Commission Open Meeting on Market Structure Initiatives
in the Options and Equities Markets, and
Rules Governing Auditor Independence
November 15, 2000
Good morning. The Commission meets today to consider adoption of rules governing auditor independence, and proposals related to the structure of our options and equities markets. Each of today's initiatives is grounded in a common theme: promoting and preserving the integrity of America's markets. As we grapple with the profound changes sweeping our markets, safeguarding the public trust – above all else – must serve as our enduring mandate and collective goal.
America's accounting firms have established a proud heritage of excellence through the years, fulfilling a mandate established in 1933 to provide investors with information that is both accurate and reliable. Yet competitive pressures and an imperfect self regulatory presence gave rise to a need to address perceived and actual conflicts of interest. The tension between regulator and the profession has led to a combination of rules and disclosures which establish clear guidelines as well as a more comprehensive disclosure to benefit America's investors and preserve their confidence and trust. I continue to respect the power of our markets and firmly believe that this private sector response today, motivated by Commission guidance, represents a constructive foundation for a new partnership, committed to the primacy of full and fair and accurate disclosure on behalf of America's investors.
As we consider today's rule that modernizes, for the first time in 18 years, the requirements for auditor independence, how did we get to this issue? Historically, it dates back to the 1970s when my predecessor, Harold Williams, imposed a disclosure standard. Yet increased economic pressures on the profession, coupled with greater competition and consolidation, mandated that we bring clarity and light to the necessarily subjective nature of independence. Too often, in a more complex business environment driven by safe and predictable short term results, companies were induced to embrace practices that came close, but sometimes crossed the line, between the reality of the numbers and the wishes of expectations.
Some might feel it is unrealistic to expect a human being to stand against the wind of economic and cultural pressure – after all, the client does pay the bill. The role of government in the circumstances is not the shackle the industry with costly regulations that can be circumvented. Rather, it is to define the issues and catalyze a public interest resolution that defines parameters of permissible activity, and discloses information that clearly defines motives.
What are the indices of independence? An independent director exercises independent judgment in determining whether an offer to acquire a company is in the best interests of its shareholders. Independent standard setters exercise judgment in weighing the competing interests of its various constituents against the needs of investors for transparency. An independent audit committee exercises judgment in challenging a CFO and an auditor with respect to the quality of financial reporting of the company instead of the acceptability of it.
As many know well, the process of working towards an effective but workable final rule has been a long, and often difficult one. Along the way, there have been some heartfelt differences of opinion on how best to handle certain issues. The Commission's staff has heard the specific concerns of all of the Big 5 firms and the AICPA, and the final rule reflects, to a great extent, their concerns.
I want to commend Jim Schiro of PricewaterhouseCoopers and Phil Laskawy of Ernst & Young for their leadership throughout this process, as well as the other three Big 5 firms and the AICPA for their willingness to come to the table and work through the issues. I firmly believe that today's result strikes a balance that serves the interests of America's investors while remaining flexible and adaptable for the unforeseen changes in tomorrow's marketplace.
Specifically, the rule would reduce the number of audit firm employees and family members whose investments in, or employment with audit clients would impair the auditor's independence. The rule also identifies certain non-audit services that, if provided to an audit client, would impair independence. I believe the scope of these prohibitions is targeted, sensible, and in many cases, consistent with the current restrictions on the profession's and the SEC's books.
The rule also permits firms to offer IT consulting services to their audit clients provided certain criteria are met, including disclosure of fees. Firms would also be allowed to perform up to 40 percent of a client's internal audit work, with no restriction for smaller companies with assets under $200 million. Lastly, under the rule, audit committees would now disclose whether they considered the types of non-audit services performed, the fees involved, and if these were consistent with an auditor's independence.
I want to acknowledge my fellow Commissioners who have be an invaluable part of this process from the very beginning; Commissioner Carey for his wise counsel and steadfast support, Commissioner Unger for identifying and pursuing critical issues that might otherwise have gone unexplored, and Commissioner Hunt for his legal insight and wealth of experience afforded this undertaking.
In addition, I reserve a special thanks and my deepest gratitude for Commission staff in the Office of the Chief Accountant, Office of the General Counsel, and Office of Economic Analysis. Their tireless dedication these past months, their many personal sacrifices, and unwavering commitment throughout this process culminated in a truly remarkable effort. Without their individual and collective contributions, today's rule simply would not have been possible.
In our options and equities markets, we consider today proposals that provide America's investors with more information about the quality of their orders and help ensure that investors receive that best execution available in our marketplace. The proposed Trade-Through Disclosure Rule, in conjunction with the amended Quote Rule, will reaffirm the commitment to price priority embodied in the 1975 National Market System legislation. Most investors expect – and have a right to expect – that they will receive the best price available in any market center of our national market system.
Today's proposal would also create enduring incentives for our options markets to link efficiently. Firms that route orders to markets joined in a linkage plan reasonably designed to limit trade-throughs would be exempt from the rule, creating a powerful incentive for markets to establish effective plans. At the same time, if a linkage plan participant believed that the technology or governance structure of a linkage had become obsolete, the market would be free to withdraw, and establish its own connections.
In this same vein, the proposed execution quality disclosure rules in our equities markets would marshal the most powerful force in our market – the relentless demands of informed investors – to drive the most efficient order routing patterns and to stimulate market center competition based on superior executions. First, market centers would disclose to the public, on a monthly basis, the critical components of execution quality; for example, where orders were executed in relation to the quoted spread, the speed of executions, and fill rates for limit orders. Second, brokers would report which market centers they sent orders to, any payment-for-order-flow or internalization arrangements they had with those markets. The day brokers and market centers begin to compete on such factors as speed and price improvement is a very good day indeed for investors.
In closing, I would like to extend my deepest appreciation for the countless hours and superb work of our Division of Market Regulation and the Office of Economic Analysis. America's investors indeed are indebted to you for the work each of you have done here today.
At this time, I'd like to turn it over to Lynn Turner, our Chief Accountant, to talk in greater detail about the proposed auditor independence rule.