STATE OF CALIFORNIA - STATE AND CONSUMER SERVICES AGENCY
GRAY DAVIS, Governor
September 25, 2000
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Re: File No. S7-13-00
Dear Mr. Katz:
Earlier this month I had the privilege of appearing before the Commission to present my personal views on the Proposed Revision of the Commission's Auditor Independence Requirements. In this letter I am providing the formal comments of the California Board of Accountancy.
The California Board of Accountancy commends the Commission for its effort to address complex public policy issues related to auditor independence. This Board recognizes that independence in fact and in appearance is a critical core value of the public accounting profession. It is a key reason for the strong reliance consumers place on the work that auditors perform. It cannot be disputed that independent auditors play an essential role in maintaining public trust in the integrity of publicly held corporate financial statements and, in fact, in the financial statements of a variety of other entities including government agencies and non-profit organizations.
Because of the importance of independence, the California Board of Accountancy's regulations mandate that licensees "shall be independent in the performance of services in accordance with professional standards." California regulations do not provide detailed standards and restrictions, and instead rely to a great extent on the standards established by other bodies, such as the AICPA and the SEC. While California CPAs perform thousands of audits and other attest/assurance work, the majority do not practice in "Big 5" firms auditing publicly traded companies. Consequently, most licensees may not be directly impacted by the Commission's rules. However, whatever the Commission does on this matter may have a significant "trickle down" impact on the concept of independence for the entire profession.
It is in this framework that the California Board would like to express its concern regarding the four guiding principles. The principles articulated by the Commission provide a useful conceptual framework for the consideration of independence issues. However, the principles, taken as a whole, do not appear to be sufficiently clear to be universally applied and enforced as a regulation.
The Board is especially concerned about the two principles which state that the auditor is not independent when the auditor "Has a mutual or conflicting interest with the audit client;" or "Acts as an advocate for the audit client." These principles are very broad and appear to apply in some situations which have no clear bearing on independence. For example, under these rules a mutual interest could occur and impair independence if the auditor and the client both support the same political candidate or the same piece of legislation. It is for this reason that the California Board urges the Commission to consider not adopting the principles as a rule and instead making them a preamble to the more specific provisions in the remainder of the proposal.
The California Board generally supports the proposal in the areas of financial, employment, and business relationships. With regard to financial and employment relationships, the Board agrees there is a need for modernization and believes it is important to recognize that in our changing world some of the current prohibitions may be rendered obsolete. From this perspective, the Board believes it is appropriate to reduce the pool of people within the firm who would be affected by investment and employment restrictions as indicated in subsections (c)(1) and (c)(2) of the proposal.
Because the accountant cannot be independent when auditing the accountant's own work, the Commission has identified the growth and expansion of non-audit services as a key concern to address in its rulemaking effort. The California Board notes that this is one of the sensitive and controversial aspects of the proposal. The Panel on Audit Effectiveness considered this issue, but was unable to arrive at a consensus. One of the arguments against the need for regulation is that the rendering of non-audit services has seldom resulted in a reported audit failure.
The California Board believes it is important to seek a balance between the need to maintain investor confidence and the need for affordable, readily available non-audit services. Within this framework, the California Board urges the Commission to consider revising its proposed restrictions on non-audit services to functions such as enterprise-wide IT consulting and full internal audit outsourcing. This may be an area that should be referred to the Independence Standards Board for further consideration.
The Board supports the provisions on quality controls to encourage firms to adopt internal controls that provide for auditor independence. Also, the Board sees the benefit in adopting a disclosure requirement. However, the form and placement of the disclosure statement needs to be carefully considered to ensure that it provides meaningful information. For example, the Commission might consider the Blue Ribbon Committee's recommendations in this area.
Thank you for the opportunity to present the California Board of Accountancy's views on this very important regulatory proposal.
c: Members, California Board of Accountancy
John Peace, CPA, Esq., Chair, NASBA
State Boards of Accountancy