August 29, 2000
Mr. Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549-0609
Re: Revision of the Commission's Independence Requirements
SEC File No. S7-13-00
Gentlemen:
Thank you for affording me the opportunity to comment on the proposed revision on Auditor Independence Requirements on September 13, 2000. I am wearing several hats as I testify. I am currently the Chair of the New York State Board for Public Accountancy, a member of the American Institute of Certified Public Accountants, and a practicing CPA in a regional firm. I have been a member of the New York State Board since 1995, a member of the National Association of State Boards of Accountancy, and a member of the Uniform Accountancy Act Committee. I have served in leadership capacities in the New York State Society of CPAs. Finally, I have been an active practitioner in a public accounting firm for over thirty- five years. Because time did not permit the New York Board to review the proposals, I am speaking for myself today.
I decided to approach the preparation for my comments as I would approach an audit. There is so much information on the Independence topic today that one must try to focus on key information. Following are documents I felt were key:
I have observed a divergence of the SEC and the leadership of the AICPA. I believe that the AICPA leadership is having a difficult time meeting the Independence Standards when it tries to expand the scope of services outside of the traditional definition of public accounting. In my opinion the AICPA leadership has forgotten that the attest service monopoly was a privilege (not a right) given to CPAs by Congress in 1933 and that part of the responsibility of that privilege is protection of the public interest. I believe that the SEC has the proper focus in applying the Independence Standard because it is trying to protect the public interest.
While the SEC Backgrounder on Auditor Independence provides history from 1970 forward, Douglas Carmichael's "Historical Perspective of the Profession's Code of Conduct" should be mandatory reading for anyone who wants to understand the evolution of Independence Standards. His chronology begins in 1931 and most critical standards were developed prior to the 1970s. One fact that appears to ring loud and clear in the development of the standards is the constant struggle between the economic needs of the professional versus protection of the public interest. I have concerns that the desire of the AICPA leadership to gain more economic benefits for its members (e.g. XYZ proposal) is moving it away from the professional organization that I joined. I now see the AICPA as a trade association that focuses on economic benefits for its members and minimizes the public interest.
The argument against the appearance of Independence is based on the fact that opponents cannot cite legal cases. Maybe I am naïve, but I believe that we need to keep as much distance as possible between acts that can harm the public and those that cannot. I believe that Independence in appearance is a warning area that probably is not litigated. It is the gray area that tells a professional that he/she is getting too close to the "fire". The concept is in the eye of the beholder, not the regulator. The financial community, who I consider to be the beholder, is speaking loudly lately, but the profession's leaders do not seem to be listening. When I review the "rules", I believe that they are based on Independence in fact. It seems to me that the battle is over the profession's attitude. I believe that the leadership of the profession is trying to move the "line in the sand" one step further away from independent regulation. I believe that they want self-regulation, which is no regulation. I hope and trust that Congress, who represents the public, sees the damage that could result by weakening key Independence standards.
I have been following the activities of the Independence Standards since its inception. I believe that a careful deliberative approach is necessary. I am concerned that two sets of standards will evolve (one for public companies and one for private companies) if the process is accelerated and if all appropriate representatives are not included in the process.
Both the SEC and State Boards are addressing recently publicized violations by one of the major firms. We can already see that financial relationships are being evaluated in light of the potential adverse impact on the public. While there is discomfort on both the professional and regulatory side, it forced us to focus on the need for reform. We do not know the outcome of the disciplinary process, but I believe that that the judgement of those involved in the process will generate an appropriate response.
The summary of William Allen's testimony demonstrates what would happen if the Commission proceeds at its scheduled pace to address the following:
A Conceptual Framework for Independence and solutions to problematic questions are being addressed at a reasonable deliberative pace by the Independence Standards Board (ISB). If the Commission arrives at different conclusions, what credibility and/or support would it get? I might have issues with the make up of the ISB, but I believe that its approach is proper and necessary if the results are to stand the test of time.
I would like to see more input from State Boards for Public Accountancy and an affirmative effort to coordinate regulations so that CPAs will not have to meet numerous and/or conflicting standards. I support Dan Goldwasser's recommendation for increasing public representation on the ISB. I fear that a gap, which could hinder the growth of mid-size firms, might develop between private and public company audits.
I believe that Alternative Practice Structures and Non-CPA Ownership are the two most obvious, but understated issues when it comes to Independence. I have spent considerable time on these topics as a member of NASBA and as New York's representative on these topics at recent legislative hearings.
The "Discussion Memorandum on the Regulation of Alternative Practice Structures" introduces a "Single Entity Approach". It states that "Independence standards must be developed that recognize the relationship and interests that may exist between the CPA, the CPA firm and all affiliated entities or persons in an APS that could influence or control behavior of the CPA firm, or its owners." With the SEC narrowing its definition of those not considered to be independent, how will these rules be applied? A CPA firm might exist, but it could be under the control of unlicensed individuals. Where does the "buck stop"? Will the ultimate responsibility end with the licensed individual? Is the public interest served?
When one looks closely at the structure of most major firms and the structure of an APS, it is hard to discern any difference except for the origin of the firm. If someone wants to claim that there is a difference, how will they explain the difference when proposed alliances with vendors occur and/or the nature of services continues to expand? With a narrowed definition of Independence, it should be expected that legal structures would be created so that regulation can be avoided and that only the audit team will meet the Independence requirements. The "Single Entity" concept questions will arise again.
We, as regulators, need to evaluate the definition of Independence with continuing evolution in mind. We, along with Congress, need to determine whether we are willing to accept that the "firewall' approach will provide sufficient protection of the public interest, or whether public accounting should be structured in a niche that assures Independence as it has been perceived by the public in the past. If we accept the one-stop shopping concept, then we should consider why the owners have to be CPAs. We just need to establish firewalls and allow other financial entities to compete on a level playing field with professional firms that began as CPA firms. This would increase competition and allow other APS structures to compete in the audit arena. If we opt for the niche approach, then the limitations on non-attest services should be evaluated so that firms that opt to make auditing their prime functions have sufficient other service capabilities to continue to attract the best and the brightest.
General Standards for Auditor Independence - Dan Goldwasser effectively demonstrated that there are times when the four guiding principles are not appropriate. Further evaluation and explanation is required.
Financial Relationships - ISB should complete its work. I object to percentage limitations. Percentages are too hard to monitor both by the CPA firms and by regulators. I believe that 5% can represent a material amount. I favor giving the regulators the ability to judge when minor violations are inadvertent or represent a pattern of abuse.
Other Financial Interests - I believe the liberalization of limitations is being created by an acceptance of the one-stop shop concept. If that is the concept that is finally accepted, then I support the changes. If the niche approach were embraced, I would favor the historic restrictive regulations.
Exceptions - I oppose the more liberal rules on audits of inheritance and gifts and new audit engagements. I believe that there is a potential infringement on the appearance of Independence even if the CPA is independent in fact.
Bookkeeping - The application of the bookkeeping restriction to smaller companies could create undue hardships. Definitions of what constitutes bookkeeping and restricting the preparation of financial statements from client records are the issues.
Proxy Disclosure Requirement - I support the proposed rule that would mandate disclosure of facts respecting non-audit services provided to audit clients. William Allen, in his Summary of Testimony, appropriately states that " It is arguable (and I believe) that disclosure is the optimal social policy". I strongly support his reasoning and conclusion. In my opinion, this rule should apply to both private and public companies.
I have attempted to reflect my own opinions and my interpretation of those associated with me on the New York State Board. I know that we would like to work more closely with the SEC. I believe that we fundamentally embrace the regulations that you espouse. I have attempted to make my comments constructive when they differed from your proposals.
I have listed the documents that I used as resources. I am attaching a copy of "Historical Perspective of the Profession's Code of Conduct" by Douglas R. Carmichael and "Revision of the Commission's Auditor Independence Requirements" because I am not sure that you have access to these documents. The other documents could be provided on request, but I believe you have access to all of them.
I encourage you to study the Alternative practice Structure and Non-CPA Ownership issues carefully. I am convinced that when you look at the structure of a CPA firm and an APS from the perspective of the committee that developed the discussion memorandum, you will see that the monopoly privilege given to the CPAs in 1933 should be reexamined. I do not favor allowing 100% non-CPA ownership, but it might be the only alternative if the profession keeps pushing for one-stop shopping.
