January 9, 2003
Jonathan G. Katz
Secretary
U. S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
File No. S7-49-02 Proposed Rule: Strengthening the Commission’s Requirements Regarding Auditor Independence
Members and Staff of the Commission:
The American Institute of Certified Public Accountants (the “AICPA”) respectfully submits the following comments on the proposed rules of the Securities and Exchange Commission (the “SEC” or the “Commission”) to enhance the independence of accountants that audit and review financial statements and prepare attestation reports filed with the Commission (the “Proposed Rule”). The AICPA is the largest professional association of certified public accountants in the United States, with approximately 350,000 members in business, industry, public practice, government and education.
The AICPA is firmly committed to working with the Commission to implement the provisions of the Sarbanes-Oxley Act of 2002 (the “Act”) and rebuild the faith of investors who depend on accounting professionals for accurate, timely and relevant financial information. We applaud the enormous effort put forth by the members and staff of the Commission to implement the Act under the extraordinarily tight time constraints mandated by Congress.
We support the Commission’s proposal to strengthen the profession’s independence rules as they relate to financial statement audits of public companies. Throughout its history the AICPA has been deeply committed to auditor independence. It is a core tenet of the accounting profession, which has a more than 100-year history of working to uphold auditor independence. All members of the profession engaged in auditing and attest services are required to maintain independence from audit clients in accordance with detailed and regularly updated independence rules, interpretations and ethics rulings.
The AICPA supports many of the Commission's proposed rules on auditor independence, and our comments and observations offered herein are intended to assist the Commission in fully implementing both the letter and spirit of the Act and are designed to improve upon the Commission's proposal. We stand ready to meet with the Commission and its staff to further clarify our recommendations.
The comments reflect our strong belief that the Commission should limit its current rulemaking efforts to implementation of the provisions of the Act without creating requirements that go beyond it unless there is a clear need for such additional action. We believe that any such need should develop as the result of implementing the Act in the months ahead.
The AICPA is also concerned about the likely impact of certain of the proposed rules on small publicly traded businesses and the accounting firms that audit them. We believe that the Commission should take special care in this critical rulemaking to address the rule’s impact on the complexities and costs of operating small publicly traded businesses, and on the ability of smaller audit firms to serve them. As explained in our comments, it is our belief that the Commission has both the authority and discretion to provide appropriate relief to small businesses through regulatory exemptions that will allow it to implement the Act in a manner consistent with the public interest and protection of investors, and at a time of great concern about the vitality of our economy.
Executive Summary
Consistent with our pledge to work with the Commission to implement both the letter and the spirit of the Act, the AICPA offers comments, observations and recommendations regarding the following substantive areas of the Proposed Rule (listed in the order that they appear in the Proposing Release):
· Conflicts of Interest Resulting from Employment Relationships (i.e., Cooling-Off). We believe that, when a member of the audit engagement team accepts employment with an audit client, the public is more thoroughly protected through a combination of restrictions and meaningful safeguards. Imposing a “cooling-off” period alone, as required by the Act, would not sufficiently mitigate the threats to auditor independence. Therefore, in order to adequately protect the public interest, we recommend that the Commission, in addition to the mandatory cooling-off requirement, strengthen its proposal by incorporating the specific safeguards set forth in Independence Standards Board (“ISB”) Standard No. 3, Employment with Audit Clients. In addition, we are concerned that the "cooling-off" restriction as proposed would impose an undue regulatory burden on smaller publicly-held businesses that Congress did not contemplate when it enacted the Act.
· Bookkeeping, Appraisal and Valuation, and Actuarial Services. We recommend that the Commission retain the limited exceptions that exist under the current SEC rule for bookkeeping, appraisal and valuation, and actuarial services. We believe such exceptions remain necessary and are consistent with both the letter and spirit of the Act.
