September 12, 2000
Testimony on Auditor Independence Rule Proposals
Comment File No. S7-13-00
Frank Torres
Consumers Union
Consumers Union1 appreciates this opportunity to provide comments to the Commission on its Proposal to Modernize the Rules Governing the Independence of the Accounting Profession (June 27, 2000). Consumers Union supports the Commission's efforts to ensure that audits are the result of a credible and independent process.
The Commission is right to propose ways to respond to the changing aspects of the financial marketplace, and in particular, how the business practices of audit firms might affect the audit process. Business consulting has grown substantially. Some companies outsource many business aspects that used to be conducted internally. The increasing amount of non-audit consulting work undertaken by audit firms raises concerns, especially where the audit and consulting work are done for the same company. Because conflicts of interest, either real or perceived, could lead to the appearance of impropriety and erode consumers' trust in the audit process, focus on this issue is warranted.
At the same time, more consumers are putting their money in financial markets. Technological advancements, a good economy, and other factors, have spurred more and more consumers to invest. Consumers may invest in the stock market directly -- even electronically --, participate in pension plans, put their money in mutual funds, or use 401k plans.
Consumers have a variety of information sources when making investment decisions. The value of that information is based, in part, on its reliability. An audit, performed by an outside auditing firm, provides a valuable tool for both existing shareholders and potential investors. Simply put, a reliable audit is a critical resource for consumers to make rational decisions about their investments.
Testimony on Auditor Independence
Consumers assume that an independent audit is, in fact, independent. In other words, consumers have a reasonable expectation that an audit provides objective information. It is crucial that there be no doubt as to the motivations of the firm preparing the audit. Consumers should not have to worry that the outcome of the audit was influenced by the relationship between the audit firm and the company being audited. If consumers have reason to question the veracity of the information contained in an audit, the audit may be of little more real value than information from an unknown or unreliable source on the Internet.
The Commission's proposal focuses specifically on those areas that warrant clear separation between the audit process and consulting work in those areas. The proposal is based on four principles: that accountants should not audit their own work, function as management or employees of the audit client, act as advocates for the audit client, or have a mutual or conflicting interest with the client. Under the Commission's proposal the audit firm could still offer those services to non-audit clients.
The purpose of an audit is to provide a fair and objective view of a company. While the company may conduct its own internal reviews, the independent audit is performed by an outside audit firm. If, for example, the audit firm ends up in the position of auditing its own work, it is difficult to see how this is any different than allowing the company to audit itself.
It is not only shareholders, potential investors, and the Commission, who rely on these audits, bank regulators rely on the audits as well. To the extent that audits are used by bank examiners for purposes of determining the safety and soundness of the banking system, the credibility of those audits takes on increased significance. Consumers Union shares the concerns raised by the Comptroller of the Currency in his July 26, 2000 testimony. The Comptroller stated that an effective audit process is an essential component of risk management for the banking industry that the audit is becoming more critical as banks expand into new products, services, and technologies, and that the audit contributes to safe and sound operations.
Consumers Union appreciates this opportunity to comment on the Commission's proposal. Accounting firm relationships and affiliations with their clients, beyond the scope of the audit itself, raise serious concerns about the independence of the audit, especially since the appearance of a conflict of interest can be as damaging as an actual conflict. Current rules need to be scrutinized and changed to reflect the changing nature of the large accounting firms, which have moved into more of a consulting and other management advisory services relationship with their clients. The Commission should take steps to ensure that actions that compromise independence are curtailed.
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1 Consumers Union is a nonprofit membership organization chartered in 1936 under the laws of the State of New York to provide consumers with information, education and counsel about goods, services, health, and personal finance; and to initiate and cooperate with individual and group efforts to maintain and enhance the quality of life for consumers. Consumers Union's income is solely derived from the sale of Consumer Reports, its other publications and from noncommercial contributions, grants and fees. In addition to reports on Consumers Union's own product testing, Consumer Reports with approximately 4.5 million paid circulation, regularly, carries articles on health, product safety, marketplace economics and legislative, judicial and regulatory actions which affect consumer welfare. Consumers Union's publications carry no advertising and receive no commercial support.