Respectfully submitted,
P. Robert Fox, CPA
Eldredge, Fox & Porretti, LLP
135 Corporate Woods, Suite 300
Rochester, NY 14623
Phone - 716-427-8900
Fax - 716-427-8947
E-mail - fox@efpcpa.com
Certified Public Accountant, 1967
Coopers & Lybrand, 1964 - 1967
Los Angeles, CA
Eldredge, Fox & Porretti, LLP, 1967 to Present (13 partners; 80+ total staff)
Rochester, NY
1995 Accountant Advocate of the Year, Buffalo District of the U.S. Small Business Administration
New York State Board of Accountancy - 1995 - Present; Vice-chair - 1999; Chair - 2000
American Institute of Certified Public Accountants - member
New York State Society of Certified Public Accountants - former Board Member and former member of the Professional Ethics Committee
Rochester Chapter, NYSSCPA - past President, past Secretary, former Chair of Managing Partners Committee and Continuing Professional Education Committees
National Association of State Boards of Accountancy - member of Uniform Accountancy Act Committee
McQuaid Jesuit High School - Board Member and Chair of Finance Committee
Brockport Foundation - past President and former Board Member
Lakeside Hospital Foundation - Board Member
Westside Economic Development Council (WEST) - Charter Member and Treasurer
Rochester Area Chamber of Commerce - former CEO Roundtable Member
Greece Chamber of Commerce - former President and current member of Advisory Council
Ref. File No. S7-13-00
Revised August 18, 2000
| Page# | Ref. Sect. 210 |
Section Description |
Status |
Comment/Description |
15 |
2-01(a) |
Qualifications of Accountants |
Unchanged |
An accountant must be in good standing and entitled to practice in the state of the accountant's residence or principal office. |
15, 74 |
2-01(b) |
General Standards for Auditor Independence |
Essentially unchanged - Retains fact and appearance - provides four 'governing principles' test |
An accountant is not independent who, with respect to an audit client, is not, or would not be perceived by reasonable investors to be, capable of exercising objective and impartial judgment on all issues encompassed within the accountant's engagement. The accountant is not independent whenever, during the audit and professional engagement period, the accountant:
|
16, 74 |
2-01(c) |
Specific Applications of Independence Standard: |
||
17, 74 |
2-01(c)(1) |
Financial Relationships |
Basic features same - Modernization incorporates more liberal provisions |
A direct or material indirect financial interest in an audit client will impair an accountant's independence. (Non-exclusive list, (c)(i) through (c)(iv)) |
17, 74 |
2-01-(c)(1)(i) |
Investment in audit client |
Modernization incorporates more liberal provisions - clarifies prohibitions, influence - much smaller group |
An accountant is not independent with respect to an audit client if the accounting firm, any covered person1 in the firm, or any immediate family member of any covered person has any direct investment in the audit client or in an affiliate of the audit client. 1Covered Person: "Covered persons" in proposed rule 2-01(f)(13) is defined to include the "audit engagement team," those in the "chain of command," all other partners, principals, shareholders, or professional employees providing any professional service to the audit client or its affiliate, and any other partner, principal, or shareholder in an "office" that participates in a significant portion of the audit. The proposal, like the current rule, would attribute all investments by a covered person's "immediate family members" -- that is, the covered person's spouse, spousal equivalent, and dependents -- to the covered person. |
18, 74 |
2-01(c)(1)(i)(A) |
Direct investment in an audit client or an affiliate of an audit client |
Unchanged - clarification - includes audit client affiliates |
Prohibition applies to any direct investment in an audit client such as stocks, bonds, notes, options, or other securities by the accounting firm and its covered persons. This is not an exclusive list of all covered ownership interests. The rule cannot be avoided through indirect means, i.e., through a corporation or as a member of an investment club. A direct investment in an affiliate of an audit client would be treated the same as an investment in the audit client. Note: Once an audit client can exercise "significant influence" over the operating or financial policies of an entity, then under GAAP, information from the financial statements of that entity will be reflected in the financial statements of the audit client. |
18, 74 |
2-01(c)(1)(i)(B) |
5% ownership limitation |
More liberal - New provision allows non-covered persons 5% ownership |
Extends a new 5% limitation ownership prohibition to a larger class of people than rule 2-1(c)(1)(I(A). An accountant is not independent with respect to an audit client when any such person or group holds more than five percent of an audit client's outstanding voting securities or otherwise controls the audit client.
|
18, 75 |
2-01(c)(1)(i)(C) |
Trustee or executor |
More liberal includes 5% ownership rule for firm and covered persons |
An accountant is not independent when the accounting firm, any covered person in the firm, or any covered person's immediate family member serves as voting trustee of a trust or executor of an estate containing more than 5% of the securities of an audit client. |
18-19,
|
2-01(c)(1)(i)(D) |
Material indirect interest |
More liberal includes 5% ownership rule for firm and covered persons |
Independence is impaired if an accounting firm, any covered person in the firm, any immediate family member of a covered person, or any group of these people has greater than 5% investment in: (i) non-client entities that have an investment in an audit client ("non-client investors"), or (ii) companies in which an audit client also has invested ("common investees"). Proposed rule 2-01(c)(1)(i)(D) does not make a distinction for an indirect investment in an audit client by an accountant through an investment company. |
21 |
2-01(c)(1)(ii) |
Other financial interests: |
||
21, 75 |
2-01(c)(1)(ii)(A) |
Loans/debtor-creditor relationship |
More liberal - limitation is firm and covered persons - includes $10,000 limit on credit card balance and "normal lending" exception |
Te accountant will not be independent when the accounting firm, or any covered person in the accounting firm, or any of the covered person's immediate family members has any loan (including any margin loan) to or from an audit client, the officers of an audit client or an affiliate of an audit client, the directors of an audit client or an affiliate of an audit client, or record or beneficial owners of more than five percent of the equity securities of an audit client or its affiliate. This rule provides a more liberal threshold by setting the credit card balance at $10,000, permits a mortgage loan not obtained during the period of the audit or professional engagement, and because, unlike the AICPA ruling, the proposed rule covers only the relatively small group of entities and people that could influence the audit. Other exceptions, loans obtained under a financial institutions normal lending procedures, terms and requirements:
|
22, 75 |
2-01(c)(1)(ii)(B) |
Savings and checking accounts |
More liberal - limited to firm and "covered persons" |
An accountant will not be independent when the accounting firm, or any covered person in the accounting firm, or any of the covered person's immediate family members has any savings or checking account at a bank or savings and loan that is an audit client or its affiliate, if the account has a balance that exceeds the amount insured by the Federal Deposit Insurance Corporation ("FDIC"). |
22, 75 |
2-01(c)(1)(ii)(C) |
Broker dealer accounts |
More liberal - limited to firm and "covered persons" |
An accountant will not be independent when the accounting firm, or any covered person in the accounting firm, or any of the covered person's immediate family members has any brokerage or similar account maintained with a broker-dealer that is an audit client or an affiliate of an audit client if any such accounts include any asset other than cash or securities (within the meaning of "security" provided in the Securities Investor Protection Act ("SIPA")), or where the value of the assets in the accounts exceeds the amount that is subject to a Securities Investor Protection Corporation ("SIPC") advance for those accounts, under Section 9 of SIPA. |
23, 76 |
2-01(c)(1)(ii)(D) |
Futures commission merchant accounts |
More liberal - limited to firm and "covered persons" |
The accountant will not be independent when the accounting firm, or any covered person in the accounting firm, or any covered person's immediate family member has any futures, commodity, or similar account maintained with a futures commission merchant ("FCM") that is an audit client or an affiliate of the audit client. |
23, 76 |
2-01(c)(1)(ii)(E) |
Credit Cards |
More liberal - raised limit to $10,000 |
A credit card balances of $10,000 or less owed by a firm, a covered person, or any covered person's immediate family member to an audit client or its affiliate, will not be deemed to impair an accountant's independence. |
24, 76 |
2-01(c)(1)(ii)(F) |
Insurance products |
More liberal - limited to firm and "covered persons" |
An accountant's independence is impaired whenever the accounting firm, any covered person in the firm, or any immediate family member of a covered person holds any individual insurance policy originally issued by an insurer that is an audit client or an affiliate of an audit client. Additionally, an accountant's independence is impaired if the audit firm obtains professional liability coverage from an audit client or its affiliate. |
24, 76 |
2-01(c)(1)(ii)(G) |
Investment companies |
Unchanged - clarified |
An accountant or the firm is not independent if the accountant or firm invests in or is in a position to influence an audit of any entity in an investment company complex if the audit client is also an entity or fund included in that investment company complex.
