September 5, 2000
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N. W.
Washington D. C. 20549-0609
Re: Reference File No. S7-13-00
Revision of the Commission's Auditor Independence Requirements
Commissioner Levitt and Commissioners:
I appreciate the opportunity to provide my testimony concerning the proposed Revision of the Commission's Auditor Independence Requirements. The unprecedented and rapid pace of change that has taken place in the business world and the accounting profession over the last two or three decades has outgrown much of the relevance of the commission's long-standing regulations and guidance concerning auditor independence. The proposed rules are not only long over due but the relevance of the proposed rules to the changes needed are well directed. I commend Lynn and his staff for an exceptional job.
As Chairman of the National Association of State Boards of Accountancy, I can assure you the outcome of these proceedings is of considerable importance to the 54 state boards of accountancy responsible for licensing and regulating the practice of accountancy across the country. State boards of accountancy take seriously their responsibility of protecting the public interest and they have a keen understanding of the importance of the public's trust and confidence in the licensed accountant.
The stature and confidence the public places in our profession has been built up over the last century through the efforts of a great number of talented persons. These individuals have given through professional associations such as the AICPA, and regulatory bodies such as the SEC and state boards of accountancy, their time and talents to identify and establish a strong tradition of skills, competencies, methodologies, professional standards, and regulations that comprise the current day practice of accountancy. It has been a remarkable accomplishment.
What has been the key to this success? What have been the primary factors that have merited the public's trust and confidence? The profession's continuing faithful demonstration of adherence to the principles of, Integrity, Objectivity and Independence and, recognition that the publics' perception of the auditor's independence is as important as its reality.
Before I proceed I must make it clear, NASBA and its state boards have not taken an official position regarding the Commission's proposed independence requirements. So what I am about share with you are my personal views. They are nevertheless, I believe, consistent with NASBA's Core Values which I am including for your information as Attachment A.
Having said that, I would like to start my response to the Commission's proposal with some overview statements. First I would like to note that, I consider the issues of auditor independence to be the most important long-standing issues facing the profession. Having said that, I would also like to note that action is needed. Indeed, I believe it is long over due.
While further study may enhance the finer points of the issues, it would do nothing to resolve the larger concerns. They have been deliberated far too long. There are clear signs the public's concerns for the auditor's independence are growing. At the same time there has been too much emotion and bottom line interest tied up in the deliberations. The longer they are allowed to go on the more polarized the positions will become.
Much of what has been proposed has received very little criticism and should be resolved quickly. The more contentious matters will not be resolved by facts or arguments and must therefore be left for resolution by the Commission as a public policy decision. I suggest that such a decision may be relatively easy, and the measure of success for making the right decision may be adopting the set of standards that would most clearly and effectively preserve the public confidence in the audit function.
My next general statement has to do with the four proposed guiding principles. I will preface it with the observation that the continuing rapid and diverse growth of non-audit services provided audit clients has contributed to the growing perception that such services may be creating a potential for conflicts of interest. More importantly, if they were allowed to continue unbridled by those who would abandon the standard of appearance of independence, we would find the integrity of the independent audit function threatened. I therefore fully endorse them. They set a sensible baseline that is simply stated, easy to understand, useable, and square on the mark. They also serve as an exceptional foundation to the other elements of the proposed revision. As guiding principles they can serve as a bright beacon giving much needed guidance to members of the profession in an increasingly complex world, and in all areas of their professional endeavors.
While I endorse the four guiding principles, it should be noted, the Commission's effort in developing them and their associated proposed independence requirements do pose a potentially serious dilemma relative to the stature and role of the Independence Standards Board. I would like to offer some comments and suggestions concerning that matter.
I believe the establishment of the Independence Standards Board was an important first step to addressing the growing concerns of auditor independence. I applaud the wisdom that brought it about, and in particular, the selection of its Chairman and Executive Director. I also appreciate the important contribution members of the ISB Board have made. In particular I would like to express appreciation to the ISB's public members. I know somewhat of the importance of the selection of public members, and I believe the ISB's public members have brought tremendous strength and respect to the Board. Their wisdom, experience and commitment to its mission have been a great benefit to the profession.
