September 20, 2000

Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609

Re: Auditor Independence File No. S7-13-00

Dear Mr. Katz:

I have been a practicing CPA since 1968. My professional career began as a staff accountant with one of the "Big 8" accounting firms. After five years with that firm, during which time I performed audits of a variety of clients ranging from mid-market non-public clients to large, publicly-held conglomerates, I joined a small local CPA firm which served non-public, small to mid-size local and regional clients. The balance of my career has been devoted to servicing the non-public, small to mid-size business market.

I am responding to the SEC's proposal concerning auditor independence because of the adverse impact it will have on the clients I and my firm service. While the SEC's proposal is aimed at auditors of publicly-held clients, there is a significant likelihood that the impact of this proposal would spread to audits of all clients. Independence is essential in any attest engagement. State licensing agencies will likely find it difficult to distinguish the need for a higher level of independence on public companies than on non-public companies. Such agencies are likely to apply the SEC ruling in a universal manner. Therefore, the SEC should consider the wide spread impact of its ruling.

Is there a need for an exclusionary ban?

The report and recommendations of the Public Oversight Board's Panel on Audit Effectiveness (the POB Report), dated August 31, 2000 was clear in terms of the facts. That report stated as follows:

"The Panel is not aware of any instances of non-audit services having caused or contributed to an audit failure or the actual loss of auditor independence."

This statement was supported by the following findings (report paragraph indicated):

5.18 The QPR reviewers did not identify any instances in which providing non-audit services had a negative effect on audit effectiveness. On about a quarter of the engagements in which non-audit services had been provided, the QPR reviewers concluded that those services had a positive impact on the effectiveness of the audit. On the balance of the reviewed engagements, the reviewers either were neutral regarding the effects of non-audit services on audit effectiveness or concluded that the services had no impact on audit effectiveness.

5.19 ...In all 15 of these engagements, the reviewers agreed that the engagement team's audit procedures were sufficient to bring an objective view to the area, provided sufficient competent evidential matter regarding the systems, processes or amounts, and were documented adequately. In addition, the reviewers agreed that the engagement team and/or the firm took appropriate steps to ensure that the non-audit services would not impair the firm's independence and that the auditors' independence was not adversely affected by the non-audit services.

In addition, note 23 in Chapter Five of the POB report stated:

The SECPS staff reported that 67 [engagements where the client also engaged the audit firm for management consulting services] were selected during the 1999 peer reviews, and consistent with prior years, no instances were found in which independence or objectivity appeared to have been impaired.

The support for an exclusionary ban is based not on the existence of a problem, but on the assumption that a problem should exist. The fact is, the very foundations of the CPA profession, integrity and objectivity, continue to serve the public well. That is not to suggest that, like any profession comprised of humans, aberrant behavior does not result in failures. However, solving this problem with an exclusionary ban would be similar to mandating that only eunuchs be permitted to run for President of the U.S. in order to eliminate inappropriate sexual harassment in the White House. The severity of the solution is not in proportion to the problem.

What would the impact of the exclusionary ban be on auditor independence?

The POB report draws a conclusion that an auditor's independence, both in fact and in appearance, will be enhanced if the auditor does not also provide non-audit services to the audit client. This assumption is based on a second assumption: the auditor's behavior in an audit might be compromised due to the fear of losing the fees generated by the non-audit services.

I would suggest that when the only service provided to a client is an audit (or other attest function requiring independence), the client has an "upper hand" in the relationship, which could impair the auditor's judgment in planning and executing the audit. This is due to the fact, as highlighted in the POB report, that clients view the audit as a commodity. When an auditor does not agree with the client's handling of a particular transaction within the financial statements, the client has little to lose by switching auditors. The client will be less concerned about switching relationships because the auditor is not providing any other work that the client perceives as value-added. Faced with the possibility of losing the client, a CPA might be inclined to "push the envelope" on the acceptability of the accounting treatment utilized by the client.

Small and mid-sized CPA firms are particularly susceptible to this concern. In most of these firms, the attest engagement comprises the major portion of the fees generated from any particular client. These firms will remain vulnerable, as a result of their financial dependence on such fees, to pressure from clients regarding accounting treatment within the financial statements. A ban on such firms providing non-audit services to audit clients will further commoditize the relationships with their clients, thus increasing the chance that a threatened loss of attest fees will impair their judgment.