|
25, 76 |
2-01(c)(1)(iii) |
Exceptions: |
New, more liberal provisions |
|
25, 76 |
2-01(c)(1)(iii)(A) |
Inheritance and gift |
More liberal than existing rule |
An accountant's independence will not be impaired if any person acquires a financial interest through an unsolicited gift or inheritance that would cause the accountant to be not independent under (c)(1)(i) or (c)(1)(ii), and the financial interest is disposed of as soon as practicable, but no longer than 30 days after the person has the right to dispose of such interest. |
25, 76 |
2-01(c)(1)(iii)(B) |
New audit engagement |
More liberal than existing rule |
Allows accounting firms to bid for and accept new audit engagements, even if a person has a financial interest that would cause the accountant to not be independent under the financial relationship rules. This exception is available to an accountant so long as the accountant did not audit the client's financial statements for the immediately preceding fiscal year, and the accountant was independent before the earlier of either accepting the engagement to provide audit, review, or attest services to the audit client; or commencing any audit, review, or attest procedures (including planning the audit of the client's financial statements). |
26, 76 |
2-01(c)(1)(iv) |
Audit Clients' Financial Relationships |
Unchanged |
An accountant is not independent when its audit client has invested, or otherwise as a financial interest in the accounting firm or an affiliate of the accounting firm. |
26, 76 |
2-01(c)(1)(iv)(A) |
Investments by the audit client in the accountant |
Unchanged |
An accountant's independence is impaired with respect to an audit client when the audit client or an affiliate of an audit client has, or has agreed to acquire, any direct investment in the accounting firm or its affiliate, whether in the form of stocks, bonds, notes, options, or other securities. |
27, 76 |
2-01(c)(1)(iv)(B) |
Underwriting |
Unchanged |
Were an audit client or an affiliate of an audit client to act as underwriter of an accounting firm or its affiliate's securities, the accounting firm would not be independent with regard to its client underwriter. |
27, 77 |
2-01(C)(2) |
Employment Relationships |
Basic features same - Modernization incorporates more liberal provisions |
When an accountant is either employed by an audit client, or has a close relative or former colleague employed in certain positions at an audit client, the accountant might not be capable of exercising the objective and impartial judgment that is the hallmark of independence. Accountants should not assume that all employment relationships not specifically described in (c)(2)(i) through (c)(2)(iv) do not impair independence. All non-specified employment relationships are subject to the general test of paragraphs (b) and (c)(2). |
28, 77 |
2-01(c)(2)(i) |
Employment at audit client of accountant |
Unchanged |
To be independent, neither the accountant nor any member of his or her firm can be a director, officer, or employee of an audit client. Similarly, an accountant is not independent if any current partner, principal, shareholder, or professional employee of the accounting firm is employed by the audit client or an affiliate of an audit client, or serves as a member of the board of directors or similar management or governing body of the audit client or an affiliate of the audit client
|
28, 77 |
2-01(c)(2)(ii) |
Employment at audit client of certain relatives of accountant. |
Modernization incorporates more liberal provisions - clarifies prohibitions - covered persons, prohibited positions and influence |
Family members of the auditor whose employment in certain positions by an audit client or its affiliate will impair the auditor's independence. Similarly, the covered person's spouse, spousal equivalent, dependents, parents, nondependent children, and siblings -- are attributed to the covered person in the firm. An audit client's employment of even a close family member will not impair an auditor's independence unless that family member is in a position to, or does, influence the preparers or the contents of the accounting records or financial statements of the audit client or its affiliate. These positions include: a member of the audit client's board of directors (or similar management or governing body), chief executive officer, president, chief financial officer, chief operating officer, general counsel, chief accounting officer, controller, director of internal audit, director of financial reporting, treasurer, vice president of marketing, or any equivalent position. Note also, the proposed rule eliminates the so-called "five hundred mile rule." |
29, 77 |
2-01(c)(2)(iii) |
Employment at audit client of former employee of accounting firm |
Modernization incorporates more liberal provisions - clarifies prohibitions, influence, capital balance in firm, unfunded or beneficial financial arrangement with firm |
An accountant's independence will be impaired by an audit client's employment of a former partner, shareholder, principal, or professional employee of the accounting firm, if the individual in an accounting or financial reporting oversight role at an audit client or an affiliate of an audit client However, independence will not be impaired if certain steps are taken to disassociate the individual from the firm. Under the proposed rules, the former partner, shareholder, principal, or professional employee must not: (i) influence the firm's operations or financial policies, (ii) have a capital balance in the firm, or (iii) have a financial arrangement with the firm, other than a fully-funded, fixed payment retirement account. Under certain conditions, use of a "rabbi trust" as a mechanism to make fixed retirement payments to a former partner or employee of the accounting firm would not impair an accountant's independence. |
30, 77 |
2-01(c)(2)(iv) |
Employment at accounting firm of former employee of audit client |
More liberal - incorporates "influence" provision |
Independence is impaired when a former officer, director, or employee of an audit client or an affiliate of an audit client becomes a partner, shareholder or principal of the accounting firm. Independence would not be impaired if the former employee does not participate in and is not in a position to influence the audit of the financial statements of the audit client or its affiliate for any period during which he or she was employed by or associated with that audit client or its affiliate. |
31, 77 |
2-01(c)(3) |
Business Relationships |
More liberal - stringent requirements limited to firm and "covered persons" - includes audit client affiliate and 5% ownership rule |
An accountant's independence, with respect to an audit client, is impaired when the accounting firm, or a covered person in the firm, has a direct or material indirect business relationship with an audit client, an affiliate of an audit client, or either of their officers, directors, or shareholders holding five percent or more of the audit client's equity securities. An accountant's independence is not impaired solely because the accountant has a business relationship with the audit client in which the accountant provides professional services to the audit client except for those specified in rule 2-01(c)(4) or acts as "a consumer in the ordinary course of business." An accountant acts as a "consumer in the ordinary course of business" when the accountant buys "routine" products or services on the same terms and conditions that are available to the seller's other customers or clients. An accountant is not acting as a "consumer" if it resells the client's products or services. Likewise, a purchase is not "in the ordinary course of business," nor is the product "routine," if it is significant to the firm or its employees. |
32, 77 |
2-01(c)(4) |
Non-Audit Services |
Basic principles are unchanged - incorporates clarification of four guiding principles of 2-01(b) |
Independence requirements apply to "any professional employee involved in providing [on behalf of an accounting firm] any professional service" to an audit client. Consideration will be given to "all relevant circumstances, including evidence bearing on all relationships between the accountant and [the client]." Does not govern non-audit services when provided to persons other than audit clients. The rule does not provide an all-inclusive list of the services that are incompatible with proposed rule 2-01(b). Whether the provision of a non-audit service not specified in the proposed rule impairs an accountant's independence will be measured against the four general principles set forth in proposed rule 2-01(b). |
33, 77 |
2-01(c)(4)(i)(A) |
Bookkeeping or other services related to the audit client's accounting records or financial statements |
Unchanged, more clearly defined |
An accountant's independence is impaired if the accountant provides bookkeeping or other services related to an audit client or an audit client's affiliate's accounting records or financial statements involving:
Because there may be bookkeeping tasks that do not involve financial information or that do not otherwise need to be considered in the audit, the definition is narrowed to services involving maintaining or preparing the audit client's or its affiliate's accounting records or financial statements, or generating financial information to be disclosed by the audit client, or its affiliate, to the public. |
33, 78 |
2-01(c)(4)(i)(B) |
Financial information systems design and implementation |
Unchanged, more clearly defined |
