches by Vice-Chairman Donald Cook (1950), Chief Accountant Andrew Barr (1970), Commissioner A.A. Sommer (1974), an article by Chief Accountant Robert Sack (1985), and the SEC’s Accounting Series Release No. 81 (1958) all state that Carter’s testimony was decisive in preventing a government corps of auditors, and these appear to be the sources accounting historians have relied on as authoritative: Wiesen, in The Securities Acts and Independent Auditors: What did Congress Intend? (1978), cited ASR No. 81 and Commissioner Sommer’s 1974 speech as the basis for his conclusion that “the testimony of Colonel Carter … was of great importance to public auditors. He influenced Congress to abandon the idea of government auditors” (Wiesen, 1978: 8, 27). Zeff, in turn, cites Wiesen (Zeff, 2003: 192).

An attempt to trace these SEC statements to their origin leads to a conclusion that they relied not on any direct knowledge, but only the basic timeline of events: the original draft of the 1933 Act made an outside audit optional at the Federal Trade Commission’s discretion, then Carter testified, and the law as enacted made the audit mandatory. (See timeline, Figure 1.) Thus the decisiveness of Carter’s testimony appears on its face a reasonable conclusion. But there is much more in the record that both regulators and accounting historians have overlooked, and which makes clear that the Colonel Carter myth is a case of inferring causation from correlation. If we were to frame the evidence in more formal terms, the appropriate null hypothesis would be that the accounting profession had no impact on the 1933 Securities Act; evidence sufficient to reject the null simply does not exist, in fact the evidence overwhelmingly supports a conclusion that the accounting profession played little if any role in the legislation.

OPEN IN VIEWER

Figure 1.

Timeline of major events in writing the audit provision of the 1933 Securities Act.

Criticism of the amount of trust it placed in the accounting profession has trailed the SEC almost continuously in its eighty-year history. Among academics, Previts and Merino (1998), Seligman (1982), Chatov (1975) and Parrish (1970) all conclude that the SEC’s decision to allow the accounting profession to set accounting principles, essentially abdicating its mandate, was a profound mistake (Chatov, 1975: 2; Parrish, 1970: 205; Previts and Merino, 1998: 271; Seligman, 1982: 197–201). The late, eminent historian Thomas McCraw viewed the decision more favorably (see McCraw, 1984: 191). This feeling has been echoed by Congress:

A review of the SEC’s record on accounting and reporting matters shows clearly that it has seriously failed to protect the public interest and fulfill its congressional mandate … Independent auditors share the SEC’s responsibility to the public. Their role in assuring compliance with the provisions of the Federal securities laws is essentially a public service role which Congress might very well have assigned to the SEC or some other governmental authority. (U.S. Congress, 1976: 173)

For the SEC (and now the PCAOB), eager to avoid debates about its reliance on the accounting profession or radical solutions like a government takeover of the audit function, the Colonel Carter myth facilitates a portrayal of these issues as settled policy. (The strategy employed by the SEC and other institutions in using myth to establish and then to avoid subsequent challenges to its legitimacy has been analyzed by Bealing et al. (1996: 334–5) and Ritti and Silver (1986: 40–1)).

The debate over the audit provision

The 1933 Securities Act was introduced in the fourth week of President Franklin Roosevelt’s (FDR) administration, as part of the rush of legislation referred to as the Hundred Days that attempted to address the nation’s economic crisis. FDR’s first bill, the Emergency Banking Act, rescued the American banking system from the brink of collapse. As historian David Kennedy writes: “The Emergency Banking Act furnished a startling demonstration of Roosevelt’s penchant for action and of the Congress’s willingness, at least for the moment, to submit to his leadership” (Kennedy, 1999: 136). In the flush of victory, Roosevelt moved ahead with several measures, including the Truth in Securities Act. FDR turned to Huston Thompson, former Chairman of the Federal Trade Commission, to work with the assistance of Walter Miller and Ollie Butler of the Commerce Department in preparing a bill (Seligman, 1982: 50–2). This draft was presented to Congress on 29 March.