· Internal Audit Services and Financial Information Systems Design and Implementation. We recommend that the Commission should define more specifically what is meant by “internal audit services” and “financial information systems design and implementation.” We believe the Commission may be prohibiting appropriate services that it did not intend to prohibit or were not contemplated by the Act. We have provided a description of such services in our specific comments.
· Management Functions. We believe there are no circumstances under which an accounting firm can perform or assume management functions or responsibilities for an audit client without impairing independence.
· Human Resources. We support the Commission’s Proposed Rule. However, contrary to the discussion in the Proposing Release, we disagree that advising an audit client with respect to the design of a management organization structure constitutes a management function that would impair independence. We recommend that the Commission adopt what is in the Proposed Rule and conform the discussion in the Adopting Release to the text of the Final Rule.
· Advisory and Financial Planning Services. We support the Commission’s Proposed Rule on broker-dealer, investment adviser or investment banking services. However, we believe it is important that the Commission clearly indicate that the Final Rule does not prohibit accountants from providing investment advisory or personal financial planning services for audit clients if, during the performance of such services, the auditor does not recommend the securities of other attest clients or assume management functions.
· Legal Services. We believe that the Commission’s current guidelines governing legal services are sufficient and represent a sensible position with respect to services provided inside and outside of the United States. We are concerned that the Commission’s proposal will lead to disparate results in different jurisdictions.
· Expert Services. We recommend that the Commission revise its definition of prohibited expert services to focus on the reason for the prohibition — “the appearance that the accountant is acting as the client’s advocate in pursuit of the client’s interests.” Not all expert services involve such advocacy or create such an appearance. For example, accountants frequently advise clients privately about a myriad of matters which can in no way be termed advocacy. In addition, the federal courts recognize an “expert” as someone with specialized knowledge, skills, training, and experience in a particular area who presents conclusions and judgments with integrity and objectivity. Further, accountants are called upon frequently to explain their actions to regulatory authorities, such as the SEC and the IRS, in non-public settings which do not involve any appearance of advocating the interests of the client. We have proposed a definition that would allow for such expert services consistent with the underlying principle.
· Tax Services. We agree with the Commission that congressional and administrative intent is clear (i.e., "a broad array of tax services are contemplated by the Act as permissible services for auditors to provide their clients, with audit committee pre-approval"). We believe the Commission needs to ensure that its Adopting Release clearly reflects that intent with respect to tax services. We also recommend that the Commission specifically recognize that tax minimization services are appropriate, while precluding auditors from advising audit clients on tax transactions for which there is no business purpose other than tax avoidance, except those that are consistent with the intent of applicable tax laws.
· Partner Rotation. We support the Commission’s objectives underpinning the partner rotation requirement for auditors of publicly-held companies and the requirements of the Act in this regard. We are concerned, however, with the breadth of the Commission’s proposal both with respect to the number of partners it covers and the length of the “time out” period. We believe that the Proposed Rule will reduce audit quality and that the public would be best served if the Commission adopted what is stated explicitly in the Act. The Final Rule should provide for an exemption for small publicly traded business and smaller public accounting firms that audit the financial statements of publicly-held companies, because partner rotation, for these firms, is tantamount to firm rotation, a concept that Congress contemplated but rejected pending further study.
· Forensic Audits. We support the performance of forensic audits as an investigative tool when there is a suspicion or evidence of fraud. However, a forensic audit is not the appropriate tool to mitigate the effects of a partner rotation exemption. We recommend alternative safeguards, such as Public Company Accounting Oversight Board (“PCAOB”) review and inspection.
· Compensation. A CPA firm’s audit personnel, including partners, should be rewarded and penalized based on both quantitative and qualitative measures, such as technical expertise and audit performance, and support a rule that would prohibit members of an audit engagement team from being directly compensated for selling non-audit services to their publicly-held audit client. However, we do not believe that the Commission’s rule should prohibit an individual from sharing in the firm’s total profits or receiving compensation from a profit pool, which may include fees for permitted non-audit services that have been approved by the client’s audit committee.