An accountant is not independent if the accountant designs or implements a hardware or software system that is or will be used to generate information that is significant to the audit client's financial statements taken as a whole. "Significant" refers to information that is reasonably likely to be material to the financial statements of the audit client or its affiliate. Since materiality determinations cannot be made before financial statements are generated, the accounting firm by necessity will need to evaluate the general nature of the information rather than only system output during the period of the audit engagement. The proposed rule would not, however, cover services in connection with the assessment, design, and implementation of internal accounting and risk management controls. |
35, 78 |
2-01(c)(4)(i)(C) |
Appraisal or valuation services, fairness opinions, or contributions-in-kind reports |
Unchanged |
The accountant is not independent if the accountant provides appraisal or valuation services, fairness opinions or contribution-in-kind reports, where there is a reasonable likelihood that the results will be audited by the accountant. The proposal does not prohibit an accounting firm from providing such services for non-financial (e.g., tax) purposes. |
35, 78 |
2-01(c)(4)(i)(D) |
Actuarial services |
Unchanged, more clearly defined |
The accountant is not independent if the accountant provides any advisory service involving the determination of policy reserves and related accounts for the audit client or its affiliate, unless the audit client uses its own actuaries or third-party actuaries to provide management with the primary actuarial capabilities. |
36, 78 |
2-01(c)(4)(i)(E) |
Internal audit outsourcing |
Unchanged, more clearly defined |
An accountant is not independent when the accountant performs certain internal audit services for an audit client or an affiliate. This does not include nonrecurring evaluations of discrete items or programs that are not in substance the outsourcing of the internal audit function. It also does not include operational internal audits unrelated to the internal accounting controls, financial systems, or financial statements. |
37, 78 |
2-01(c)(4)(i)(F) |
Management functions |
Unchanged |
An accountant's independence is impaired with respect to an audit client for which the accountant acts, temporarily or permanently, as a director, officer, or employee of an audit client, or an affiliate of the audit client, or performs any decision-making, supervisory, or ongoing monitoring functions. |
37, 78 |
2-01(c)(4)(i)(G) |
Human resources |
Unchanged |
An accountant's independence is impaired with respect to an audit client when the accountant recruits, hires, or designs compensation packages for, officers, directors, or managers of the audit client or its affiliate of the audit client's management or organizational structure; developing employee evaluation programs; or conducting psychological or other formal testing of employees. |
38, 78 |
2-01(c)(4)(i)(H) |
Broker-dealer, investment advisor, or investment bank services |
Unchanged |
An accountant is not independent if the accountant acts as a securities professional for an audit client or an affiliate of the audit client, such as a broker-dealer, promoter, underwriter, analyst of the audit client's or an affiliate of the audit client's securities, investment advisor, or in any capacity recommending the purchase or sale of an audit client's or an affiliate of an audit client's securities, or designing the audit client or an affiliate of the audit client's system to comply with broker-dealer or investment adviser regulations. . |
39, 78 |
2-01(c)(4)(i)(I) |
Legal services |
Unchanged |
An accountant is not independent of an audit client if the accountant provides any service to the audit client or its affiliates that, in the jurisdiction in which the service is provided, may be provided only by someone licensed to practice law. |
40, 79 |
2-01(c)(4)(i)(J) |
Expert services |
Unchanged |
An accountant's independence is impaired as to an audit client if the accountant renders or supports expert opinions for the audit client or an affiliate of the audit client in legal, administrative, or regulatory filings or proceedings ("expert services"). The proposal would not prohibit an accountant from testifying as a fact witness to its audit work for a particular audit client. |
41, 79 |
2-01(c)(4)(i)(J)(i) |
Tax services |
Unchanged |
The proposed rule would not affect tax-related services provided by accountants to their audit clients. Consideration is being given however, as to whether special considerations apply when the auditor provides a tax opinion for the use of a third party in connection with a business transaction between the audit client and the third party. |
41-43 |
Request for comment on alternative proposals for non-audit service rules: |
a. Prohibit non-audit services
| ||
43, 79 |
2-01(e) |
Transition |
For comment |
Two years:
|
44, 79 |
2-01(c)(5) |
Contingent fees |
Change - consistent with current AICPA Code of Conduct Rule - includes affiliates of audit clients |
An accountant is not independent under the standard of paragraph (b) of the rule if the accountant provides any service 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. Consistent with the AICPA Rule, however, the proposed definition of "contingent fees," in proposed rule 2-01(f)(12), contains an exception for fees that are fixed by courts or by federal, state, or local governments. |
45, 79 |
2-01(d) |
Quality controls, Elements of the proposed quality control system: |
New - conditions for limited exception for certain independence impairments |
The proposed rules establish a limited exception for accounting firms that maintain certain quality controls and satisfy certain conditions when a particular accountant did not know, and was reasonable in not knowing, the circumstances giving rise to the impairment of independence. In certain situations an accounting firm's independence will not be impaired if:
|
46, 79 |
2-01(d)(i) |
1. Written independence policies and procedures |
New |
The largest firm's independence policies and procedures must be reduced to writing, be comprehensive and cover all professionals in the accounting firm, and address all aspects of independence, including financial, employment, and business relationships, and fee arrangements. |
46, 79 |
2-01(d)(ii) |
2. Automated systems |
New |
Large firms must have automated systems to identify financial relationships that may impair independence. The system must be updated on a regular basis and allow employees to post their investments to the system. The system, would maintain a list of employee holdings and check them against a current list of clients. |
46, 79 |
2-01(d)(iii) |
3. Training |
New |
Large firm quality controls also must include annual or ongoing firm-wide training about accountant independence. This training should be designed to raise awareness and understanding of the applicable rules. Each professional in a large accounting firm should be able to demonstrate a minimum level of competence with respect to professional standards, legal requirements, and firm policies and procedures. |
46, 79 |
2-01(d)(iv) |
4. Internal inspection and testing |
New |
To qualify for the limited exception, large firms must monitor compliance by their firm, their firm partners and their firm professional employees with the applicable independence rules of the profession, standard setters, and other regulatory bodies. This would entail procedures to audit, on a test basis, the completeness and accuracy of information submitted by employees and partners, and information in a client investment database. |
47, 79 |
2-01(d)(v) |
5. Notice of names of senior management responsible for independence |
New |
With respect to large firms, that all firm members, officers, directors, and employees be notified of the name and title of the member of senior management responsible for compliance with the independence requirements. |
47, 79 |
2-01(d)(vi) |
6. Prompt reporting of employment negotiations |
New |
A firm professional would not be independent if he or she were to audit a client while simultaneously negotiating employment with that client. The quality control system of a large firm, therefore, would contain written policies and procedures to require firm professionals to report promptly to the firm as soon as they begin employment negotiations with an audit client. The large firm also would have appropriate procedures in place to remove any such professional from that audit client's engagement immediately and to review that professional's work related to that client. |
47, 80 |
2-01(d)(vii) |
7. Disciplinary mechanism |
New |
Large firms' quality control systems also have a disciplinary mechanism for enforcement |
47, 80 |
2-01(e) |
All relevant circumstances |
Unchanged |
All relevant circumstances in making independence determinations, including all relationships between the accountant and the audit client or its affiliates will be considered. Considerations will not be limited to the relationship between the audit client and the corporate entity whose name appears on the audit client's filing. |
48, 80 49 |
240.14a(101) |
Proxy disclosure requirement
|
Reinstatement of requirement in place from 1978-82, and additional disclosure requirements |
The proposal would require companies to: (i) describe specifically each professional service provided by its accountant, and (ii) indicate whether the company's audit committee or, where no such committee exists, board of directors approved the service and considered the effect that the provision of each disclosed service could have on the accountant's independence.