What would the impact of the exclusionary ban be on the quality of the audit?

The POB report accurately points out that non-audit professionals, and audit professionals trained in consulting skills, are becoming essential to the conduct of an effective audit. In small and mid-size CPA firms, attracting and hiring non-audit professionals, or training audit professionals in non-audit skills, represents not only a sizable investment in relative terms, but a "tough sell" when the only use of such skills will be on attest engagements. Prospective hires are likely to view their career paths as limited. For these firms, attest clients represent the very best source of non-audit, consulting work. They are less likely to be able to sell such non-audit services to either their non-attest clients or to new clients who only seek consulting services. The former type of client will tend to be smaller clients who can't afford a significant amount of consulting services. The latter type of client is not motivated to select a CPA firm other than its own firm; it is more likely to seek out a firm with a significant reputation in the desired consulting specialty.

Therefore, small and mid-size CPA firms will find their opportunities for non-audit services greatly reduced, and their opportunity to hire or train professionals with non-audit skills dramatically reduced. To the extent such skills are useful or required in the course of the attest engagement, they will not be available. Unfortunately, many CPAs will attempt to adapt their skills to the needs of the attest engagement. This will result in poorer quality audits.

What would the impact of the exclusionary ban be on the cost to the client of an audit?

The POB report draws the following conclusion concerning the audit fees charged to clients:

"The rule we recommend will make it unnecessary to treat auditing as any kind of loss leader, because there will be no other services to be cross-marketed. The incentive to compete on price will be sharply reduced."

In the small and mid-size CPA firm arena, audit (and other attest engagements) and tax services have traditionally represented at least 70% of all fees generated. Notwithstanding the fact that this percentage would increase under the exclusionary ban, such firms have also traditionally been very aggressive in pricing audit and attest services. Price is often the advantage that such firms offer prospective clients, due to their lower salary and overhead costs as compared to larger firms. Price competition will not only continue, but probably be exacerbated due to an inability of these firms to be able to sell non-audit services to their best clients. And, as such firms reduce their prices, they feel compelled to enhance the "efficiency" of their audits. Unfortunately, this may often translate into reducing scope on the attest work, which in turn often reduces the quality of the audit.

What would the impact of the exclusionary ban be on the ability of CPA firms to attract qualified auditors?

Many states have mandated a 150 hour requirement in order to become a CPA. The result of requiring a five-year college education has had a dramatic effect on the number of students who choose to apply for an accounting curriculum in college. University professors with whom I have inquired about their new accounting classes, indicate that enrollment in such classes is down by approximately 25%. When this reduced enrollment is combined with the inability of CPA firms to compete, salary and benefit-wise, with the new technology opportunities, the number of bright students entering the CPA profession is dramatically reduced.

Even among those who do enter the profession, most have to be promised that they will not be "stuck" only performing attest engagements. They are interested in assembling a wide range of skills that allow them to move up in the organization, or prepare them for a different job opportunity. Audits are, frankly, considered boring. The creative minds - just the ones you want in the process of evaluating and dealing with audit risk - don't want to be "auditors" anymore.

We need to be able to offer our talented staff the opportunity not only to acquire non-audit skills, but to utilize them on our clients. Otherwise, we will lose these staff to firms that provide consulting services.

What would the impact of the exclusionary ban be on the ability of clients to obtain reasonably priced consulting services?

For the clients of small and mid-size CPA firms, their relationship with their CPA is unique. It involves the highest level of trust and sharing of information. The consulting services sought by such clients is often based on the intimate knowledge the CPA has of the client's business. Often, this type of consulting engagement can be completed by the auditor in less time than it would take for the client to explain to a new consultant all of the information that the auditor already knows.

The inability of the audit client to rely on the auditor's intimate knowledge of the client's business would significantly raise the cost to the client of obtaining the consulting services, and often deter the client from seeking such services. This would often result in a client not achieving all the financial success they might have achieved with proper consulting advice.

The proposed exclusionary ban rule is so flawed in terms of its impact on both the CPA profession and its clients that it should not be implemented. The SEC should continue to work with the CPA profession, and rely on organizations such as the ISB, in order to encourage more effective audits. The current proposal is punitive in nature and will have the profession battling the SEC instead of trying to collaborate on reasonable solutions to real problems.


Michael Pierce, CPA, CFE