I believe the Commission needs to take the opportunity to reinforce the important role, stature and mission of the ISB by incorporating much of the ISB's language into the proposed regulations and by having the ISB fine-tune some of the aspects of the proposed revisions that need additional clarity and consideration. One such matter is the fourth of the four guiding principles, the one dealing with advocacy. While I fully support the guiding principles, I also believe this particular principle should be given additional consideration because I believe there maybe select situations in which advocacy services for an audit client would not pose a conflict of interest or jeopardize independence. Furthermore, the ISB would be the proper forum to develop such specificity and such a delegation would reinforce the prominence of the ISB's role.
I should also note, as a member of the ISB's Conceptual Framework Task Group, there can be considerable confusion regarding the ultimate disposition of these four guiding principles and the more specific aspects of the Commission's proposed revision. Because the Conceptual Framework Task Group is comprised of a broad mix of individuals it has been able to bring together in its deliberations many different and exceptional quality professional skills and experiences from within and outside the profession. A highly qualified professional staff and expert consulting resources also support the Task Group.
While the work of the Task Group has moved along rather slowly significant milestones have now been reached and progress can begin to accelerate. I hope the Commission will continue to look to the ISB to formulate the foundation framework for its independence standards rather than supplant its efforts with what may be a more narrowly based set of guiding principles. Indeed, the considerations of the proposed guiding principles by the ISB and its Conceptual Framework Task Group may result in their refinement and ultimate incorporation into a broader framework founded on considerable deliberation and empirical research.
There are two other concepts that are used extensively in the proposed revision, "covered persons" and "affiliate". "Covered persons" is a concept that parallels work being done by the ISB and has been incorporated into its Family Relationships Invitation to Comment, and some elements of this concept also appear in the Standard #3, Employment with Audit Clients. The concept of "affiliate" is also being dealt with in the ISB's Discussion Memorandum, Evolving Forms of Firm Structures and Organization. I would encourage the Commission to assure the ultimate definition of these terms is consistent with the use being made of them in the ISB's standard setting processes and pronouncements. The reliance of the SEC in the standard setting processes of the ISB is critical to its success. While there may be a need on occasion to provide broad guidance, actions that would appear to preempt the work of the ISB will only serve to undermine its stature and role with the profession.
Now having dealt with these broader issues, I would like to address some of the more specific matters of the Commission's proposal.
I concur with the Commissions proposal 2-01(c)(1), Financial Relationships. There is one aspect of this proposal however, that I believe will raise some concern among the various state boards and that relates to liberalization of investments by partners, principles and shareholders in audit clients when not included in the "covered persons" provision. While I believe most state boards may readily embrace the more liberal provisions of the Financial Relationships proposal, I also believe there will be many that will want to retain the prohibition of investments in any audit client to all partners, principles and shareholders. My reasoning on this matter is that there is extensive networking and sharing of expertise that goes on within the firm, it transcends geographic boundaries and occurs at will, or as necessary to meet client needs. I believe such a proscription would not only be in the public's interest, but also in the firm's interest. I would encourage further consideration of this proposed proscription.
I am in full agreement with the provisions of the Commission's proposal 2-01(c)(2), Employment Relationships and, the proposal 2-01(c)(3), Business Relationships. I suggest however, the Commission consider incorporating the ISB's language from its Family Relationships Invitation to Comment into the Employment Relations proposed revision since its provisions are so similar and the ISB's standard setting role would be reinforced by such an action.
I am in general agreement with the proposed revisions concerning 2-01(c)(4), Non-Audit Services. I agree with these provisions because they are designed to preclude the auditor from engaging in services that could cause one to question their independence or objectivity. I would oppose a blanket prohibition for non-audit services.
Ensuring the independence of external auditors in both appearance and fact is essential to investor confidence in the use of financial statements. It should be remembered, many factors affect independence. Some may be very subtle and difficult to assess nevertheless, their consequence on auditor judgment and investors' perceptions are important to the efficiency of our capital markets and the public's confidence in them.
Safeguards alone cannot be relied upon to adequately preserve auditor objectivity and independence. Because of the importance of public perceptions and confidence and for the protection of the public's interest, public policy dictates Commission action regardless of the pressures and influence of some constituents. I believe these issues are too important to yield to end runs and gamesmanship.