Thompson’s bill did not include an audit requirement, but simply empowered the Federal Trade Commission, “in its discretion, [to] require the production of a balance sheet exhibiting the assets and liabilities of any issuer, representative, or underwriter, or his income statement, or both, to be certified to by a public accountant approved by the Commission”. This was no accident. Thompson knew, or thought he knew, a great deal about accounting, and his testimony before Congress suggests he had strong reservations about the profession. As he explained to the House Committee on Interstate and Foreign Commerce:

The Federal Trade Commission has had a very, very great experience in the analyzing of accountants’ statements in all of the power investigations that have been going on [into the public utility industry], and volume after volume has been gotten out and sent to the House and the Senate which illustrate the fact that they certainly have the knowledge down there of how to read an accountant’s statement and how to make the accountant give the real and accurate statement. (Legislative History of the Securities Acts, Vol. 2, Item 20, 129; hereafter cited as Ellenberger and Mahar, 1973)

During his testimony, he is asked specifically whether he would support a requirement that filers’ financial statements be signed by the controller or by “certified accountants”. Thompson responds: “So far as the controller phase of it is concerned, I think that perhaps an amendment putting in the word ‘controller’ would be all right”, and conspicuously avoids endorsing CPA audits (Ellenberger and Mahar, 1973, Vol. 2, Item 21: 85–6).

Thompson’s skepticism of the accounting profession was based in part on the schism between the two organizations claiming to represent it. Since 1921, the American Institute of Accountants and the American Society of Certified Public Accountants had been at odds over which could claim to represent the American profession. The AIA leadership tended to be drawn more from the national firms auditing big business, and was viewed by many as a Northeastern elite strongly influenced by British practice (Lee, 2014: 13; Carey, 1969: 314). The damage from this rivalry was laid bare when accountants tried to influence events in Washington: the Chairman of the Federal Trade Commission (FTC) reportedly asked representatives from the AIA and American Society of Certified Public Accountants (ASCPA) why the two organizations did not get together (Carey, 1969: 355). One prominent accountant would later note: “The profession had been greatly handicapped in its contacts with governmental agencies in Washington, due to the inability of the representatives of the two societies to represent the interests of the profession as a whole” (Montgomery, 1939: 73).

But these concerns did not completely comprise accounting’s image in Washington or the public’s mind in 1933. A primary goal of the Securities Acts was restoring investor confidence during the worst years of the Great Depression. Regular publication of reliable financial statements, achieved in part by CPA audits, was often cited as an essential part of this effort. In the years leading up to the Securities Act, two influential works, William Z. Ripley’s Main Street and Wall Street (1927) and Berle and Means’ The Modern Corporation and Private Property (1932), highlighted the auditor’s role in protecting the small investor (Ripley, 1927: 215; Berle and Means, 1932: 310). And, during the debate over the bill, many congressmen and journalists revealed a (perhaps) surprising familiarity with auditing and respect for the profession. In March 1933, Barron’s ran a subheading promoting “Publicity Through Audited Statements” in an article entitled “Administration to Protect Investors”, while a writer in the Wall Street Journal lectured its readers that “the logic of the matter leads to the simple conclusion that all corporation accounts to stockholders should be audited by independent public accountants” (Barron’s, 27 March 1933: 20; Wall Street Journal, 30 March: 1).

In Congress, knowledge of accounting, as with any topic, varied widely, but the hearings held on the Securities Act demonstrated that among several members, both auditing and auditors enjoyed a strong reputation. Senator Alva Adams of Colorado stated that:

In many instances I would rather have a statement of certified public accountants, such as Ernst & Ernst, or Price, Waterhouse & Co., or somebody else of like kind, than to have the statement of some director who knew nothing about it and who merely walked up and said: “Where do I sign?” (Ellenberger and Mahar, 1973, Vol. 2, Item 21: 208)

Senator James Couzens of Michigan asked: “How is the public to rely upon the accuracy of an employee who is under the direction of a superior officer? Why shouldn’t there be provision made that there will be certification by public accountants?” (Ellenberger and Mahar, 1973, Vol. 2, Item 20: 12). Admittedly, this opinion was not universal. Price, Waterhouse & Co.’s role in the Kreuger and Toll scandal was noted by one senator (Ellenberger and Mahar, 1973, Vol. 2, Item 21: 274). ²

