That question, frequently heard during financial scandals earlier this decade, is being asked again as an increasing number of companies are being probed about the practice of backdating employee stock options, which in some cases allowed executives to profit by retroactively locking in low purchase prices for stock.

For the accounting industry, the question raises the possibility that the big audit firms didn't live up to their watchdog role, and presents the Public Company Accounting Oversight Board, the regulator created in response to the past scandals, its first big test.

"Whenever the audit firms get caught in a situation like this, their response is, 'It wasn't in the scope of our work to find out that these things are going on,' " said Damon Silvers, associate general counsel at the AFL-CIO and a member of PCAOB's advisory group. "But that logic leads an investor to say, 'What are we hiring them for?' "

Others, including accounting professionals, aren't so certain bookkeepers are part of the problem. "We're still trying to figure out what the auditors needed to be doing about this," said Ann Yerger, executive director of the Council of Institutional Investors, a trade group. "We're hearing lots of things about breakdowns all through the professional-advisor chains. But we can't expect audit firms to look at everything."

One pressing issue: Should an auditor have had reason to doubt the veracity of legal documents showing the grant date of an option? If not, it is tough for many observers to see how auditors could be held responsible for not spotting false grant dates.

"I don't blame the auditors for this," said Nell Minow, editor of The Corporate Library, a governance research company. "My question is, 'Where were the compensation committees?' "

To sort out the issue, the PCAOB advisory group - comprising investor advocates, accounting experts and members of firms - last week suggested the agency provide guidance to accounting firms on backdating of stock options. A spokeswoman for the board said, "We are looking to see what action they may be able to take."

To date, more than 40 companies have been put under the microscope by authorities over the timing of options issued to top executives. Federal authorities are investigating whether companies that retroactively applied the grant date of options violated securities laws, failed to properly disclose compensation and in some cases improperly stated financial results. A number of companies have said they will restate financial statements because compensation costs related to backdated options in questions weren't properly booked.

All of the Big Four accounting firms - PricewaterhouseCoopers LLP, Deloitte & Touche LLP, KPMG LLP and Ernst & Young LLP - have had clients implicated. None of these top accounting firms apparently spotted anything wrong at the companies involved. One firm, Deloitte & Touche, has been directly accused of wrongdoing in relation to options backdating. A former client, Micrel Inc., has sued the firm in state court in California for its alleged blessing of a variation of backdating. Deloitte is fighting that suit.

The big accounting firms haven't said whether they believe there was a problem on their end. Speaking at the PCAOB advisory group's recent meeting, Vincent P. Colman, U.S. national office professional practice leader at PricewaterhouseCoopers, said his firm was taking the issue "seriously," but more time is needed "to work this through" both "forensically" and to insure this is "not going to happen going forward."

Robert J. Kueppers, deputy chief executive at Deloitte, said in an interview: "It is one of the most challenging things, to sort out the difference in these (backdating) practices. At the end of the day, auditors are principally concerned that investors are getting financial statements that are not materially misstated, but we also have responsibilities in the event that there are potential illegal acts."

While the Securities and Exchange Commission has contacted the Big Four accounting firms about backdating at some companies, the inquiries have been of a fact-finding nature and are related to specific clients rather than firmwide auditing practices, according to people familiar with the matter. Class-action lawsuits filed against companies and directors involved in the scandal haven't yet targeted auditors.

Backdating of options appears to have largely stopped after the passage of the Sarbanes-Oxley corporate-reform law in 2002, which requires companies to disclose stock-option grants within two days of their occurrence.

Backdating practices from earlier years took a variety of forms and raised different potential issues for auditors. At UnitedHealth Group Inc., for example, executives repeatedly received grants at low points ahead of sharp run-ups in the company's stock. The insurer has said it may need to restate three years of financial results. Other companies, such as Microsoft Corp., used a monthly low share price as an exercise price for options and as a result may have failed to properly book an expense for them.

At the PCAOB advisory group meeting, Scott Taub, acting chief accountant at the Securities and Exchange Commission, said there is a "danger that we end up lumping together various issues that relate to a grant date of stock options." Backdating options so an executive can get a bigger paycheck is "an intentional lie," he said. In other instances where there might be, for example, a difference of a day or two in the date when a board approved a grant, there might not have been an intent to backdate, he added.

"The thing I think that is more problematic is there have been some allegations that auditors knew about this and counseled their clients to do it," said Joseph Carcello, director of research for the corporate-governance center at the University of Tennessee. "If that turns out to be true, they will have problems."

-- DAVID REILLY (The Wall Street Journal)