· Communication with Audit Committees. We support the Commission’s proposal to enhance communication with audit committees and believe the suggested additional requirements supplement the existing requirements of Statement on Auditing Standards (“SAS”) 61, Communication with Audit Committees. We offer a number of comments that we believe will help strengthen the Commission’s proposed communication process.
· Disclosure of Principal Accountants’ Fees. We believe that the proposed changes to the proxy disclosure rules regarding the principal accountant’s fees, in general, provide more meaningful information to investors than the Commission’s current proxy disclosure rules. We believe, however, that the disclosure would be more meaningful if “audit-related fees,” which are proposed as a separate categorical disclosure, were combined with audit fees and the required disclosures were accompanied by a description of the services provided in a sub-categorical disclosure.
· Transition. We believe that a reasonable, orderly transition period is necessary and appropriate for the effective implementation of the Act.
The SEC’s Broad Exemptive Authority
As many of these comments and recommendations suggest, the AICPA believes that the Commission has the authority to craft appropriately tailored exceptions or exemptions from the auditor independence restrictions set forth in the Act. Certain statements in the Proposing Release, however, suggest that the Commission is concerned that the Act limits its ability to exercise its statutory authority to adopt such exemptions. In particular, the Release implies that Congress did not intend to allow the Commission to exercise its existing authority under the Securities Exchange Act of 1934 (the “Exchange Act”) when implementing the Act. As a threshold matter, we believe such a view would be mistaken.
Nothing in the Act amends Section 36(a) of the Exchange Act, which provides:
the Commission, by rule, regulation, or order, may conditionally or unconditionally exempt any person, security, or transaction, or any class or classes of persons, securities, or transactions, from any provision or provisions of this title or of any rule or regulation thereunder, to the extent that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors.
Most of the Act’s auditor independence provisions are drafted as amendments to Section 10A of the Exchange Act and, accordingly, fall within the purview of the Commission’s authority under Section 36.
Several other factors support the conclusion that the Commission’s general exemptive authority was unaffected by the Act. First, Section 3(c)(2) of the Act states that:
[n]othing in this Act or the rules of the Board shall be construed to impair or limit . . . the authority of the Commission to set standards for accounting or auditing practices or auditor independence, derived from other provisions of the securities laws or the rules or regulations thereunder, for purposes of the preparation and issuance of any audit report, or otherwise under applicable law.
Through this provision, Congress explicitly recognized that the Commission had the authority, prior to the Act, to establish independence standards, and should continue to exercise that authority in a manner consistent with the public interest and the protection of investors.
Second, despite some statements in the Proposing Release suggesting that the Commission has little discretion when implementing the auditor independence provisions of the Act, the Commission clearly recognizes that it retains broad discretion with respect to the proposed rulemaking. In particular, the Proposing Release contains numerous questions soliciting comments as to whether the Commission should craft exemptions. For example, the Commission asks whether it is appropriate to exempt small publicly-held businesses or smaller public accounting firms from the employment with clients (“cooling-off”), audit partner rotation and internal audit outsourcing provisions of the Act. Furthermore, the SEC’s proposals regarding audit partner rotation and compensation — which the Commission acknowledges exceed any rulemaking obligations imposed under the Act — indicate that the Commission believes that it has considerable discretion when proposing rules to “carry out” the requirements of the Act.
Third, Congress has followed a practice of expressly limiting the Commission’s general exemptive authority under Section 36. It did not do so here. For example, Section 36(b) of the Exchange Act specifically provides that the Commission may not exercise its Section 36(a) authority to exempt any person, security or transaction (or classes thereof) from the provisions of the Exchange Act governing the regulation of government securities brokers and dealers. The Act, however, did not limit the Commission’s authority to exempt persons, securities or transactions from the operation of Section 10A, as amended. Indeed, if Congress intended the provisions of the Act to be self-executing, without any exercise of discretion by the SEC, it would have been unnecessary to direct the Commission to adopt rules to “carry out” those provisions.