It was into this atmosphere that Colonel Carter entered. Carter had served as an army administrator in World War I and would later rise to the rank of major general during World War II. At the time of his testimony, he was president of the New York State Society of Certified Public Accountants (NYSSCPA) and one of the profession’s most prominent spokesmen on financial reporting and auditing issues. As recently as 8 January 1933, Carter had been quoted in the New York Times praising the New York Stock Exchange’s decision to require annual audits for all listed companies (New York Times, 8 January 1933: N7). On 30 March Carter sent telegrams to both the House and Senate committees assigned to consider Thompson’s bill (New York Times, 31 March 1933: 4). Sam Rayburn of Texas, chairman of the House committee and the congressman most responsible for passing the Securities Act, was eager to get the bill through Congress as quickly as possible to take advantage of FDR’s popularity, and so called few witnesses in the hope that the hearings could be kept to a minimum (Seligman, 1982: 55); Carter was not invited to testify before the House committee. The Senate committee did invite him, and in a brief session on the morning of Saturday, 1 April 1933 that heard only two witnesses, Carter gave his famous testimony.

Carter began by reading a prepared statement:

At the outset I wish to have it understood that my sympathies are with the general principles of the proposed bill known as the Federal Securities Act. I also wish to have it understood that I would advocate that, if possible, the proposed bill be changed so as to afford even greater protection to the investor than it now contemplates.

His first suggestion was that a company registering a new issue of securities should present financial statements for three years, rather than for one year as the Thompson draft required: “At present prospectuses accompanying the issuance of securities generally give such statements for 3 years or more. We have had that in this country for a number of years”. To this Senator Thomas Gore of Oklahoma acidly remarks: “It has not done much good, then, has it?” Before Carter can answer, Senator Robert Reynolds of North Carolina charitably jumps in with a more encouraging query: “In other words, your suggestion is designed to not be of injury to reliable companies who have been operating profitably?” Carter eagerly replies: “That is right”. Carter then offers his second suggestion, that the “balance sheet, statement of income and surplus shall have been examined by an independent accountant and his report present his certificate”. At this point, Senator Alben Barkley of Kentucky offers another pointed non sequitur: “How much more additional employment would that give to certified accountants?” Admirably not rising to the bait, Carter patiently explains that “Eighty-five percent of the companies that are listed on the exchanges in New York today are examined”. After a brief exchange with Senator Reynolds over what an auditor’s opinion involves, Senator Barkley jumps in again:

In other words, before the officers of the company that is issuing stock shall file that statement that is contained in this bill with the Federal Trade Commission, the company must call in outside independent accountants and give them the job of going over it and passing on whether they have told the truth or not. Well, I am not for your amendment, I will say that now.

Carter then points out that the current draft already allows the FTC to require an audit by a public accountant, and that his suggestion is simply that it be made mandatory.

Shortly after this exchange, Senator Barkley begins the only discussion I have found, either in the 11-volume Legislative History of the Securities Acts, or the papers of the authors of the Act, or any contemporary newspaper, magazine, trade or academic journal, of the idea of creating a government bureaucracy to perform the audits of corporations: ³ “Do you not think it is more in the interest of the public … that [audits] be done by some government agency rather than by some private association of accountants?” After a brief digression, Senator Reynolds resumes the discussion:

After it goes to the [Federal Trade] Commission they have to check up to see who is right; they have to go through and audit again. There has to be a government audit, as suggested by Senator Barkley. Would it not be creating more difficulty and more expense and more time for the government if auditing organizations interest themselves in these various and sundry corporations?

In reply, Carter explains that the FTC would not need to re-perform the audit done by independent accountants, and that “it is an impractical thing for the government agency to do it effectively … because it involves such a large force” (Ellenberger and Mahar, 1973, Vol. 2, Item 21: 55–67).

As recently as August 2011, the PCAOB stated that

Among the other proposals the [AICPA’s 1978] Cohen Commission considered in this area was “to have independent auditors approved, assigned, or compensated by a government agency or to have audits conducted by a corps of government auditors …[a]rrangements such as these were specifically rejected when the federal securities acts were adopted” (PCAOB, 2011: 30 and App. A)

As we have seen, this is not an accurate summary of the 1933 hearings. The idea was mentioned twice, almost in passing, and no one other than Carter even expressed a clear opinion on it. There is no evidence that the proposal was ever formally studied, and certainly not that it was “specifically rejected”. Actually, an alternative to the current regulatory model that has been the subject of some discussion in recent years received more attention in the hearings than government auditors: the proposal to introduce a third-party payer into the auditor-client relationship as a means to end accounting firms’ financial reliance on the companies they audit. In current debates, this generally involves either taxing corporations and then using these funds to hire auditors, or doing away with the statutory audit entirely and instead requiring companies to purchase insurance against financial misstatements, which presumably would result in the insurance company hiring auditors. ⁴ In the 1933 Senate hearings, Senator Couzens offers Huston Thompson “a practical proposition. Let the Federal Trade Commission, if they want to, pick the certified public accountants, at the expense of the person registering”. Thompson, apparently not having considered such a system, replies circumspectly that “if you are going to make those requirements perhaps you can protect the situation, but it will become somewhat involved” (Ellenberger and Mahar, 1973, Vol. 2, Item 21: 209–10).

