The new group is telling businesses to clean up their practices or expect penalties.

WASHINGTON (AP) – The accounting industry is getting a chance to reform itself, but firms that don’t do it willingly will be punished harshly, the head of an independent oversight board says.

In an Associated Press Interview, William McDonough, the former Federal Reserve official who heads the board created to shore up investor confidence, said he is bringing “tough love” to the job of policing the nation’s auditors of public companies.

He also said the board, which had a rocky start in a controversy over selection of its first chairman, former FBI Director William Webster, will be working at full effectiveness in about a year despite having hired only 33 inspectors so far. The Public Company Accounting Oversight Board, as it is called, believes it will need at least 125 inspectors to examine the hundreds of accounting firms that audit the books of publicly traded corporations.

The board, created by Congress to replace the accounting industry’s own regulators amid a wave of corporate scandals, has subpoena power and the authority to discipline accountants. The corporate fiascos that began with Enron Corp. exposed inadequate internal controls and auditors at major firms who had become too cozy with the corporations whose books they examined.

McDonough suggested a similar agency also may be needed for the mutual fund industry, an idea already raised by lawmakers and regulators.

As a result of the corporate scandals, the public “lost faith in the ability of the accounting industry to govern themselves,” McDonough said. “They should wish to rise to a new level of virtue. They should wish to save themselves.”

William Donaldson, chairman of the Securities and Exchange Commission, persuaded McDonough, 69, to lead the oversight board after he retired as president of the New York Federal Reserve Bank. McDonough took over in June, at an annual salary of $556,000.

Now he occupies an airy, eighth-floor corner office in a downtown suite formerly occupied by the now-fallen accounting giant Arthur Andersen – an irony that McDonough called poetic. Perhaps, too, it’s a lesson for accounting firms that don’t toe the line. The rent was a bargain for the office in the heart of Washington’s K Street power corridor, the accounting board has said.

Under the unusual law setting up the oversight board, accounting firms will be given 12 months to correct problems and violations that turn up in board inspections. During that time, the firms’ alleged lapses will not be made public, except in especially egregious cases.

Should problems be cleaned up to the board’s satisfaction, no further action would be taken. Otherwise, said McDonough, “Then we have to get very tough.”

That could mean civil penalties of as much as $750,000 for individual auditors and $15 million for firms, as well as temporary suspension or a permanent disqualification from auditing public companies.

Already, McDonough said, signs of positive change are appearing in “the tone at the top” of the big accounting firms. “It is clear that the people running the major firms are all saying the right thing,” he insisted. He added, a bit more tentatively, that the thousands of partners at the so-called Big Four firms – Ernst & Young, PricewaterhouseCoopers, KPMG and Deloitte & Touche – also appear to be onboard. It was the Big Five before Andersen was convicted last year of obstruction of justice for destroying Enron audit documents. There were eight in the 1980s, but mergers thinned the top ranks, which raised misgivings among policy-makers about reduced competition and the number of choices for companies seeking auditors.

The accounting firms – only the Big Four have been inspected so far – have been cooperative with the board’s examiners, McDonough reports.

He has been on the speech circuit stumping for greater backbone among CPAs and other changes in conduct. McDonough has warned directors, for example, that as company watchdogs they must go beyond a rote adherence to the new rules imposed after the scandals. He reminds business audiences that Americans are still angry about recent corporate conduct, especially executive pay.

“It’s tough love,” he said in the interview. “I think we are being very effective already. … I’m very, very confident we will be successful.”

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On the Net:

Public Company Accounting Oversight Board: http://www.pcaobus.org

AP-ES-11-17-03 1749EST