Arthur Levitt, the

Securities and Exchange Commission

chairman, assailed the accounting industry Wednesday for cutting off funding last week to an oversight board that the SEC had directed to look into conflicts that have arisen because accounting firm employees own stock in companies they audit.

"This is a most significant setback to self-regulation and independent oversight," Levitt said in an address at the

New York University Center for Law and Business

. "Indeed, it raises profound questions as to the profession's commitment to self-regulation."

Saying he remains concerned about erosion of independence among accounting firms, Levitt also said Wednesday that his agency should develop "bright line" rules to clearly define what types of services auditing firms should and should not provide.

The

American Institute of Certified Public Accountants

or AICPA, which represents the nation's large accounting firms, immediately defended its decision to halt the funding of the review of investments by its members' employees.

The

Public Oversight Board

, which the SEC authorized to conduct the review, was proceeding without a plan acceptable to the accounting firms that pay for its work, said Alan Anderson, the AICPA's senior vice president for technical services.

"All we want to do is get a handle on the scope of the project," Anderson said.

But accounting firms have made progress in restoring their independence in general, he said.

"We have made substantial strides in the past several years," Anderson added.

Levitt said the SEC could draft new rules for accounting firms by summer. The guidelines should help prevent potential conflicts that arise when accounting firms act not only as auditors to corporations, but also as consultants, as often is the case.

He said the suggestion by accounting firms that the SEC simply develop "principles" to avoid conflicts may not be effective.

"Maybe a more reliable way to safeguard independence would be to clearly define those consulting services that compromise the integrity of the audit without adding meaningful benefits," Levitt said.

Anderson of AICPA said he welcomed Levitt's challenge to the industry.

The extent of the conflict of interest issue is evident in statistics about services big accounting firms now provide, Levitt said.

In 1977, auditing provided 70% of accounting firm revenues. Now it amounts to just 30%. Meantime, consulting and management advisery services have grown from a source of just 12% to more than half of the revenue at big accounting firms, according to Levitt.

Levitt said he is heartened by recent plans by consulting firms to divest their consulting operations or erect a "firewall" to separate them from auditing services.

The issue of investments by accounting firm employees arose in January when the SEC released a report that showed three-quarters of partners at the Big Five accounting firm

PricewaterhouseCoopers

violated auditor independence rules by holding stakes in companies the firm audited.

Levitt said Wednesday that he believed most of those violations were inadvertent. And he added he believes similar violations occur at all the large accounting firms.

"The most significant public policy issue was never the egregiousness of a particular violation, but rather the inadequacy of internal controls," he said.

The SEC will work to modernize its investment rules for accounting firm employees, something the industry has called for, to eliminate outdated provisions such as some restrictions on investments by employee relatives, Levitt said.

Improving the accuracy of financial reporting and accounting has been a recurring theme for Levitt since he launched a crusade to clean up corporate accounting practices in a

speech at NYU a year and a half ago.

At the time, he bemoaned what he called a gray area between legitimate financial reporting and outright fraud, "a gray area where the accounting is being perverted."

Since that speech, the SEC has made moves to crack down on slippery or illegal corporate reporting, a subject the chairman touched only briefly.

Last fall, in one broad, well-publicized stroke, the agency announced enforcement actions against 68 people and companies it said had cooked their books by manipulating earnings to paint artificially rosy financial pictures of themselves.

The companies and individuals had reported sales that weren't actually made, hidden delinquent loans through shoddy accounting and inflating earnings by exchanging non-cash assets, the SEC charged.

Then in December, the SEC approved new rules aimed at making certain corporate audit committees more independent and effective at catching accounting irregularities within companies.

Levitt emphasized his continued concerns about the accuracy of financial reporting last month, telling an audience at

the Economic Club of Washington

"a gradual, but perceptible erosion of the quality of this reporting may be undermining the systemic integrity of our marketplace."

"Unfortunately, this gamesmanship persists," he said then.

He re-iterated that concern Wednesday.

"This country's accountants have been both the beneficiaries and the source of investors' acceptance of the sanctity of reported numbers," he said. "We're going to safeguard this heritage by determining that the independent audit is not a means to anything else, but rather a critically important end in itself.