|
|
Historical Perspective of the Profession's Code of Conduct by Douglas R. Carmichael Sec. File No. S 17/13/00 | ||
| I. | Eras in the Development of a Professional Code | |
| A. | 1917 to 1961 - Individual Rules of Conduct | |
| B. | 1962 to 1972 - Code of Professional Ethics | |
| C. | 1973 to 1987 - [New] Code of Professional Ethics | |
| D. | 1988 to 1999 - Code of Professional Conduct | |
| II. | Evolution of the Concept of Independence in the Profession's Standards | |
| A. | Chronological Low and High Points in the Evolution | |
| B. | Academic and Regulator Critics' Challenges to the Profession's Concept of Independence | |
| III. | Challenges to the Profession's Prohibition of Competitive Practices | |
| A. | Initial Challenge on Competitive Bidding | |
| B. | Final Challenge to Traditional Beliefs on Competitive Practices | |
| IV. | Technical Standards Enforcement and Ethics Requirements | |
| A. | Early Ethics Coverage of Technical Standards | |
| B. | Ethics Requirements for Compliance with AICPA Pronouncements | |
| V. | Form of Practice | |
| A. | Early Ethics Coverage | |
| B. | New Era on Form of Practice | |
| VI. | Reflections on the History of the Code | |
| A. | What is a Profession? | |
| B. | Why Does a Profession Have a Code? | |
| C. | How Does a Code Differ from Personal Ethics of Members? | |
| D. | What is the Relation of a Code to the Public Interest? | |
| E. | What Does the History of the Code Tell Us? | |
|
Historical Perspective of the
Profession's Code of Conduct by Douglas R. Carmichael | ||||||
| I. | Eras in the Development of a Professional Code | |||||
| A. | 1917 to 1961 - Individual Rules of Conduct | |||||
| 1. | The new Institute of Accountants in the United States of America, formed in 1916, had 8 rules adopted by Council in April 1917. The rules covered the following matters. | |||||
| a. | Use of title "Members of American Institute of Accountants." | |||||
| b. | Certification of financial statements containing essential misstatements of fact or omissions. | |||||
| c. | Practice by others in name of a member [fronting]. | |||||
| d. | Commissions or brokerages to or from the laity [fee-splitting]. | |||||
| e. | Occupations incompatible with the practice of public accounting. | |||||
| f. | Certification of statements not prepared under satisfactory supervision. | |||||
| g. | Notice to Institute of participation in efforts to secure legislation. | |||||
| h. | Solicitation of clients of other members. | |||||
| 2. | By the time of merger of the AIA with the American Society of Certified Public Accountants in 1936, the Council had adopted four additional rules: | |||||
| a. | Offers of employment to employees of fellow members. (1919) [Pirating] | |||||
| b. | Contingent fees.(1919) | |||||
| c. | Advertising. (1918 and 1922) | |||||
| d. | Participation in activities of schools whose promotional methods or activities were discreditable to the profession. (1929) | |||||
| 3. | Council supplemented these rules with the following resolutions that had less force than the rules. | |||||
| a. | Audit companies and similar organizations were detrimental to the interests of the profession. (1919) | |||||
| b. | Public accountants should not permit their names to be used in conjunction with estimates of future earnings in a manner that might suggest vouching for the accuracy of the forecast. (1931) | |||||
| c. | No member should certify financial statements of any enterprise financed in whole or in part by the public distribution of securities if he were himself the actual or beneficial owner of a substantial financial interest in the enterprise or was committed to acquire such an interest. (1934) | |||||
| d. | Competitive bidding for professional engagements was contrary to the best interests of clients, the public, and the profession. (1934) | |||||
| 4. | Council adopted and enforced the rules. | |||||
| a. | Council voted on rules proposed by the ethics committee. | |||||
| b. | Not until 1941 was the process changed to require a mail ballot of members to amend, repeal or approve rules and two-thirds majority of members voting to achieve the change. (Members at an annual meeting took Council's powers away.) | |||||
| c. | Council sat as a trial board to hear charges preferred against members by the ethics committee. | |||||
| d. | Rules and resolutions were adopted in reaction to notorious instances of misconduct or widespread instances of conduct that embarrassed or humiliated the membership. (For example, the rule on proprietary schools resulted from the trial of a member associated with a school whose activities had been the subject of a complaint.) | |||||
| 5. | John Carey (staff director of the AIA) and crafter-in-chief of the rationalization of the rules of conduct summarized the 16 rules in effect in 1955 as follows: | |||||
| a. | Professional Attitude (Firm name style and description; corporate practice; incompatible occupations; conduct of related occupations; advertising; solicitation; competitive bidding; offers of employment). | |||||
| b. | Confidence of Clients (confidential relationship, splitting fees; fronting; use of name). | |||||
| c. | Confidence of Third Parties (conformity with GAAP and auditing requirements; contingent fees, vouching for forecast accuracy; no substantial financial interest in public audit client). | |||||
| B. | 1962 to 1972 - Code of Professional Ethics | |||||
| 1. | An overhaul of rules begun in 1956 resulted in a codification of rules including references to formal opinions of the ethics committee in 1962. | |||||
| a. | Called for the first time the "Code of Professional Ethics." | |||||
| b. | Beginning with a brief preamble and grouped under five main headings | |||||
| 1) | Relations with clients and public | |||||
| 2) | Technical standards | |||||
| 3) | Promotional practices | |||||
| 4) | Operating practices | |||||
| 5) | Relations with fellow members | |||||
| The new code codified the existing rules in rational groups. | ||||||
| 2. | Prior rules were for the practice of public accounting, but applicability to tax services and consulting services was not clear. | |||||
| a. | In 1933 a Council resolution clarified that the rules against contingent fees did not apply to tax practice. | |||||
| b. | In 1957 a rule was adopted to the effect that a member should not permit an employee to perform for clients any services the member was not permitted to perform. This rule was aimed at CPA firms who employed lawyers as members of their tax departments, but had broader applicability. | |||||
| c. | In separate opinions in 1962 the ethics committee took the position that except for those rules that were solely applicable to the expressions of opinion on financial statements the Code of Ethics applied to tax services and management services. | |||||
| C. | 1973 to 1987 - [New] Code of Professional Ethics | |||||
| 1. | In 1968 the ethics committee began an effort to restate the ethical code that was to be focused on affirmative goals rather than negative rules. | |||||
| 2. | In 1969 the ethics committee redirected the effort to emulate the American Bar Association's restatements of ethics. A special committee headed by Wallace Olson undertook to develop - | |||||
| a. | A relatively few general principles of ethics in essay form explaining the rationale for appropriate behavior. | |||||
| b. | Minimum requirements under the related general principles. | |||||
| 3. | In March 1973 by mail ballot of the membership a new code was approved with the following key features - | |||||
| a. | A forepart "concepts of professional ethics" that explained the underlying philosophy for the rules of professional conduct that followed. | |||||
| b. | An explicit recognition that two of the rules - relating to integrity and objectivity and to discreditable acts - were applicable to members both within and outside public practice. | |||||
| c. | An explicit recognition that all the rules except those that by their wording applied only to expressing an opinion on financial statements were applicable to all services provided by members in public practice. | |||||
| d. | Rules that explicitly required members to comply with AICPA pronouncements on GAAS and accounting principles promulgated by bodies designated by Council. (A declaration of intent that the AICPA would enforce technical standards, including particularly GAAP and GAAS.) | |||||
| e. | No rules on competitive bidding as a result of a consent decree entered in 1972. | |||||
| 4. | Beginning in 1977 the Department of Justice and Federal Trade Commission attacked the rules against unprofessional competitive practices. | |||||
| D. | 1988 to 1999 - Code of Professional Conduct | |||||
| 1. | A 1984 report by an AICPA special committee (the Anderson Committee) proposed a new approach to ethical and technical standards, including an update of ethics rules. | |||||
| 2. | In January 1988 the membership adopted a new code with the following key features. | |||||
| a. | Called a "Code of Professional Conduct." | |||||
| b. | Consisting of a Principles section that provides a framework and a Rules section. | |||||
| c. | The Rules section is enforceable and applies to all AICPA members - in public practice, in industry, in government, and in education. | |||||
| d. | The Rules contain no prohibitions again unprofessional competitive practices. | |||||
| II. | Evolution of the Concept of Independence in the Profession's Standards | |||||
| A. | Chronological Low and High Points in the Evolution | |||||
| 1. | 1931 - 1932 - Frederick Hurdman addressed relations between client and accountant and proposed a prohibition against acting as an auditor and as a director or officer of a corporation. Action was deferred. Next year the ethics committee introduced a similar resolution. It was defeated. | |||||
| 2. | 1933 - The Securities Act of 1933 required certification of financial statements by "an independent public or certified accountant." Federal Trade Commission regulations stated an accountant would not be considered independent with respect to any registrant in which the accountant had any interest, direct or indirect, or with which the accountant was connected as an officer, agent, employee, promoter, underwriter, trustee, partner, director, or person performing a similar function. Subsequent regulations changed the prohibition to any substantial interest, direct or indirect. | |||||
| 3. | 1934 - Council adopted a resolution (not rule) against certifying financial statement of a public audit client in which a member had a substantial financial interest. (Even Carey noted this seemed to some to be only an echo of the SEC requirements.) | |||||
| 4. | 1937 - The SEC in an ASR defined a substantial financial interest as 1% of a CPA's personal fortune. | |||||
| 5. | 1941 - The Council resolution of 1934 was adopted as a rule. | |||||
| 6. | 1947 - Independence was adopted by the membership at an annual meeting as one of the generally accepted auditing standards. The special report of the committee on auditing procedure contains the following matters of note. | |||||
| a. | Independence was described as involving "complete intellectual honesty," "an honest disinterestedness" in the formulation and expression of an opinion, and "unbiased judgment and objective consideration of facts as the determinants of that opinion." | |||||
