25 September 2000
Mr Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N. W.
Washington, D.C. 20549-0609
Re: U.S. SEC's Proposed Rule Governing Auditor Independence ? File No.
The Fédération des Experts Comptables Européens (FEE) (Federation of European Accountants) welcomes the opportunity to comment on the U.S. Securities and Exchange Commission's proposed rule amendments regarding auditor independence.
FEE is very much concerned by the U.S. SEC's proposed rule on auditor independence since it would be applicable to the work of European Union based auditors who have European clients that are registered with SEC or subsidiaries of SEC registrants. These auditors are subject to independence requirements that are currently in the process of being developed by the European Union in cooperation with FEE along the same lines as those now being followed by the International Federation of Accountants and by the U.S. Independence Standard Board. FEE's concern is based on the fact that the approach of the proposed rule differs radically from that being applied in the European and worldwide projects. FEE believes that in the current and developing global economy, more international cooperation and harmonisation must be considered and the profession needs to continually strive for global solutions.
A worldwide general consensus in favour of the framework conceptual approach
In 1998 the European accounting profession, through FEE, issued a policy paper called Statutory Audit Independence and Objectivity, which sets out a Common Core of Principles concerning independence issues. This paper has been well considered by the EU Commission's Committee on Auditing (see role and membership in Appendix) as a basis for developing a European code of conduct and the European Commission has committed itself to a conceptual approach. FEE has developed a conceptual approach considering the different kinds of threats that arise with respect to statutory audit independence and objectivity and the possible safeguards, including prohibitions, to offset these threats. Because most of the specific situations in which statutory audit independence and objectivity are at risk, or perceived to be so, are common in most of the European Union Member States, the document applies a conceptual rather than a rule based approach.
A very similar approach has been used by the Ethics Committee of the International Federation of Accountants (IFAC) in its proposed current draft revision of the section on independence on its Code of Ethics for Professional Accountants.
FEE also participates in ISB task forces and has so far commented on the following subjects using the conceptual approach:
When considering the "U.S. SEC's proposed rule", the conceptual approach is also used as the basis for our review.
This approach provides a set of fundamental principles which individual auditors can use to fit ethical dilemmas. Auditors are guided as to which threats they might encounter and which safeguards they might put in place to combat them. This analysis, by way of threats and safeguards, assists auditors in deciding their proper course of action. FEE expresses grave disappointment that the SEC proposals seem to ignore the conceptual approach losing the advantages of comprehensiveness and consistency offered by this approach. FEE considers the main weakness of the prescriptive approach is the need to have a multitude of detailed rules, which cannot cover all possible situations where the auditor's independence might be impaired.
The FEE Common core of principles
The common core of principles on statutory audit independence and objectivity published by FEE in July 1998 outlines in its first part the concepts governing statutory audit independence and objectivity. It explains the notions of independence of mind and independence in appearance and the expectations of those directly affected. The following extract sets out FEE's position on these issues:
The expression of an objective opinion should always be the ultimate goal of the statutory audit. Independence is the main means by which the statutory auditor demonstrates that he can perform his task in an objective manner. In dealing with independence, one must address both:
Independence of mind
I.e. the state of mind which has regard to all considerations relevant to the task in hand but no other; and
Independence in appearance
I.e. the avoidance of facts and circumstances, which are so significant that an informed third party would question the statutory auditor's objectivity.
Objectivity is essential for any professional person exercising professional judgement. This is particularly so for statutory auditors, whose professional opinions are likely to affect rights between parties.
In order to safeguard their objectivity, statutory auditors contemplating any work or engagement requiring objectivity of judgement should consider certain matters before deciding whether to accept a new contract or appointment, or whether to continue an existing appointment. The matters to be considered fall under the following headings:
The document considers too the different kinds of threats which arise with respect to statutory audit independence and objectivity and the possible safeguards, including prohibitions, to offset these threats. The issues described represent the most common situations in which the statutory auditor's independence and objectivity are at risk or are perceived to be so. They concern:
FEE believes that the framework approach is in practice more rigorous than a detailed rule-based approach offering a number of advantages, such as:
FEE shares the SEC's view that independent auditors play a key role in providing assurance to investors that the financial information disclosed by issuers is reliable. Furthermore, SEC emphasises the importance of both independence in fact and in appearance for the auditors, which is fully supported from a European point of view.