Carter’s testimony made little impression on reporters: it was briefly mentioned only in the New York Times and Wall Street Journal, and the Times managed to get his name wrong (“J.H. Carter, president of the New York State Society of Certified Public Accountants” New York Times, 2 April 1933: 1; Wall Street Journal, 3 April 1933: 8). Neither the audit requirement nor the idea of government auditors was noted in either article. (Newsweek mentioned that Thompson’s draft did not require an independent audit; Newsweek 8 April 1933: 20). The only accounts by persons who would have been in a position to know what happened were by two prominent members of the AIA: George O. May in his memoirs and John Carey in his official history of the Institute, and neither claims that the testimony had any influence. Ironically, the only person Carter apparently won over was Senator Barkley, who would later point out to Huston Thompson that “an association of certified accountants has been down to ask us to provide that before these statements are filed they shall be investigated by certified accountants and passed on as correct” (Ellenberger and Mahar, 1973, Vol. 2, Item 21: 85).

His testimony may not have meant much to Carter, either. Colonel Carter remained prominent in the profession for two decades; two months after his Senate testimony, he was elected president of the National Association of Cost Accountants (New York Times, 16 June 1933: 33). He remained an active partner at Haskins & Sells until 1947, and then served on the Hoover Commission Committee on Reorganization of the Executive Branch (New York Times, 5 January 1965: 33; Previts and Merino, 1998: 330). Though his testimony became legendary in the accounting profession, Carter seems to have had no wish to promote this or even to acknowledge it. He left no record of his 1933 testimony, writing no memoirs and granting no interviews. This can be interpreted either as gentlemanly modesty, or that he understood the event was ultimately little more than a historical curiosity.

In the end, the entire process in the Senate turned out to be a sideshow. Huston Thompson’s draft was met with scathing criticism, though there is no evidence the audit provision had anything to do with this (Time Magazine,12 June 1933: 51). At the urging of Sam Rayburn, the Thompson bill was abandoned in the House and FDR offered a new bill drafted by protégés of his advisor, Felix Frankfurter. As further evidence that Carter’s testimony was ineffectual, the Senate would continue to use Thompson’s draft, and a later draft of the Senate bill, dated 26 April 1933, has the phrase “to be certified to by a public accountant” crossed out entirely (Materials Documenting the Genesis of the Federal Securities Act, 1933, located in the Small Manuscript Collection at Harvard Law School, hereafter cited as “Materials … 1933”, Folder 1-14, Sec. 6(f), 20).

Before leaving Carter’s testimony, it is worth discussing why he testified. Carter was the only representative of the accounting profession to appear at these hearings. John Carey makes clear that Carter acted on his own: “He took this step without consultation with the Institute … He may not have been aware of what the Institute was doing, or he may not have felt it was enough” (Carey, 1979: 34; Carey, 1969: 185).

What the Institute was doing was scrambling to develop a lobbying strategy when the Securities Act was introduced. Again from John Carey: “Despite William Z. Ripley, despite Berle and Means, despite the Pecora investigation, despite public demand for reform of the securities markets, the Institute had made no effective preparation to deal with legislation to that end” (Carey, 1969: 182). Previts and Merino question this, noting that the AIA had been involved with the New York Stock Exchange (NYSE) through its Committee on Cooperation with Stock Exchanges and with previous attempts at federal legislation (Previts and Merino, 1998: 457). But the AIA’s 1933 Yearbook provides a thorough and, perhaps, unintentionally revealing description of the Institute’s response to the Securities Act:

About the middle of March when it was first publicly announced that a proposed federal securities bill was expected, the Institute prepared to keep close watch over the progress of any such bill and to establish machinery whereby it might communicate with the legislative authorities and make any suggestions which might appear advisable on behalf of the accountancy profession. At the meeting of council of the Institute on April 10th authority was given for the creation of a special committee to deal with the matter, composed of chairmen and members of other committees of the Institute. (AIA, 1934: 261)

