September 25, 2000
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: SEC File No. S7-13-00
Dear Mr. Katz:
Centerprise Advisors, Inc. provides accounting, tax, consulting, information technology, employee benefits administration and other professional and business services to middle-market clients in a variety of industries. Centerprise began its operations in July 2000 when it acquired the non-attest businesses of five regional accounting firms, as well as two business services firms. Since the acquisitions, the CPAs who are employed by Centerprise and choose to provide audit and other attest services now do so through separate, licensed firms in which Centerprise has no ownership interest. Under the "separate practice" structure, one of a number of alternative practice structures developed in recent years, Centerprise leases professional and other staff as well as facilities and ancillary support services to attest firms on a non-exclusive basis. Currently, Centerprise is 70%-owned by CPAs and we employ more than 300 licensed CPAs. As discussed below, we have a number of concerns with the Commission's proposal.
The proposed rules could harm businesses, clients, audit quality and investor confidence.
We believe that independence is the core of the profession and that independence, combined with auditor expertise and audit quality, forms the bedrock for investor confidence in financial statements. As a result, we applaud the Commission's efforts to ensure that independence standards evolve in response to changes in the industry and its markets. However, in this case, we do not believe that the Commission's proposed new rules are an appropriate response to those changes. For the reasons discussed in this letter, we believe that the proposed rules could have a significant negative effect on our business and would not be in the best interests of the middle market clients we serve. Furthermore, we believe that the rules would not improve and in fact could reduce the quality of audits while undermining the investor confidence that independence is intended to promote.
The comment period should be extended.
As a starting point, we join numerous commentators in urging the Commission to extend the comment period for the proposal by 180 days. In the proposal, the Commission has requested comment on hundreds of questions. We have not been able, in the 75 days available to us, to explore in detail the potential impact of many of the issues raised by the Commission, and testimony and comments submitted to the Commission to date indicate that many others are in the same position. We are concerned that the Commission, on a fast track to address a perceived problem, is taking action without a complete understanding of the potential negative implications of that action for investors, businesses, audit clients, audit quality and the accounting industry. We believe that the Commission's decision-making process and its ultimate product would benefit if we, accounting firms, clients, investors, academics and others had additional time to examine these questions and provide information to the Commission.
In addition, the following specific comments are made with respect to the proposal:
The scope of services prohibitions are too broad.
We agree that the provision of certain non-audit services to an attest client, such as bookkeeping or serving as a broker-dealer, underwriter or analyst with respect to a public company's securities, may impair independence. However, we take issue with the Commission's adoption of the four basic principles as a conceptual framework. While these principles may be relevant factors in assessing potential independence issues, we believe that they are too abstract, and too open to interpretation, to comprise the whole analysis.
Providing diversified services can increase audit quality. Consistent with our view of the governing principles, we believe that the proposed prohibited services derived from them are too broad. They sweep up a number of services which, in the experience of our CPA employees, can actually increase the auditor's knowledge and understanding of the client's business and enhance the quality of the audit. Such services include consulting related to systems and systems implementation, which can provide valuable insights and information not otherwise available to the auditor. Similarly, consulting with respect to internal controls enables the auditor to better understand the client's systems and design an appropriate audit. An auditor who provides tax planning services may be better able, through increased knowledge of the client's tax issues, to determine appropriate accruals. While we do not support the prohibitions generally, if the
Commission proceeds to implement any such restrictions, we support the suggestion that the rules identify services that would not impair independence and recommend that these include services that are a "natural outgrowth" of the audit, as suggested by the Commission, as well as services that serve as preparation for and enhance the audit as discussed above.
The examples above are not exclusive, and they point to a broader issue that the Commission is apparently disregarding in proposing these rules. We find that our clients' businesses and systems are increasingly complex. The clients' auditors need to thoroughly understand these complexities to design and perform quality audits. We believe that increased knowledge on the part of auditors--be it knowledge of the particular client or more general expertise in substantive areas such as technology, human resources, tax or others--leads to higher-quality audits. We are concerned that the proposed rule would separate the audit competency from the competencies of consultants, valuation experts, IT experts and others, all of whom we believe are valuable resources to an auditor. This lack of resources could significantly reduce the quality of audits.
With respect to one particular prohibited service--expert testimony on behalf of an audit client--we note that applicable consulting standards require that the professional be independent in fact in such circumstances. Despite the Commission's concern that such testimony would result in the appearance of advocacy and thus violate one of the four proposed principles, we believe that a reasonable investor would understand that the nature of expert testimony requires objectivity, not advocacy.