Some would challenge these concerns with the argument that there have never been cases of an audit failure caused by the providing of non-audit services. This argument doesn't focus on the critical public interest concern regarding whether the auditor was independent. I don't believe it is adequate that the auditor's non-attest services didn't cause an audit failure. The critical factor is, whether the auditor was independent? That is the important public concern. Members of The Panel on Audit Effectiveness " . . . almost all agreed that the potential for appearance problems was quite significant."1 A similar significant public concern for non-audit services impairing auditor independence was revealed in the findings of a NASBA Public Perceptions survey, Defining the Public Interest.
To date, the diversification of services in the CPA Profession has not impacted significantly the confidence executives have in the work CPAs provide for them. Although one in four (23%) executives says the changes have made them less confident in the work of CPAs they hire, 62% say they really don't matter. The greatest level of concern is among those from smaller companies (30% say less confident), whereas 75% of those from the largest companies say it makes no difference. However, the finding that one-quarter (26%) of executives who initially rated their confidence in CPAs an eight to 10 on a 10 points scale report that the diversification of services in the CPA profession makes them less confident in the work they perform serves to underscore the importance of this issue."2
The prohibition of non-audit services to an audit client is a common sense rule. It is properly based on the reality that one cannot be independent or objective when evaluating one's own work. For instance, it is incongruous to think that an audit firm could help its client's management build and implement an accounting system then help management monitor it with the firms outsourced internal audit staff, and then audit the financial statements and believe the public would consider the firm has retained its independence and objectivity.
Another concern I have is the risk of mutual dependence that may arise in situations when the audit form is also providing significant consulting services. The client risks becoming too dependent on the audit firm for its expert audit and systems knowledge and the engagement partner risks becoming too dependent on the workflow and revenue stream of the audit client. In such a situation neither finds it easy to want to end the relationship and whatever the bad news, knowingly or unwittingly, it become easier to pass over.
Many have suggested the rendering of non-audit services have never been proven as having impaired an audit. My experience has been that by the time a case is before the state board or the SEC, the circumstances have generally degenerated to a much more egregious situation. Consequently, the strength of the case is focused on a much higher profile matter than the auditor's lack of independence. Most of these cases get settled before judgment and as a consequence there is not an adequate record of the root causes of the case.
Other arguments that have been raised in objection to this prohibition suggest such a prohibition would result in firms not being able to retain qualified staff to support the technology requirements of their complex clients' audits and as a result the quality of audits would decline. This argument shouldn't cause much concern since the Panel on Audit Effectiveness reported that between 1990 and 1999, 75 - 80% of audit clients chose to have a firm, other than their audit firm provide their consulting services. I believe that is a sufficient market to permit them the opportunity to develop and retain adequate staff with strong technology skills.
The proposed proscription of non-audit services has become the most emotional and contentious of the proposed revisions. Some have even suggested that it be dealt with separately from the other provisions where it appears there may be general agreement. I think that proposal is rather curious since the underlying common concept of all the proposed revisions is not only independence in fact, but appearance as well.
It is clear the firms and in particular the AICPA believe they have a significant financial interest in these proposed changes. So much so the AICPA has decided to take their message to the halls of congress in an effort to short circuit the SEC's rule making process. I think the Institutes decision is unfortunate. It demeans the profession and will only be viewed as self-serving. Such behavior is generally ascribed more to a trade association than a professional organization.
Before I conclude my comments on the proposed revisions for non-audit services, I would like to comment on one additional matter, one I feel particularly strong about. That of outsourcing the internal audit function. I oppose any provision that would permit management and the board of directors to allow outsourcing of the internal audit function. I do not believe it is appropriate for management to delegate these responsibilities. The internal audit function is a management function and the Commission's proposal to prohibit its outsourcing should be upheld.
Having said that, I would acknowledge that it might be appropriate to allow some limited work such as securing specialized skills to be outsourced so long as management maintains responsibility for controls. I suggest this provision be considered by the ISB for additional refinements of the proscription.
I agree with the proposed, 2-01(c)(4)(ii) Transition, the two-year transition period is a reasonable period.
The proscription 2-01(c)(5), Contingent Fees is already in place in most state laws and rules, and the AICPA's Professional Code of Conduct. I suggest the ISB be given charge of assuring it is developed in harmony with those standards and regulations.
