National Association of State Boards of Accountancy
150 Fourth Avenue North, Suite 700, Nashville, TN 37219-2417
Tel 615/880-4200 Fax 615/880-4290 Web www.nasba.org
August 26, 2002
Harvey L. Pitt, Esq.
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
Dear Chairman Pitt:
The National Association of State Boards of Accountancy appreciates the opportunity to review and comment on the Securities and Exchange Commission's Proposed Rule: Framework for Enhancing the Quality of Financial Information Through Improvement of Oversight of the Auditing Process.
We recognize that many of the provisions discussed in the proposed rule have been addressed in the bill recently signed by President Bush. However, since the Commission will be called upon to interpret this legislation as it oversees the new board's operations, we believe it is important for us to address the questions raised in the proposal's "Discussion of Proposed Rules." In this way, as the Commission offers guidance, it will have input from the state regulators to consider. It is our firm belief that the exchange of information and ideas among state and federal regulatory authorities is essential to providing optimal public protection.
Our comments are presented in order of the questions raised within the exposure draft
Regulation S-X Definitions
We would suggest the definitions of both "attest" and "review" as they appear in the Uniform Accountancy Act be included in Regulation S-X. This language has already been incorporated in several states' laws and would facilitate coordination of regulation.
Requirements for Financial Statements and Attestation Report
It is the state boards of accountancy that evaluate each licensee's competence for licensure and that each firm has met the appropriate requirements for a permit to practice. To fold these assurances into the proposed framework, proposed rule 2-01(a)(2) and existing rule 2-01(a)(1) should include a requirement that the accountant/firm be licensed/registered with the appropriate state board of accountancy. As stated in existing rule 2-01(a)(1) the public accountant should be "in good standing and entitled to practice as such under the laws of the place of his residence or principal office."
In response to the posed question, "Should accountants that audit only entities that are not issuers of securities be outside the scope of the rules?" We would refer back to proposed rules. The definition of "accountant" for purposes of the proposed rules on oversight board (210.13-02(a)) refers just to accountants with respect to certain financial statements or reports filed with the SEC. Therefore, it follows, "accountants" who have no SEC audit clients are not "accountants" for purposes of the proposed rules. It may be most appropriate to embody the strict prohibitions for SEC auditors into audit standards, rather than incorporate them as part of independence requirements that would apply to all certified public accountants.
Definitions of Article 13
Accountant - Here the question is raised if "accountant" should cover both accounting firms and individual accountants. Arguably, in order to be fully effective, regulation should reach to both accounting firms and individual accountants. Close coordination of state and federal authorities would seem the right solution.
Delinquent - The Public Company Accounting Oversight Board should not impinge upon the states' rights to license or grant practice privileges, but should refer these cases to state boards (as recommended in Sarbanes-Oxley Section 105 (4)). Should the PCAOB be administered by NASBA, the state boards might consider presumptive implications of delinquency under UAA Section 23 Practice Privileges.
Member Accountant in Good Standing - An accounting firm's or individual's being in good standing should be contingent on willingness to cooperate with PCAOB's inquiries. Relevant state board disciplinary actions should be a consideration.
Professional Engagement Period - This should be resolved in favor of consistency.
Professional Standards - We would suggest that there should be an addition to the definition of "professional standards" to read: "For purposes of this definition, State Boards of Accountancy are presumed to be authoritative."
SEC Clients - There are "clients," and then there are "SEC clients," and then there would also be "Section 15(d) SEC clients." State Securities Regulators by rule often grant particular compliance exemptions to Section 15(d) filers.
Definitions Generally - Where Sarbanes-Oxley fails to provide a definition, inclusion of the definitions cited in the Uniform Accountancy Act should be considered (such as "accountant's report").
Conditions of Commission Recognition of Public Accountability Boards
CPAs have historically played the primary regulatory role of serving on state boards of accountancy. Typically, CPAs make up the majority of state boards. These CPAs take an oath to protect the public. CPA state board members have performed ethically and aggressively in fulfilling this state law mandate. Our judicial system calls for a jury of peers to decide wrongdoing. State board members perform this role and their contributions have added to the creditability of the outcomes.
The distinction made in footnote 89 of the SEC proposal should be recognized. While state board members often are accountants, they are also regulators and could hold either an "accountant" or "public" seat on the board. NASBA could recommend highly qualified people for either category to the Commission. We would recommend that always at least one oversight board member should be either a past or present state board member.
