Office of the Chief Accountant:
Regarding Auditor Independence
Letter to KPMG Peat Marwick LLP
SECURITIE5 AND EXCHANGE COMMISSION
WASHINGTON. D C. 20549
January 7, 1999
Mr. Michael Conway
KPMG Peat Marwick LLP
599 Lexington AvenUe
New York New York 10022
Dear Mr. Conway:
You have requested the staff's view with respect to a possible equity offering by KPMG Peat Marwick ("KPMG" or "the firm") of an interest in its consulting business. This letter is based on the facts provided in the firm's letters to the staff (October 2, November 6, and 13, 1998) and subsequent meetings and discussions. Any different facts or conditions may result in our reaching a different conclusion. I emphasize that this letter represents the views of the staff and the Commission has not yet been asked to reach a conclusion on the following issues.
Your submission suggests that KPMG plans to create an affiliate, K Consulting, to operate KPMG's consulting business. KPMG will retain a controlling interest in K Consulting, but a minority equity position in K Consulting will be sold either in a public offering or through a private placement. KPMG also has undertaken that K Consulting will be subject to and comply with the Commission's independence rules and interpretations.
These facts present fundamental issues with respect to the independence requirements in the federal securities laws, Rule 2-01 of Regulation S-X, and section 600 of the Codification of Financial Reporting Policies. The staff believes that the ownership by an audit client, or by an affiliate of a client (including persons associated with the client in a decision-making capacity, such as officers, directors or substantial stockholders, and controlled subsidiaries of the client or material investees), of an equity interest in KPMG or its affiliates is inconsistent with the language and purpose of these provisions. Because of KP4~IG's control of K Consulting, ownership of shares of K Consulting constitutes a direct financial interest in and a business relationship with both K Consulting and KPMG. In our view, this direct financial interest and business relationship would affect the independence of the auditor in both fact and appearance.
You stated in your letter of December 10, 1998 that if the firm undertakes an offering as described above, it would not permit clients to invest in K Consulting. We strongly believe that it is the firm's responsibility to implement a quality control system before the offering begins that ensures that neither KPMG audit clients nor their affiliates become K Consulting shareholders, and we ask that prior to undertaking the offering you review that quality control system with the staff. If such investments did occur, KPMG's independence would be deemed impaired with respect to those investors and KPMG could not, in a manner consistent with the federal securities laws and the Commission's rules, examine their financial statements. Disposal of the shares by the client or affiliates would not cure the lack of independence. In addition, the staff believes that the quality control system established by KPMG should be subject to its internal inspection program and peer review.
We have discussed with you our belief that a public offering by K Consulting raises questions regarding KPMG's independence from others involved in the offering process and in the secondary market. For example, independence would be impaired with respect to underwriters that are also audit clients, due to the financial and business relationships between an underwriter and registrant. Similarly, there is a question whether KPMG would have the requisite independence to audit broker-dealer firms that exercise discretionary buy and sell authority over customer accounts holding significant positions in K Consulting or employing securities analysts who follow K Consulting. KPMG should consult with the staff before undertaking any audit engagements with clients with
whom it has such relationships.
These issues are closely related to those raised by alternative f rm structures, which the staff already has asked the Independence Standards Board ("ISB") to consider. We have asked the ISB to consider the issues raised by your proposed transaction, to give the matter its highest priority, and to complete its deliberation by December 1999. Should the ISB be unable to proceed in accordance with this schedule, we will make our own recommendations to the Commission on these issues.
In the event that KPMG proceeds with its offering in advance of ISB or Commission action, it runs the risk that these groups may find the resultant structure inconsistent with the independence KPMG must maintain in order to examine and certify financial statements that comply with the federal securities laws. KPMG, of course, must immediately comply with any standard adopted by the ISB or the Commission and we would vigorously oppose suggestions that, by going forward with this transaction, the firm has become "grandfathered" or in some way not fully subject to such standard. Please understand that the staff is not rendering any legal opinion with respect to a possible transaction.
Your request obviously raises important and fundamental issues dealing with investor protection. Scott Bayless, Robert Burns and I will be pleased to respond to questions you may have about this letter.
Lynn E. Turner