I support 2-01(d), Quality Controls and Elements of the Proposed Quality Control System. I would encourage the Commission however, to make the proposed internal inspection and testing provisions mandatory. Existing professional standards already require an in-form quality assurance program and I believe it would be appropriate for this requirement to be mandated.
The proposed 2-01(e) All Relevant Circumstances provision may appear ominous and threatening. However, I believe its application is bounded by the other provisions of the proposed revision and in particular the four guiding principles. As such I support it.
I believe there is great wisdom in the proposed, 240.14a(101) Proxy Disclosure Requirement Disclosure of Fees and Leased Personnel and I fully support it. However, because of its singular importance I believe it should be required in all financial statements and quarterly filings with the SEC.
In conclusion, there will be a cost to the implementation of the revised rule and it would be most difficult to assess. However, I believe there would be significant benefits to improving the public's confidence in the audit function and the capital markets that would most assuredly out weigh the costs of the changes.
I encourage the Commission, as it considers its options, to focus on the remedy that is most likely to preserve the auditor's independence and the public's confidence in the audit function. The solution that will provide these two benefits is most likely to be the more effective solution to maintaining investor's confidence in the capital markets. I also suggest that the concerns of the public should take precedent over those of the profession. This is the formula that has helped preserve the public's confidence in our capital markets and helped them become the strongest in the world. Let's not give that up for the short-term benefit of a few.
Thank you for the opportunity to respond to the Proposed, Revision of the Commission's Auditor Independence Requirements, I hope you find my comments helpful.
Sincerely,
Dennis Paul Spackman, CPA, Chairman
National Association of State Boards of Accountancy
50 East North Temple, #1500
Salt Lake City, Utah 84150-3643
| 1 | Panel on Audit Effectiveness Report and Recommendations, paragraph 5.2, May 31, 2000 |
| 2 | Public Perception Survey, Defining the Public Interest, Wirthlin Worldwide, October 1999, page 6. |
NASBA's mission is to enhance the effectiveness of state boards of accountancy
In carrying out this mission, NASBA has defined core values that recognize and support the sovereignty of its member boards. These core values are the basic tenets for the protection of the public interest and must not be compromised. These core values:
Joint, AICPA/NASBA Proposed Model Code of Conduct Principle of Objectivity
Objectivity is a distinguishing feature of the accounting profession and is critical to maintaining the public's trust and confidence. It is a state of mind that imposes the obligation to be impartial and free of bias that may result from conflicts of interest or the inappropriate subordination of judgment. Objectivity requires a licensee to exercise an appropriate level of professional skepticism in carrying out all professional activities.
Although a licensee may serve multiple interests in many different capacities, objectivity must be maintained. This requires a careful assessment of the effects on objectivity of all professional relationships and activities.
A licensee should maintain objectivity in the performance of all professional activities in whatever capacity performed.
Joint, AICPA/NASBA Proposed Model Code of Conduct Principle of Independence
Independence where required by professional standards, is essential to establishing and maintaining the reliability of, and the public's confidence in, the information reported on by the licensee.
A licensee should be independent in fact and appearance. Independence in fact is the absence of a licensee's interest in, relationship with, or services provided to, a person or entity, that results in the licensee's loss of objectivity. Independence in appearance is the absence of such interests, relationships, or services which may, to a reasonable person having knowledge of all the facts, appear to result in an unacceptable threat to the licensee's objectivity.
When considering independence issues, it is presumed that the reasonable person would consider, among other factors:
A licensee in the practice of public accounting should be independent in fact and appearance when engaged to provide services where independence is required by professional standards.
Personal observations concerning independence:
My commitment to preserving the publics trust and confidence in the profession's integrity, independence and objectivity extends all the way back to the late 1960's when I was completing my master's degree. I was given the opportunity, as research assistance to one of my college professor's, to review Utah's Accountants Licensing Act and recommend means of strengthening its candidate qualification and regulatory provisions. Little did I know at that time, that some twenty year's later Tom Nelson and I would lead the State Society in actually bringing about the enactment of many of those provisions. From that time forward I have continued to commit much of my career to service in the profession and I have been most fortunate to have had the opportunity to serve in a number of meaningful positions with a great number of fine men and women devoted to similar ideals.