| b. | Independence was said to imply an attitude of "judicial impartiality that recognizes an obligation... for a fair presentation of facts which [the auditor] owes not only to the management and owners of the business (generally in these days, the holders or equity securities of a corporation) but also to the creditors of the business, and to those who may otherwise have a right to rely (in part, at least) upon the auditor's report, as m the case of prospective owners or creditors. | |||||
| c. | The committee noted that there had arisen "a quest for signs - signs by which any lack of independence might be recognized," and referred to the AIA rules of professional conduct as precepts to guard against the presumption of loss of independence. | |||||
| d. | Five rules were cited as presumptions of professional law for the auditor: False or misleading financial statements; contingent fees; financial interest in clients' business; commissions and brokerage; incompatible occupations. | |||||
| e. | The implication of the discussion was that these presumptions were not generally rebuttable. | |||||
| f. | Further development of the concept of independence in the auditor's mental attitude and approach was deferred to future committee deliberations. (However, that did not happen and development of independence was left to the ethics committee.) | |||||
| 8. | 1952 - Mr. E. B. Wilcox in a chapter in the CPA Handbook expressed the following views. | |||||
| a. | Independence is an essential auditing standard because the opinion of the independent accountant is furnished for the purpose of adding justified credibility to financial statements which are primarily the representations of management. If the accountant were not independent of the management or his clients, his opinion would add nothing. | |||||
| b. | Those who rely on the credibility he furnishes are apt to be creditors or investors, or sometimes employees, customers, or governmental agencies. It is for their assurance that the independent expert opinions are provided, and the accountant incurs a profoundly professional obligation to this unseen audience even though he does not know who they are. | |||||
| 9. | 1952 - The ethics committee considered the adequacy of coverage of independence in the rules of conduct. | |||||
| a. | The only rule was limited to the question of financial interest. | |||||
| b. | There was no general guidance on the concept of independence. | |||||
| However, no action was taken. | ||||||
| 10. | 1954 - The Illinois Society of CPAs made any financial interest, direct or indirect, in any client organization an impairment of independence. | |||||
| 11. | 1959 - Andrew Barr, Chief Accountant of the SEC, chastised the Institute for its double standard on financial interest which applied only to public clients. | |||||
| 12. | 1960 - Thomas Higgins, chairman of the ethics committee supported a proposed rule to prohibit a member from expressing an opinion on financial statements if the member was connected with the client by holding a director or officer position or by having a direct financial interest or material indirect financial interest. The annual meeting voted to defer the proposal. (Carey noted that negative press coverage was a humiliation to many members.) | |||||
| 13. | 1961 - The annual meeting adopted the proposal and it was approved in a mail ballot of the membership. The new rule had the following features: | |||||
| a. | Independence in fact was required with respect to the enterprise when expressing an opinion on the financial statements of the enterprise. | |||||
| b. | An auditor had a responsibility before expressing an opinion to assess relationships with the enterprise to determine whether, in the circumstances, the auditor would expect the opinion to be considered independence, objective, and unbiased by one who had knowledge of all the facts. | |||||
| c. | An auditor would be considered to be not independent if the auditor or any partners had a direct financial interest or material indirect financial interest or was connected with the enterprise in a capacity such as a director, officer, or key employee. | |||||
| d. | The examples concerning financial interest and employee-type relationships were said to be not all inclusive. | |||||
| 14. | 1961 - The ethics committee followed adoption of the new rule with Opinion 12 (similar to current interpretations). | |||||
| a. | It defined relationships that should be avoided as those which to a "reasonable observer" who had knowledge of all the facts might suggest a "conflict of interest" that might impair the auditor's objectivity. | |||||
| b. | Normal professional or social relationships, it observed, would not suggest a conflict of interest in the mind of a reasonable observer. | |||||
| c. | It endorsed the statement that independence is a state of mind, but stated "the committee recognizes it is of utmost importance to the profession that the public generally shall maintain confidence in the objectivity of [CPAs] in expressing opinion on financial statements. In maintaining this public confidence, it is imperative to avoid relationships which may have the appearance of a conflict of interest. | |||||
| d. | It attributed the prohibition against any financial interest or service as an officer or director of audit clients to this reasoning concerning avoiding the appearance of a conflict of interest. | |||||
| e. | It observed that the committee did not intend to suggest that rendering services other than audit services would suggest a conflict and summarized the committee's opinion "that there is no ethical reason why a member or associate may not properly perform professional services for clients in the areas of tax practice or management advisory services, and at the same time serve the same client as independent auditor, so long as he does not make decisions, or take positions which might impair that objectivity." | |||||
| 15. | 1973 - The new code of professional ethics made subtle changes to the treatment of independence. | |||||
| a. | Rule 101 required that a member or member's firm not express an opinion unless the member and firm "are independent with respect to the enterprise." The rule stated that "Independence will be considered to be impaired" if there were financial interests or connections with the enterprise in a capacity equivalent to management or employee. | |||||
| b. | The new rule thus dropped the explicit emphasis on being in fact independent and removed the explicit duty to assess relationships and consider whether independence would be considered to be impaired. | |||||
| c. | The same basic types of relationships were prohibited, but coverage of prohibited financial interests was more detailed. For example, a prohibition against loans to or from clients or officers of clients was explicitly incorporated in the rule. | |||||
| d. | The concepts essay included the following principle: "A certified public accountant should maintain his integrity and objectivity and, when engaged in the practice of public accounting be independent of those he serves." | |||||
| e. | The concepts essay defined independence as follows:
"Independence has traditionally been defined by the profession as the ability to act with integrity and objectivity." | |||||
| f. | The concepts essay stated the following criterion for the exercise of collective professional judgment: "In establishing rules relating to independence, the profession uses the criterion of whatever reasonable men, having knowledge of all the facts and taking into consideration normal strength of character and normal behavior under the circumstances, would conclude that a specified relationship between a CPA and a client poses an unacceptable threat to the CPA's integrity or objectivity." | |||||
| g. | The prohibited relationships of "certain financial relationships" and "relationships in which a CPA is virally part of management or an employee under management's control" are described in the essay as relationships that pose a threat to integrity and objectivity as to exceed the strengths of countervailing forces and restraints. | |||||
| h. | The essay endorses the point that "when a CPA expresses an opinion on financial statements, not only the fact but also the appearance of integrity and objectivity is of particular importance." | |||||
| i. | The essay notes that the appearance of independence is not required in the case of management advisory services and tax practice, but encourages avoidance of the proscribed relationships even in these circumstances. | |||||
| j. | The essay does not take a blanket position on whether particular services are or are not compatible with audit independence, but expresses doubt that a CPA would deliberately compromise integrity by expressing an unqualified opinion on financial statements that cover up a poor decision by the client on which the CPA has rendered advice. However, CPAs are admonished to avoid involvement in situations that would impair the credibility of their independence in the minds of reasonable men familiar with the facts. | |||||
| k. | Rule 102 on integrity and objectivity prohibits a member from knowingly misrepresenting facts and requires those in public practice to not subordinate judgment to others. | |||||
| 16. | 1988 - Further nuances and subtle changes are made to the concept of independence in the next new code. | |||||
| a. | New Rule 101 on independence applies only to a member in public practice and requires independence only when standards promulgated by bodies designated by Council require independence in the performance of a professional service. Thus, any requirement to be independent in fact must be within those standards as it is within GAAS. | |||||
| b. | The old Rule 101 prohibitions against financial interests and virtually being part of management are moved t6 Interpretation 101 - 1. The prohibitions are stated as examples of transactions, interests, or relationships that shall cause independence to be considered to be impaired. | |||||
| c. | New Rule 102 on integrity and objectivity applies to all members in the performance of any professional service. | |||||
| d. | The Articles in the Principles section of the code include one on integrity and one that combines coverage of objectivity and independence. | |||||
| e. | The Article on objectivity and independence provides that "a member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services." | |||||
| f. | There is also a separate Article on scope of services that requires observance of the other principles of the code in determining the scope and nature of services to be provided. | |||||
| B. | Acadeinic and Regulator Critics' Challenges to the Concept of Independence and the Profession's Response | |||||
| 1. | 1960 - Tom Wise writing in Fortune ("The Auditors Have Arrived") said:
"The management services business has burgeoned in the accounting profession during the past few years. Many accountants find it confusing and hard to justify, but others consider it a logical and lucrative extension of what they have been doing in the financial field all along.