FEE believes that the provision of non-audit services to an assurance client can benefit both the client and financial statement users as it increases the auditor's understanding of the client's business and may result in a better assurance engagement. The provision of non-audit services may, however, create risks to the auditor's independence. New developments in business, the evolution of financial markets, rapid changes in information technology, and the consequences for management and control, make it impossible to draw up a comprehensive list of all situations where providing non-audit services to an assurance client might impair independence and of the different safeguards that might mitigate those risks. As a result, it is difficult to set an exclusionary ban that, FEE believes, could be even harmful to audit effectiveness.
FEE recommends alternatives based on a framework approach such as the identification of specific threats and the development of tailored safeguards, including firewalls, which could sustain independence without impairing the ability of the auditor to respond to his clients needs. Therefore, an auditor may provide services beyond the assurance engagement as long as there are sufficient safeguards to preserve independence. Where adequate safeguards are not available prohibition should be applied.
On that matter, the European Commission, in its draft recommendation concerning "Statutory Auditor's Independence in the EU: A set of Fundamental principles", does not generally prohibit the non-audit services and uses a conceptual approach rather than extensive blanket prohibitions.
As well, IFAC International Ethics Committee, in its current exposure draft on Independence, agrees with FEE on that point. The IFAC Committee believes that the provision of non-audit services is acceptable provided that there is in place a framework requiring the auditor to assess the risks to independence of the service and take appropriate steps to mitigate those risks.
Such restrictions as proposed in the SEC document will also harm the recruitment and retention of the most qualified personnel, causing degradation in audit quality.
Practical experience of new developments in business, the evolution of financial markets, and the consequence for the company management and control of rapid changes in information technologies have demonstrated that in view of the wide range of possible situations, it may be impossible or inappropriate to draw up a comprehensive list of all those situations where the provision of non-audit services to an audit client would no longer be compatible. Considering the benefits of the conceptual approach such as its flexibility to be applied to a wide range of threats and its capacity to reach appropriate decisions concerning circumstances that are not addressed by specific rules, FEE does indeed recommend that approach be applied for non-audit services.
FEE disagrees with a general rule that an auditor's independence is necessarily impaired if providing non-audit services to an audit client. In its view the provision of non-audit services to an audit client has no impact on the auditor's independence provided there is no involvement of the auditor in any decision-making of either the audit client or its management. In this case a self-review threat cannot be assumed.
The proposed general prohibition of non-audit services totally ignores the benefits of providing such services to audit clients. It should be recognised that the provision of non-audit services to an audit client brings benefits to both the client and investors as it increases the auditor's understanding of the client's business and is likely to result in a better audit. Consequently, many companies would be adversely affected if they were denied the right to obtain other services from their auditors.
Practical experience has demonstrated the difficulty and the inefficient rigidity of drawing up a list of prohibited non-audit services as done in appendix A, which could in any case be arbitrary.
Nevertheless, there are specific issues requiring particular attention because of their sensitivity in terms of independence in appearance.
Preparing accounting records and financial statements
The FEE CCP paper clearly states that an auditor should not participate in the preparation of the company's accounts and accounting records save in relation to assistance of a routine clerical nature or in emergency. However, that paper also recognises that practice in respect of this issue varies between member States in respect of smaller companies. FEE believes that where member states invoke the notion of the public interest (or, more usually, the absence of it) as a reason for permitting auditors to provide such non-audit related services as the preparation of accounting records and financial statements, the auditors concerned are under a professional obligation to assess the significance of the self-review threat that exists. In such case, the auditor should always remain extremely cautious and document clearly the position he has adopted.
Appraisal or valuation services
FEE believes that an auditor on assurance engagement should not provide to his assurance client expert services which lead to the valuation of amounts material in relation to the financial statements and the valuation of which involves a significant degree of subjectivity inherent to the matter concerned. In such situation, the auditor should either refuse to perform the assurance engagement or advise the assurance client to seek an alternative source for the particular expert services.
Fee agrees that an auditor should not assist the audit client in the resolution of a dispute or litigation which involves matters that, in the aggregate, would reasonably be expected to have a material impact on the client's financial statements and a significant degree of subjectivity inherent to the case concerned.
Tax services should be allowed including acting for the client before the courts or the tax administration in tax litigation which is an area where the appearance of independence would normally not be at risk, because interested third parties understand that the auditor has the most appropriate technical expertise and is better placed to defend his client in cases which are generally not significantly subjective.