This Special Committee on Public Relations began keeping track of the bill, and “through various channels the committee was able to transmit to persons influential in the administration and in congress the more important suggestions which had come before it” (AIA, 1934: 259). One possible reason the committee was burdened with the misnomer “Public Relations” was that the AIA already had a Committee on Federal Legislation, as well as a Committee on Appointment of Auditors and a Committee on Cooperation with Stock Exchanges, the last of which had been working with the NYSE for several years to achieve an annual audit requirement for listed companies. This committee merits particular attention because its members included George O. May (chairman) and Colonel Carter. But none of these existing committees was deemed appropriate for the task of lobbying Congress and the White House, nor were either May or Carter appointed to the Committee on Public Relations. In their report in the 1933 Yearbook, the Public Relations Committee makes no mention of Carter or his testimony, although it is difficult to imagine they were not aware of it, given that five of its nine members worked in New York and one of these, George P. Auld, was a partner in Carter’s firm of Haskins & Sells (AIA, 1934: 261). What the committee does say in its report may have been intended as a backhanded swipe at Carter’s efforts:

It has been suggested that members forward to the Institute their objections to, or proposals for amendment of, the act itself or the regulations or registration-statement forms of the federal trade commission, rather than communicating direct with the authorities at Washington. The Institute’s committee is in communication with the federal trade commission, and it is thought that it might be more convenient and more effective if the profession were to act through a central agency, rather than as individuals. (AIA, 1934: 267)

Another question is the role of George O. May. A native of England, formerly the managing partner of Price, Waterhouse and Co. in the United States, and since his retirement from the firm in 1927 the leading voice in gaining increased recognition and respect for the profession from Wall Street, academia, and the press, May’s reputation was one of brilliance and arrogance (Doron, 2011: 118). May must have been the first name suggested in creating a group to represent the profession in Washington, but there is no mention of him in the Public Relations Committee’s report. One clue can be found in Carey’s attempt to explain what motivated Carter to work on his own without coordinating with the Institute:

The fact that he took this step without consultation with the Institute pointed up some of the flaws in the profession’s organizational structure, and in personal relations among some of its prominent members … he had not been made to feel an intimate member of the Institute’s inner circle. Colonel Carter was a relatively recent arrival among the heads of the large accounting firms. He was a West Point graduate, formerly a regular army officer … a handsome man, of military bearing, with a flashing smile and attractive personality. However, the habit of command apparently kept some colleagues at a distance … then again, there was some feeling of rivalry between the large firms of purely American origin – Haskins & Sells and Lybrand, Ross Bros. and Montgomery – and those of British origin … Since George May of Price Waterhouse was highly influential in the institute, Colonel Carter may have been moved to demonstrate via his office in the New York State Society that native American accountants were capable of providing leadership. (Carey, 1979: 34; also see Doron, 2013: 260)

Carter may well have had fundamental disagreements with May about how to respond to the securities bill. May was opposed to any legislation that mandated an audit or that regulated the accounting profession in any manner (Miranti, 1990: 141). It was largely due to his influence that the New York Stock Exchange announced in January 1933 that it would require annual audits for listed firms, and that led to the publication of Audits of Corporate Accounts (1934), at the time the most comprehensive effort to define accounting principles. Government oversight would have undermined what May considered the signal achievements of his career.

The AIA’s goal was to make independent audits mandatory, rather than at the discretion of the FTC, the same as Carter urged (Carey, 1969: 184). The Institute’s officially stated concern was that “less reputable issuers” of securities would be able to avoid an audit unless the legislation required one in all cases (AIA, 1934: 259; Carey, 1969: 184). But it may also have occurred to the Institute, and to Carter, that allowing the FTC to choose when it would order a CPA audit would leave accounting firms at the beck and call of government administrators, where an audit requirement for all issues would provide a captive market to the profession.