"In effect, the auditors are going into competition with management consultants." | |||||
| 2. | 1961 - What is generally regarded as the first widely publicized criticism of management services as an impairment of independence was in Philosophy of Auditing by Mautz and Shara£ | |||||
| a. | The authors developed a concept of independence with two components. | |||||
| 1) | Practitioner-independence | |||||
| 2) | Profession-independence | |||||
| b. | They suggested that management services created such a significant mutuality of interest between the consultant and the client that the impartiality necessary for auditing was endangered and that an auditor would not appear completely independent to alert intelligent outsiders. | |||||
| c. | They recommended a separation between auditors and consultants within a firm. Audit partners and staff would have no involvement in soliciting, performing, or collecting for consulting services. | |||||
| 3. | 1965 - Arthur A. Schulte, Jr., in an article in the Accounting Review reported the results of a mail survey focused on the compatibility of management consulting and auditing. | |||||
| a. | Ml classifications of third parties (analysts, loan officers, and investment officers) split approximately 67% to 33% on the issue, i.e. 33% believed management consulting has serious implications for audit independence (except those in the largest banks and brokerage house of whom only 17% saw a problem). | |||||
| b. | MCPA, representatives criticized Shulte's use of the term consulting which they characterized as emotionally charged and in general nit picked his questions for failing to specify the types of services performed. | |||||
| 4. | 1966 - Abraham Briloff in another article in the Accounting Review used the term management services and specified types of services. | |||||
| a. | Briloff's findings showed that over 50% of financial community respondents believed management services and auditing were incompatible. | |||||
| b. | Briloff had met all the criticisms the AICPA leveled at Schulte, but the AICPA pursued a new path of attack. Many of the specific services he cited, they charged, were likely to appear to third party observers as unrelated to accounting and auditing and, thus, outside a CPA's expertise. | |||||
| 5. | 1966 - Manuel F. Cohen (then chairman of the SEC) spoke at the AICPAs annual meeting. | |||||
| a. | He cautioned CPAs about performing services, such as market surveys, factory layout, psychological testing, and executive recruiting, that could not be related logically to the financial reporting process or to information and control systems broadly defined. | |||||
| b. | He expressed the view that these types of services raised serious questions concerning audit independence and suggested that pursuit of these activities could undermine the audit function. | |||||
| 6. | 1967/1968 - The AICPA focused on the issue at its annual meeting. Shulte made a presentation of his study and Malcolm Devore reported on the results in a study by the committee he headed that had been appointed to look into the matter. | |||||
| a. | The Devore committee found no evidence that performing management services had ever impaired independence in fact, but acknowledged that some third parties believed that such services created an appearance of lack of independence. | |||||
| b. | The Devore committee acknowledged Mr. Cohen's views, but said it could find no sound rationale for identifying how specific services might impair independence. The committee also noted that these services, e.g. psychological testing, were performed by relatively few firms and were a very minor part of their practice. | |||||
| c. | The Devore committee observed that services not related to the types of work the public associated with accountants might seem strange or inappropriate, but did not believe this justified prohibiting these services. | |||||
| d. | The Devore committee also observed that there was not sustained interest from any quarter in pursuing the inquiry and the AICPA concluded the issue was best dealt with on a case-by-case basis rather than by the development of more definitive criteria for determining whether specific services impaired independence. | |||||
| 7. | 1978 - The Cohen Commission reviewed the management services controversy and the attention to the topic by AICPA committees and academics in the ten year period since the Devore committee's initial conclusions. | |||||
| a. | It carefully reviewed charges by Briloff that there were indeed instances in which management services impaired audit independence. It agreed with Briloff that the Westec case was a case in which the performance of consulting services impaired independence. | |||||
| b. | Westec involved providing merger and acquisition consulting, including participation in the acquisition program and structuring of transactions to ensure that the desired accounting treatment was achieved. It is worth emphasizing that all subsequent coverage of this topic by AICPA committees, POB committees, and others have strived to ignore this finding. | |||||
| c. | The Cohen Commission also believed that there was a deplorable subordination of the audit fi3nction in the performance of a consulting engagement involving Yale Express. However, the Cohen Commission did not view this as supporting critics because it occurred after the audit. However, in retrospect it is clear evidence that consulting activities impaired the auditor's duty to third party users of audited financial statements. | |||||
| d. | The Cohen Commission concluded that accounting advocacy situations in which a CPA firm advocated a particular accounting treatment for a client before a regulatory body posed a great danger of impaired independence. It concluded that providing advice on accounting principles in general required professional standards to help preserve audit independence. The AICPA has diligently ignored the Cohen Commission's recommendations in this area. There are no professional standards on the incumbent auditor's provision of advice on applying accounting principles. Yet, there are significant instances in which auditors have been deeply involved in assisting clients to structure transactions to achieve particular accounting results and in which independence has been impaired. There are also clear examples in which auditors have advocated particular accounting treatments with regulators that have resulted in audit disasters. CPA firms interventions with FSLIC on the accounting for debt securities of savings and loans is a clear cut example. | |||||
| e. | The Cohen Commission questioned whether executive recruiting services for top management positions and certain actuarial services might impair independence. The AICPA Division for Firms SEC Practice Section has imposed restrictions in these areas. | |||||
| f. | The Cohen Commission, however, concluded the facts did not support a prohibition against specific services and recommended other measures to strengthen independence. | |||||
| g. | The other recommendations included greater board or audit committee involvement with the auditor. It suggested the auditor should take the lead in informing the board about the services provided, fees, and the relationship to audit responsibilities. | |||||
| 8. | 1979/1999 - From the public Oversight Board's Report "Scope of Services by CPA Firms" (1979) through the AICPA's White Paper to the Independence Standards Board (1997) there has been a great deal written, much churning activity, but no real change. | |||||
| a. | The 1979 POB report heralded the new proxy statement disclosure requirements imposed by the SEC in ASR 250. Chairman John J. McCloy thought the disclosures would remove the mystery surrounding the type and magnitude of certain services and provide a restraining influence on services generally perceived as being incompatible with professional stature. Alas, those disclosure requirements have come and gone with little lasting effect one way or the other. | |||||
| b. | There is throughout these materials the constant refrain that there has never been a single instance in which consulting practice has compromised audit independence. As explained earlier, this is not true. Further, even if there were many instances, they should not be expected to capture attention under current circumstances. Litigation is about proving liability, causation, and damages. Lack of independence itself is seldom raised as an issue without even considering trying to prove the motivation for lack of independence. | |||||
| c. | There is also throughout these materials little recognition of the valid and important distinction made by Mautz and Sharaf between practitioner-independence and profession-independence. The issue is not the appearance of independence of the individual CPA firm providing management services. The issue is the appearance of independence of auditors as a professional group. Transgressions of the individual CPA firm can bring harm to the professional group. It is not the case that the only possible harm is to the individual firm that appears to lack independence. | |||||
| III. | Challenges to the Profession's Prohibition of Competitive Practices | |||||
| A. | Initial Challenge on Competitive Bidding | |||||
| 1. | 1966 - The Department of Justice informed the AICPA that the ethics rule prohibiting competitive bidding would likely be deemed a restraint of trade. Shortly it obtained consent decrees related to similar rules of professional societies of engineers and architects. The AICPA based on advice of legal counsel had earlier announced it was not going to enforce the rule. | |||||
| 2. | 1971 - The Department of Justice began an investigation and requested all documents the AICPA had related to the rule on competitive bidding. | |||||
| 3. | 1972 - The AICPA was informed that the Department of Justice was prepared to litigate unless the AICPA entered a consent decree. Legal counsel advised the rule was almost certamly to be found to be a violation of federal antitrust laws. As a result of these developments, the new code under consideration in 1972 that was adopted in 1973 had no rule on competitive bidding. In May 1972 the AICPA entered a consent decree that enjoined any attempts to prohibit members from making fee quotations for professional services. | |||||