Auditor independence is a matter of great concern to me. I have spent a good deal of my time over the last few years dealing with this subject. As the founding chair of NASBA's Ethic's Committee, I instituted the annual Ethics Conference that has been jointly sponsored by the AICPA, American Accounting Association and NASBA. I chaired the joint committee between NASBA and the AICPA that served to establish a principles based Model Code of Conduct. The proposed Model Code of Conduct has been adopted by NASBA's Board of Directors and endorsed for consideration of adoption by the state boards of accountancy. It was also adopted by the AICPA's Professional Ethics Executive Committee and awaits endorsement by the Institute's Board of Directors and a vote of Council before it is given to its membership for consideration of adoption.
Last year I established an Alternative Practices Task Force to consider the implications on auditor independence of non-licensee ownership. And I focused attention of NASBA's Litigation Analysis and Support Committee on initiatives that have advanced the establishment of an open and positive working relationship with the SEC to strengthen the enforcement and investigative efforts of the state boards of accountancy.
Another significant accomplishment was the adoption this year of NASBA's Core Values. These core values recognize the sovereignty of state boards of accountancy relative to their statutory role of preserving and protecting the public interest through effective regulation of the practice of accountancy. NASBA's leadership is fully committed to preserving these core values and in facilitating, strengthening, and supporting state boards in their regulatory role. I am attaching for your information (Attachment A), a copy of NASBA's mission statement, goals and core values.
Dennis Paul Spackman, CPA, Chairman
National Association of State Boards of Accountancy
September 5, 2000
Dennis is the 1999-2000 Chairman of the Board of Directors of the National Association of State Boards of Accountancy (NASBA). He has served seven years as a member of it' Board of Directors. He served three years as a Director-at-Large and three years as the Region Director for the six state, Mountain States Region. He served one year as Vice Chairman. He is the founding chair of both the NASBA Ethics Committee and Audit Committee. He served two years as Chairman of NASBA' Administration and Finance Committee. He served five years as a member of the joint AICPA/NASBA, International Qualifications Appraisal Board which represents the accounting profession in the establishment and administration of international reciprocity standards and mutual recognition agreements. He has served as a member of several other NASBA committees including the International Reciprocity, Acceleration of Changes in the CPA Examination, Legal Liability Task Force, and Ownership of Public Accounting Firms by Non-Licensees. He served as a member of the implementation task force for the establishment of a NASBA affiliate for-profit corporation, Professional Credential Services, Inc.
He has a distinguished record of service in the accounting profession. He is currently serving as a member of the AICPA Computerized Uniform CPA Examination Implementation Committee. He has served as a Member of Council of the AICPA, and he has served a number of years as a member of the AICPA's State Legislation and Region Legislation Planning Committees. He has served as President of the Utah Association of CPAs, twice as Chairman of the Association's State Legislation Committee, and Chairman of the Long Range Planning and Awards Committees.
He has, over the years, played an important role in helping formulate and move through Utah's legislative and Administrative Rule Making processes the profession's, Accountants Licensing Act and its Rules and Regulations.
He is a member of the Board of Faculty Advisors for the University of Utah, School of Accountancy where he served four years as Chairman of its Curriculum Committee. He also serves as a member of the Board of Faculty Advisors for the Brigham Young University School of Accountancy and Information Systems. He served eight years as a member of Utah's State Board of Accountancy and, three years as its Chairman. He is a member of the American Institute of CPAs, Utah Association of CPAs, American Accounting Association, and Association of Certified Fraud Examiners.
He serves as a member of the Board of Directors and as Secretary and Treasurer of a not-for-profit environmental corporation. He has served as President of the South Salt Lake County Rotary Club and as a member of the Board of Directors and Treasurer of the South Salt Lake County Recreation District. He has served as a Zone and Assistant District Commissioner for the Boy Scouts of America.
He is Chief Accountant for the Church of Jesus Christ of Latter-day Saints and has been responsible for directing the monthly and annual consolidation, analysis and reporting of the Church' worldwide operations and investments. His current responsibilities include directing the administration of the Church' financial policies and procedures, systems of internal control, and its prospective, strategic financial and performance analysis, and reporting.
He received his master's and baccalaureate degrees from Brigham Young University. He is married to Ann Pyne. They have four children. He enjoys the out of doors, camping and hiking. His favorite hobby is photography. His favorite books are documentaries and biographical histories. He enjoys classical music.