Testimony of William Baker on S7-13-00

COMMENTS
OF
WILLIAM D. BAKER, ESQ.
PRESIDENT
ARIZONA BOARD OF ACCOUNTANCY
ON
AUDITOR INDEPENDENCE

Mr. Chairman and Commissioners, I am honored to have the opportunity to participate in the hearing on Auditor Independence and to submit these written comments concerning that subject.

I am William D. Baker. I am an attorney in Phoenix, Arizona and have been practicing for almost 40 years. My practice involves representing special purpose districts, which are municipal corporations of the State of Arizona. I have also represented industrial development authorities. I have represented the issuer in over 50 municipal bond issues, both general obligation and revenue bonds. My clients are also required by Arizona statute to submit audited financial statements to the Arizona State Treasurer and to the County Board of Supervisors where the districts are located, the purpose of which is to assure those officials of the financial condition of the districts. All of these transactions, the issuance of bonds and the compliance with the Arizona statute, require audited financial statements that are above reproach since the investment bankers and the State officials rely upon the accuracy and veracity of these statements.

I am appearing here today as a public member of the Arizona Board of Accountancy and I also happen to be its President. The remarks I make today do not reflect the position of the Arizona Board, since we have not had time to have the Board review and approve these comments. They are based upon my experience not only as a user of financial services provided by certified public accountants but also as a five-year member of the Arizona State Board.

I have read the record of the hearing held on Wednesday, July 26, 2000, and was intrigued by the various and wide-ranging viewpoints that were expressed at that hearing. I have also read information provided by the AICPA concerning your proposed rules as well as other documentation. Obviously, I am not an expert nor am I a Certified Public Accountant. My viewpoint is both as a regulator and as an attorney representing my clients who utilize the services of Certified Public Accountants to produce audited financial statements.

In Arizona, we have many registered firms and CPAs who audit publicly traded companies as well as regulated and unregulated financial enterprises. In my five years of service on the Arizona Board, I can tell you that the Arizona Board takes its obligations of responding to complaints that registrants have not lived up to the standards of the profession very seriously. In order to aid us in doing that, we have established in the Office of the Arizona Attorney General a special investigatory and prosecutorial unit specifically for violations of the Arizona Accountancy statutes, rules and professional standards. We firmly believe that any oversight activity or establishment of rules that would lead to improvements in the conduct of audits, enhancing the reliability of financial reporting and bolstering investor confidence are vitally important.

We are also well aware of the dramatic changes that are taking place in the accounting profession that are transforming that profession. We recognize that these changes are having a dramatic impact, not only upon the profession, but also upon the regulators of the profession. I say this because there appears to be great haste in attempting to change the regulation of the profession as well as the adoption of rules governing the standards of care. I speak not only about this rule but also the Public Oversight Boards proposal for a Self-Regulatory Organization. I see no need for the haste on either front, nor do I see the role at the State Boards being considerate.

We must remember that being a Certified Public Accountant is a privilege and not a right and that privilege is issued by each State. As the Chairman said during the July 26^th hearing, this is a franchise. This valuable franchise carries with it implied traits of integrity, intelligence and independence. In order to protect the public, our standards should make sure that those traits are recognized and enforced. Your proposed rule would seem to do that but perhaps it goes too far.

In Arizona, our statutes and rules utilize the AICPA auditing standards as the foundation for our review of a registrant's actions. While the establishment of a new rule by the Securities and Exchange Commission dealing with Auditor Independence would only apply to those firms practicing before the Securities and Exchange Commission, the natural progression of such rules and standards is that they become superimposed upon each State Board's own rules and regulations. This is because if the SEC suspends the license of a Certified Public Accountant to practice before the SEC, that then becomes grounds for suspension of the license of the Arizona CPA whom the SEC has suspended.

As a public member I take very seriously my obligation to protect the public. The testimony at your July 26, 2000, hearing talked in great detail that the public being protected was the investor. That is true at the SEC. However, I would like to put that into a little different perspective. The public that also needs protected, besides the investor, are the public agencies who do not have audit committees, who are not sophisticated business people but who are required by law to engage the services of a Certified Public Accountant to provide them with audited financial statements which can assure the taxpayers of the State and County that these agencies receive an audited financial statement that can be relied on and one that is performed by a competent, independent accountant.