Requirement to companies to disclose in their annual statements non-audit services provided by their auditors during the last fiscal year
FEE agrees that the auditor should assess this risk to independence in terms of the nature of the non-audit services provided, the fees generated from assurance services and, of total fees. Nevertheless, as safeguards, FEE doubts that disclosure of audit and non-audit services is efficient and believes that it does not give a true picture of the objectivity and independence issues. FEE considers more appropriate to involve the companies corporate governance systems combined with enhanced oversight by the audit committee and/or supervisory board of the nature and volume of non-audit services. Such involvement would mitigate threats to the auditor's independence, both in fact and in appearance.
Generally FEE agrees with the proposal to limit the group of persons who cannot invest in an audit client to "covered persons in the firm" and their "immediate family members". It meets the reality of audit firms acting on a global basis.
In FEE's opinion reasonable investors would question the auditor's independence if a close relative holds a "key position" at an audit client. From a third party's perspective FEE believes that the ISB's stricter position with respect to immediate family members is necessary to ensure an auditor's independence.
Where a former employee of an audit firm has an employment relationship with an audit client, in our opinion the statutory auditor's independence is impaired if significant connections remain between the former employee and the audit firm. This implies that the former employee should not be permitted to derive retirement or other benefits from the audit firm unless these are made in accordance with pre-determined arrangements that cannot be influenced by any remaining connections between the employee and his former firm.
It seems to be important to emphasize that the materiality of any financial ties should be assessed from the perspective of the firm, not from the former employee.
A mandatory "cooling-off period" for former partners and professional staff of an audit firm who join audit clients seems to be arbitrary and, therefore, should not be required.
FEE agrees to the proposed rule that an auditor is not independent if he provides audit services to an audit client or an affiliate of an audit client for a contingent fee or receives a contingent fee from an audit client or an affiliate of an audit client.
FEE agrees with the proposed exception for audit firms that have appropriate quality controls to address independence and meet certain conditions. FEE also believes that it will encourage these firms to put in place such internal controls to prevent and detect any independence impairments. Adequate quality control is an essential and integral part of the FEE framework approach.
We would be pleased to discuss with you any aspect of this letter you may wish to raise with us.
FEE Comment letter to U.S. SEC Proposed
Rule governing Auditor Independence
The Committee on Auditing of the European Commission
The Committee on Auditing was established by the Commission Communication "The Statutory audit in the European Union: the way forward" of May 1998. It meets two to three times a year on different locations in the EU. The Committee on Auditing is a platform where statutory audit regulators from the 15 Member States and the 3 countries of the European Economic Area, together with representatives of the audit profession, the internal auditors and the European representatives of the large audit firms deal with statutory audit matters. The overall objective is to develop a common view on statutory audit at EU level, in particular for matters that are not covered by existing EU legislation, the 8th Council Directive on company law "The approval of persons responsible for carrying out the statutory audits of accounting documents". In the context of a single EU capital market audited financial information should have the same level of credibility throughout the European Union facilitating and stimulating cross border investments
The priorities on the agenda of the Committee on Auditing are:
The principle way to achieve the objectives of the Committee on Auditing is monitored self-regulation but the Commission will not hesitate to propose new legislation when and where it considers this to be necessary. The Committee on auditing will report on all matters to the Contact Committee on the Accounting Directives
Members of the Committee on Auditing are representatives of the European Commission (who is chairing the Committee), of the accountancy profession at European Level (including FEE, European Contact Group of Region firms and International Auditors) and at national level and representatives of national governments and regulators. In this last category we can mention:
Austria: Ministry of Justice
Belgium: Ministry of Economic Affairs
Denmark: Danish Commerce and Companies Agency
Finland: Ministry of Trade and Industry ? Central Chamber of Commerce
France: Commission des OpTrations de Bourse
Germany: Bunderministrium of Justiz ? Bundeministrium of Wirtschaft
Greece: Ministry of National Economy
Ireland: Department of Enterprise of Employment
Italy: CONSOB Ministry of Justizia
Luxembourg: Ministry of Justice
Norway: Ministry of Finance
Portugal: Comisspo do Mercado De Valores Mobiliares ? Ministry of Finance
Spain: Instituto de Contabilidaj y Auditores de Cuentas
Sweden: Ministry of Justice
The Netherlands: Ministry of Economic Affairs ? Ministry of Justice
United Kingdom: Department of Trade and Industry ? Auditing Practices Board