The scope of services prohibitions could have significant negative consequences for audit quality and clients. Our client base consists primarily of middle-market companies, many of which are privately-owned. If, as many predict, the Commission's rules become the model for state regulators, we are concerned that the severe restrictions on the permitted scope of services would damage our clients by limiting their ability to obtain a broad range of services from a single, cost-effective source. Alternative practice structures evolved, and we were formed, in response to the demands of middle market clients. In recent years, our CPA owners, as "trusted advisors," were increasingly asked by their audit clients to provide a broad range of high-quality, non-audit services. We've been able to respond to their needs and provide such services at reasonable prices in part because we can leverage our employees and our knowledge across a wide range of services.
If the Commission's proposed restrictions were imposed by state regulators on private companies, we believe that we and virtually every other firm in the country would be required to restructure our business in fundamental ways. While we can't predict precisely what that restructuring would entail, we believe, as do many commentators, that the industry would ultimately be divided into audit and non-audit firms, with a number of possible adverse consequences:
We urge the Commission to take into account the possible adoption of its rules by state regulators, and the possible negative consequences of such adoption, in considering the proposed rules.
The proposed disclosure requirements would disadvantage alternative practice structures and mislead investors.
As discussed above, Centerprise leases its professional staff to various attest firms pursuant to services agreements. Under the Commission's proposed rules, any public company that hired such an attest firm as its principal auditor would be required to disclose the leasing arrangement. As this disclosure requirement is targeted solely at firms such as Centerprise that have pursued alternative structures, we believe it would create an unfair disadvantage for the attest firms with whom we contract as compared to traditional firms which the Commission apparently believes are preferable from an independence standpoint. Such an endorsement by the Commission is unfounded and potentially misleading to investors. It fails to take into account the efforts by state regulators and others to ensure that alternative structures comply with independence and other professional standards. In addition, we point out that the ISB, in its proposal concerning alternative practice structures, noted several ways in which such structures may benefit independence and the quality of audits.
Additionally, we believe the proposed disclosure is unnecessary and counterproductive when one considers the independence standards with which our structure must already comply. Both the AICPA and the ISB have considered alternative structures, the dual employment and other relationships they involve and their possible impact on independence and have adopted (or in the case of the ISB proposed) additional rules to protect the public interest. Under AICPA Interpretation 101-14 as applied to the separate practice structure, the attest firm and its members are subject to the same rules as would apply in a traditional structure, but the rules extend to include the leased employees who work on the engagement and employees of Centerprise who are in a position to influence decisions made on the engagement. Similarly, under the Commission's proposed rules, independence rules for an attest firm with whom we contract would be extended to include Centerprise and its affiliates. By requiring disclosure of the leasing relationship, the Commission is apparently inviting the investor to second guess either the adequacy of independence standards related to the separate practice structure or the ability of audit committees to comply with them. Again, we believe that the proposed disclosure would confuse investors, most of whom are not in a position to understand the complex relationships and issues involved, and would undermine the very confidence in financial statements that the Commission's proposal is intended to foster.
Materiality should be applied when defining "affiliate."
We believe that the proposed definition of "affiliate of an accounting firm" is overly broad and urge the Commission to consider materiality in its analysis. By way of example, Centerprise is owned in part by outside investors, including one large company that owns less than 10% of our voting securities. Under the proposal, the independence rules would extend from an attest firm to this entity and its directors and officers, and a loan from the entity to an audit client of the attest firm would impair the attest firm's independence even if both the investment in Centerprise and such loan were immaterial to the entity. We believe that the 5% equity ownership level, while familiar from a number of other "affiliate" definitions in the securities laws, is too low as a threshold at which the professional judgment of an auditor is deemed compromised. This is especially true in cases where the minority interest is owned by one subsidiary of a large company and the loan or other financial or business relationship is far removed in a separate subsidiary. We fear that the adoption of this broad standard, and the compliance and independence checking burdens it would impose, would deter investors, particularly large, diverse institutions, from investing in accounting firms. We urge the Commission to consider the approach employed by the AICPA in Interpretation 101-14, which used a materiality concept in assessing the likelihood that financial relationships would cause certain persons to attempt to influence an audit engagement.
The ISB should continue its work.
Finally, on a personal note, for the last year and a half I have been a member of the ISB's Firm Structure's Task Force which studied independence concerns related to evolving forms of firm structure and organization. While I did not always agree with the concerns expressed or the conclusions reached, I found the process to be informed and deliberative with the public interest paramount. The ISB has done considerable and important work in this area and in its overall mission of developing a conceptual framework for independence. Personally and on behalf of Centerprise, I echo many other commentators in urging the Commission to allow the ISB to complete its work. In doing so, the Commission would be taking responsibility for acting in the best interests of the public, while also taking responsibility for ensuring that the consequences of such actions don't work against those very interests.
We appreciate the opportunity to offer our comments on the proposed rules.
Very truly yours,
/s/ Robert C. Basten
Robert C. Basten
Chairman and Chief Executive Officer
Centerprise Advisors, Inc.