As a lawyer, the Canons of Ethics require me to owe my duty to my client. An auditor, however, owes a duty not only to his client to perform the audit in accordance with recognized auditing standards but the auditor also owes a duty to those who will rely upon that audited financial statement such as banks, investment bankers, investors and public officials. This requires the auditor to be independent, both in fact and in appearance.

I personally am a firm believer that no auditor can be independent if he has a financial relationship with his client. Since the auditor is a partner in a firm, that restriction should apply to all partners in that firm as well as managers and other employees of the firm. As a lawyer, our Canons of Ethics preclude us from entering into a business transactions with a client without going through a lot of hoops in order to get such a relationship "blessed". While the Canons of Ethics give some leeway and are not an absolute prohibition, my experience in 40 years of practice is that it is just the opposite of the Nike ad, you just should not do it.

How far that prohibition should reach, I don't know, but if the spouse, if the in-laws, if the parents, are investing in mutual funds and one of the stocks in the mutual fund happens to be the client of the auditor, then I do not think that that should be a prohibited investment.

There can be no greater appearance of lack of independence than that created by financial investments in the audit client. What auditor would issue a report with a "going concern" modification on the financial statement of a client in whom he has his funds invested?

Insofar as non-audited services are concerned, in a State like Arizona, I am afraid that that would have a real impact on providing audit services to businesses in our rural communities. While the Uniform Accountancy Act attempts to put additional requirements on those people performing audits, that, coupled with the SEC rule that would prohibit the provision of non-audit services, could preclude the registrant in a small farm town from providing tax services and bookkeeping services to the same client that he audits. This certainly would be a boon to the business of the aggregator and consolidator and require the CPA to make a choice as to what services he will provide. I think that some of the traditional non-audit services provided by CPA's such as tax advice should be authorized by the rule. Tax advice is an exception but as pointed out, advocacy is not. That, in the tax arena might not make much sense.

These previous statements are again based upon my feeling that if the SEC rule is adopted with prohibitions on the provision of non-audit services to the audit client, then this rule will eventually "trickle down" and ultimately apply to what I call the general practitioner in the rural areas.

In conclusion then I believe Auditor Independence, in both fact and appearance, is vital to maintaining the integrity of the audit. Your proposed rules are a step in that direction. However, with any new rule, come objections.

In my opinion, the rules should strive to produce better accounting and reporting, to maintain and enhance the franchise, and to assure the public regarding the integrity and independence of the auditor.

I believe that if the four rules or tests set forth in Rule 210-2-01(d) were used as a test for the soundness of the other proposed rules the public would be well served. These are: that the accountant cannot have a mutual or conflicting interest with the audit client; that the accountant cannot audit his or her own work (or that of his/her own firm); that the accountant cannot function as management or as an employee of the audit client; and, the accountant cannot act as an advocate for the audit client (with perhaps an exception in the tax arena).

Thank you for your consideration of these comments.

BIOGRAPHICAL SKETCH OF
WILLIAM D. BAKER, ESQ.

William D. Baker is the founding president of the law firm of Ellis & Baker, P.C., a Professional Corporation in Phoenix, Arizona. He has represented special purpose districts and public service corporations throughout Arizona in matters before federal and state administrative and regulatory agencies and in the courts, including territorial disputes, rate cases, financing and Central Arizona Project water matters. He represented agricultural financing corporations for over 30 years as well as industrial development corporations and the issuance of their bonds to finance various projects.

He specializes in the practice of water-related law and issues and special district law and issues, including election law and municipal finance. He represented the two Arizona irrigation districts, which filed Chapter 9 bankruptcy.

Mr. Baker received his A.B. from Colgate University, Hamilton, New York and his J.D. from the Boalt School of Law at the University of California, Berkeley.

He is licensed to practice before the U.S. Supreme Court and in the State of Arizona and is an inactive member of the State Bar of California. He has authored several articles for professional journals.

Mr. Baker was appointed by the Governor of the State of Arizona to serve as a public member of the State Board of Accountancy in 1995 and was reappointed by the Governor to an additional five-year term as a public board member. He has served as Secretary and Treasurer of the State Board and is currently serving as President of the Arizona State Board of Accountancy.

He resides in Phoenix, Arizona. Mr. Baker has been and is involved in many state and local community and civic organizations. He is listed in the Who's Who in America and Who's who in Law.