Carter had not consulted with his colleagues before acting, but he at least was working towards the same goal. George May, on the other hand, was trying to lessen the CPA’s role in the Act. At approximately the same time as Carter’s testimony and the Committee on Public Relations’ lobbying efforts, May wrote a letter to Sam Rayburn suggesting that independent audits be at the discretion of the company’s management: “A declaration by the chief accounting officer of the issuer, or by an independent public accountant, that the balance sheet and statement of income are, in his opinion, properly prepared on the basis of a fair and consistent application of the methods of accounting” ⁵ (emphasis added). May was working to undermine his colleagues’ efforts, and if he had been successful the independent CPA audit would not have gained the legal mandate the Securities Act provided. It is also entirely possible that May did this in secret. When John Carey chronicled the AIA’s and Carter’s efforts on the 1933 Act, he made no mention of May’s letter; nor does the AIA’s Committee on Public Relations (Carey, 1969: 182–92; Carey, 1979: 33–5; AIA, 1934). This would also explain why May did not testify during the hearings. Carey wrote that the AIA did not send a representative to speak at the hearings because “they might have been subjected to hostile questioning. This could have resulted in further adverse publicity, and possibly even more punitive legislation than that proposed” (Carey, 1969: 183). But May had testified in January 1933 at the hearings investigating the Krueger and Toll scandal, and would testify again at the hearings on the 1934 Securities Exchange Act. In any case, as this article has described, the accounting profession drew little attention either in the hearings or in press coverage. Perhaps May avoided the 1933 hearings because he did not want a public record of his opposition to the legislation’s audit provision.

The origins of the audit requirement

After Thompson’s draft was abandoned, President Roosevelt enlisted Felix Frankfurter to prepare a new Securities Bill. Frankfurter, a professor at Harvard Law School and future Supreme Court Justice, had been an informal advisor to Roosevelt for several years. Frankfurter recruited three of his protégés, James Landis, Benjamin Cohen and Thomas Corcoran, all of whom would play important roles in FDR’s administration. (This is described in detail in Seligman (1982), Ritchie (1980) and Parrish (1970).) For purposes of determining the origin of the auditing provision in the 1933 Act, the salient facts are that Landis, Cohen and Corcoran were first informed by Frankfurter on the evening of Thursday 6 April that they had been charged with writing the bill. They began the next day, working furiously in a Washington hotel room using the 1929 British Companies Act as their template, and presented a completed draft to Sam Rayburn on Monday10 April (Landis, 1959: 33). “Confidential Committee Print No. 1”, dated 10 April, contains the requirement that a balance sheet and income statement “certified by an independent public or certified accountant … shall be submitted” (Materials … 1933, Sec 5(25): 14). The 1929 British Companies Act requires an audit report to be included with each annual filing by “a member of a body of accountants established in the United Kingdom” (The Companies Act 1929, 19 & 20 Geo. 5, c.23, Sections 110 and 133). Given the circumstances of the creation of this “hurried draft”, it is unlikely that anyone had the opportunity to lobby its writers (Landis, 1959: 34). The audit requirement of the 1933 Securities Act was, most likely, simply taken from the 1929 British Companies Act.

Whether Frankfurter and his team gave any considered thought to the audit provision is more difficult to determine. According to Landis’ biographer, Landis was recruited for his skill in drafting legislation, and knew little about finance (Ritchie, 1980: 45). If any of the authors had strong feelings about auditing issues, it would have been Cohen or Corcoran, both of whom had experience on Wall Street (Ritchie, 1980: 45).

From this first draft of 10 April, the bill would undergo several changes before it reached its final form, but the audit requirement would remain in place. It is entirely possible that the efforts of Colonel Carter or the AIA helped win the confidence of enough influential congressmen to keep the audit requirement in the bill, though there is no evidence of this. ⁶ Two prominent Wall Street lawyers, A.I. Henderson and Arthur Dean, also spoke in favor of an audit requirement (along with several other points), and according to Landis “their criticism went primarily to certain technical features and much of it had merit … We spent a long, hot afternoon with Henderson and Dean, ending with a number of technical changes particularly in the schedules to the bill that had not had a thorough going over by the subcommittee” (Landis, 1959: 40–1). (This refers to the “Schedule A” that contains most of the accounting and auditing provisions in the Securities Act.)

The AIA’s work was apparently decisive in one area. Both the Thompson and the Landis, Cohen, Corcoran drafts included provisions for “chartered accountants”. Presumably the drafters copied this term from the British Companies Act, unaware that it had no meaning in the United States. The report of the AIA’s Committee on Public Relations is careful to avoid taking credit for the audit provisions of the Securities Act, except on this point, and in fact two of the drafts included in James Landis’ papers have the word “chartered” crossed out and replaced by hand with “certified public” (Materials … 1933: Folder 1-19, 37; Folder 1-34, 9).