| 4. | 1973 - The new code had no rule on competitive bidding, but continued to prohibit advertising, solicitation, and other competitive practices that did not reflect the proper professional attitude. This professional attitude was considered essential to maintaining independence. For example, Carey had argued that soliciting an engagement put an auditor in a subordinate position to the client. | |||||
| B. | Final Challenge to Traditional Beliefs on Competitive Practices | |||||
| 1. | 1972-1976 - The Department of Justice pursued other professions for prohibition of competitive practices that were considered to be in violation of federal antitrust laws. For example, the legal profession's prohibition against advertising was successfully attacked. The AICPA leadership had been concerned since the 1972 consent decree that the AICPA code rules would not withstand challenge. The AICPA's consent decree on competitive bidding had essentially conceded that the accounting profession was subject to the antitrust laws. In fact, no private professional organizations were able to sustain an exemption from the federal antitrust laws. | |||||
| 2. | 1977 - The Department of Justice and The Federal Trade Commission began investigations on the accounting profession's ethics rules and entrance requirements that might be viewed as restricting competition. | |||||
| 3. | 1978 - After attempting modest changes to the rules designed to give up major restrictions on competition, but retain some limited restriction on uninvited solicitation of specific clients, the MCPA ultimately, on advice of legal counsel, submitted rules that removed most prior restrictions to Council. By a very narrow margin Council approved submission of the issue to the membership. | |||||
| 4. | 1979 - The membership approved repeal of rules prohibiting uninvited solicitation and offers of employment and substantial changes to prohibitions against advertising and incompatible occupations. For example, only advertising or solicitation that is false, misleading, or deceptive is prohibited. | |||||
| 5. | 1980 - All investigations of the accounting profession's anti-competitive restrictions were closed. Between 1972 and 1979 virtually all of the prohibitions against competitive practices had been repealed under threat of legal action. | |||||
| IV. | Technical Standards Enforcement and Ethics Requirements | |||||
| A. | Early Ethics Coverage of Technical Standards | |||||
| 1. | 1917 to 1968 - As early as 1929, there were rules that prohibited a member from giving an unqualified opinion when the member was aware of significant misstatements or omissions, or when the member or others directly under the members supervision had not done an audit. Ultimately, in 1940, there were rules that required report modification for departures from GAAP and from generally accepted audit procedures - there were only two such procedures, inventory observation and receivable confirmation. However, there were no requirements to conform with AICPA pronouncements on accounting principles or auditing standards and procedures. | |||||
| 2. | 1969 - The membership by mail ballot rejected a proposed rule that
required disclosure of departures from APB Opinions. The vote was
extremely close; the vote missed approval by approximately one-half of
one per cent.
AICPA officials maintained that little had changed because Council had declared APB Opinions constituted GAAP and there was a rule that required disclosure of GAAP departures. | |||||
| B. | Ethics Requirements for Compliance with MCPA Pronouncements | |||||
| 1. | 1973 - The new code contained two rules that explicitly required members to comply with AICPA pronouncements on GAAS and pronouncements on accounting by bodies designated by Council - the FASB, APB, and committee on accounting procedure. | |||||
| 2. | 1988 - The next new code repeated the 1973 rule on accounting principles, but the rule on compliance with GAAS was broadened to require that a member who performs auditing, review, compilation, management consulting, tax or other professional services shall comply with standards promulgated by bodies designated by Council. The AICPA tax division has never requested that its statements on responsibilities in tax practice be enforceable. | |||||
| V. | Form of Practice | |||||
| A. | Early Ethics Coverage | |||||
| 1. | 1919 - Council resolved that audit companies and similar organizations were detrimental to the profession's interests. | |||||
| 2. | 1938 - An ethics rule was adopted that prohibited members from affiliation with corporations engaged in accounting. | |||||
| 3. | 1958 - An ethics committee opinion was issued that held that a separate organization in which a member had an interest should not be permitted to do things the member was prohibited from doing, including advertising, solicitation, and practicing in the corporate form. | |||||
| 4. | 1967/1969 - Carey indicates that Marvin Stone in his term as president advocated modification of the rule on practice in the corporate form to provide protection against unlimited liability. Others were interested in tax advantages. Council approved an amendment that permitted corporate practice if certain requirements were met. For example, all owners had to be CPAs and if liability was limited there had to be liability insurance of $50,000 per owner up to a maximum of $2 million. | |||||
| 5. | 1972 - The first codified code had a section on operating practices that had several rules on form of practice. The permitted forms of organization were proprietorship, partnership, or professional corporation. The name of the organization could not include names of persons not practicing in the firm, but former partners names could be used. | |||||
| 6. | 1973 - The new code included a specific rule on form of practice and name. It explicitly stated what prior rules had implied that use of a fictitious name was prohibited. It also prohibited a name indicating specialization or that was misleading as to type of organization. | |||||
| B. | New Era on Form of Practice | |||||
| 1. | 1988 - The new code's rule on form of organization and name prohibits only use of a misleading firm name. The nearly 70 year ban on audit companies was lifted. | |||||
| 2. | 1994 - Council passed a resolution permitting some non-CPA ownership. A super majority (66 2/3%) of ownership in terms of financial interests and voting rights were required to belong to CPAs. A subsequent (1997) Council resolution revised the CPA ownership to a 51% majority to correspond with the Uniform Accountancy Act. | |||||
| 3. | 1999 - A new interpretation is issued dealing with alternative practice structures. The interpretation explains the application of independence requirements to non-traditional firm ownership structures in which a traditional form of CPA firm that performs attest services is closely aligned with another organization, public or private, that performs other professional services. | |||||
| VI. | Reflections on the History of the Code | |||||
| A. | What is a Profession? | |||||
| 1. | Exists to fulfill a definite service within society that requires a high degree of skill or knowledge. | |||||
| 2. | Holds as the first ethical imperative the desire for service - ideal of service. | |||||
| B. | Why Does a Profession Have a Code? | |||||
| 1. | To solve the ethical problem of reconciling the service ideal with the legitimate economic interests of its members. | |||||
| 2. | To provide a foundation for the confidence of those who rely on the service. | |||||
| C. | How Does a Code Differ From Personal Ethics of Members? | |||||
| 1. | Personal ethics is the subject of general theories of ethics. It is the focus of philosophical inquiry into the rational basis for right conduct. It is the concept of duty for duty sake. ("A man should be upright; not be kept upright." Marcus Aurelius as quoted in the 1973 Code.) | |||||
| 2. | Professional ethics is related to general ethics, but is more than a special application of general ethics. A professional code is an agency of social control. The goal of a profession's code is not to enable the individual members to live a proper life. The goal is to serve as a system of control. | |||||
| 3. | A profession's code describes the duties of members of the entire group toward those outside the group. [Carey (1966) described this as notifying the public that the profession will protect the public interest, i.e. that in return for the faith that the public places in the profession, the members of the profession accept the obligation to behave in a way that will benefit the public.] | |||||
| D. | What is the Relation of a Code to the Public Interest? | |||||
| 1. | Most organized professions have duties to clients and to the public. A lawyer has responsibilities to the court and the law as well as to individual clients. A doctor has responsibilities for public health as well as to individual patients. | |||||
| 2. | Poor management of duties to the public versus to actual clients can cause loss of respect for a profession. | |||||
| 3. | CPAs, by at least 1947, had adopted technical and ethical standards and accepted a legal obligation for responsibilities to parties other than actual clients. | |||||
| a. | The GAAS standard on independence adopted in 1947 explicitly recognized an obligation to creditors and to prospective owners and creditors. | |||||
| b. | The ethics rules lagged behind and only prohibited a substantial financial interest in a public audit client. | |||||
| c. | Nevertheless through GAAS, CPAs accepted "a profoundly professional obligation to this unseen audience..." (Wilcox, 1952) | |||||
| d. | Montgomery's Auditing (1975) describes the vital role of independence as follows "...avoid favoring an articulate, persuasive client who is at hand against a silent, impersonal public." | |||||
| E. | What Does the History of the Code Tell Us? | |||||
| 1. | Can the status of "trusted professional" be transferred to all services rather than the definite service of auditing that has been the historical service ideal? | |||||
| 2. | What has replaced the "professional attitude" component of the Code? | |||||
| 3. | What must be done to preserve the confidence of the public in the integrity and objectivity of CPAs as a professional group? | |||||