George May also continued his efforts to influence the bill. In his “Memorandum Regarding Securities Bill H.R. 4314”, May writes that “suggestions … which I had prepared, came to the attention of the Investment Bankers Association” (May, 1936, Part IV: 54). A copy of the bill with suggestions from the IBA has the line “certified to by a certified or public accountant” crossed out, and another section includes May’s language: “A declaration of the treasurer or one of the principal accounting officers of the issuer or by an independent public accountant … that the balance sheet and the statement of income are in his or their opinion correctly stated” (Materials …1933: Folder 1-18, 16, 36). They did not make a favorable impression on James Landis: “The Investment Bankers Association had suggested a series of amendments to the House bill, all of which had to be scanned carefully and most of which were discarded” (Landis, 1959: 46; for Landis’ opinion of May, see Doron, 2011:118).

By the time the Securities Act was signed into law on 29 May, the accounting profession had begun to establish a working relationship with the Federal Trade Commission. Prominent members of both the AIA and ASCPA spent several days in Washington during the summer of 1933 helping write the detailed regulations to implement the law (Bane, 1933: 597; Landis Papers Box 12, reply to Landis speech, 30 October 1933). Though they would earn the thanks of FTC staff, they did not impress everyone. James Landis was in charge of implementing the Securities Act at the FTC, but familiarity with accountants did not improve his opinion of them. While the Chief of the FTC’s Securities Division, in a speech before the ASCPA, would commend “the services of those men in connection with preparing the rules and the forms that were first promulgated under this act … without them we would still be drafting forms” (Bane, 1933: 587), Landis’ early experiences with accountants in creating and then implementing the Securities Act left him so underwhelmed that in February of 1934 he would be writing to the New York State Society of CPAs:

I wonder if you would have any suggestions for me with reference to this problem. There are many good accountants as you know, but there are very few accountants who are more than good technicians, i.e. men who are continually thinking in terms of the nature of their profession, the nature of accounting and what it means, and the duties and responsibilities that can be thrust upon accountants. I am after a man of that type now, one who could truly serve us in helping decide rightly the truly basic problems dealing with accounting that we are facing. (Landis Papers, Folder 2-3, letter to Louis Renn, 25 February 1934)

Landis’ feelings would only harden over time. In 1936 he would tell the Investment Bankers’ Association: “The impact of almost daily tilts with accountants, some of them called leaders in their profession, often leaves little doubt that their loyalties to management are stronger than their sense of responsibility to the investor” (Chatov, 1975: 114). And this opinion was not Landis’ alone. A private letter to an FTC official offering a “few suggestions for the selection of directors” to serve on a committee to represent bondholders recommends several prominent organizations, including the American Bankers Association, the Association of Life Insurance Presidents, and the American Bar Association, and then notes the American Institute of Accountants: “There are four associations of accountants but this is the only outstanding one; even at that, it is not of the same prestige as the organizations mentioned above, and might be omitted” (Frankfurter Papers, letter to Raymond Stevens, 23 July 1933, Box 134, Folder 84). It is difficult to reconcile these comments with a conclusion that the accounting profession was successful in its early attempts to burnish its image in Washington.

Conclusion

The accounting profession’s hastily organized efforts to influence the writing of the audit requirement in the 1933 Securities Act were largely ineffectual and perhaps irrelevant, not only because it was included without their input, but because the audit requirement itself was most likely unnecessary. The 1934 Securities Exchange Act, which regulated publicly traded stock (as opposed to new registrations, which the 1933 Act regulated), did not require an audit report to be submitted with a company’s annual filing, but simply permitted the newly created Securities and Exchange Commission to require one, which the SEC subsequently did with Regulation S-X. With this in mind, it seems safe to assume that Huston Thompson’s provision that the FTC could require an audit at its discretion would have had the same effect for the 1933 Act.

Arguably of greater consequence for the profession has been the myth that a government takeover of the audit function was prevented by Colonel Carter’s testimony, and that such a proposal was carefully considered and “specifically rejected” by Congress in 1933, as the PCAOB stated in August 2011. The frequent mischaracterizations of these events through the past eight decades have handicapped discussion of this issue, allowing it to be dismissed as outside the mainstream of American practice. It has also allowed the accounting profession to claim that its seat at the table of Wall Street regulation was earned, not hastily and reluctantly granted.