Since the oversight board is envisioned as a not-for-profit corporation, are the staff employees to be government or contract employees? Where will the staff be located, in one or more major cities? If the staff is located only in Washington, DC, extensive travel would be required and that could limit the number of individuals who would apply for such a job. Should the staff be based in multiple locations, overhead would increase and there would be need for more managers/supervisors. Who would be responsible for supervising the staff? If contracts are awarded, who ensures that work meets contract requirements? If several CPA firms were to be awarded contracts to perform the peer reviews, who ensures that the firms consistently apply standards? Who makes the staff assignments?
Studying how monitoring is done in other countries, such as the United Kingdom, would be something the oversight board should do to discover "best practices."
Supplemental Reviews, Disciplinary Proceedings, and Dispute Resolution Procedures
The PCAOB must have the authority to institute disciplinary proceedings to determine if an accountant is engaged in any act or practice in violation of rules or membership requirements. We would envision such a process to be similar to the current SEC proposed statement of charges in which a "Wells response" is requested. Such a response to the proposed statement of charges would indicate whether the PCAOB would move forward for further investigation or refer the firm directly to the SEC.
Conflicts of Interest
The issues of conflict of interest have a long history of complex and contentious debate and will require extensive research by the oversight board before new rules can be adopted. Until the research is completed, the current standards must be relied on. Effectively incorporating standards dealing with the appearance of conflict of interest is critical to achieving public confidence in financial reporting. The final standards and rules should be the result of a consensus between the PCAOB and the SEC.
Funding for the PCAOB
We are generally in agreement with the proposals concerning funding the oversight body. The schedule of fees to correlate to the numbers of SEC registrants audited or the size of the firms requesting membership would be appropriate. The PCAOB should determine the specific funding system.
Funding for the FASB
Having a source of funding for the FASB independent of its sale of publications and receipt of voluntary donations seems important and support from issuers (as outlined in Sarbanes-Oxley) is a good way to achieve this.
A similar approach could be considered to fund the GASB. The users via government source funding, perhaps from within the GAO budget, should similarly provide a certain portion of the GASB budget.
Fair Dispute Resolution Procedures and Notices of Delinquencies
Ninety days seems an extraordinary amount of time when the public interest is at risk. The notification of affected parties should be set at a maximum of 30 days. A simple statement of facts should be sufficient for such notices.
The PCAOB should reserve the right to issue rules and policies regarding professional standards when it deems the work of private sector organizations does not adequately protect the public interest. The PCAOB and the SEC should work jointly on these practices and policies when determining which bodies are considered authoritative in circumstances where neither the SEC nor the PCAOB have specific rulings.
Open and Deliberative Process
An open and deliberative rulemaking process will be essential to gaining the public's confidence in the PCAOB. Procedures setting out the process employed in rulemaking should be left to the PCAOB to decide. The difference between open process concepts versus internal governance should be made. Matters affecting registered firms and issuers require an open and deliberative rulemaking process. Governing documents, membership requirements and similar procedures could be handled internally to the extent there is minimum public impact.
Continued professional education is a requirement for licensees in all but one state. Adding training to "increase investor confidence" may have some public relations value, although it may do little to address the real issues. Several states already have mandatory continuing professional education in ethics for all licensees.
Other Duties or Functions
The PCAOB should have the ability to take on special projects that fall within its jurisdiction and responsibility or to provide participation in the development of professional standards by convening study and advisory committees or participate in other professional standard-setting work. Rules and regulations that are not yet fixed are difficult to evaluate. The PCAOB will need a mechanism to adopt rules and policies to govern its operations with flexibility and reason. The requirements as stated in the SEC's proposed framework are reasonable and provide improved public protection.
Quality Control Requirements
The AICPA and SECPS quality control and membership requirements set forth appropriate controls to assist firms in monitoring and enforcing the critical elements of independence, integrity and objectivity. These requirements would appear to address the Commission's concerns as set forth in the proposed rules.
A central office requirement should be a key resource for engagement partners. Significant auditing and accounting and reporting expertise can be shared throughout the firm via a central office requirement. The proposed rule does not appear to generate any competitive concerns. However, the drafting in proposed rule 13-04(e)(8) should be clarified so that a PCAOB could authorize an alternative to a central office function "for firms that could not meet this requirement because of their size."
The rules established by the Independence Standards Board (ISB) set the proper framework for the PCAOB's quality control concerns. The ISB developed some very good requirements based upon careful study. The new oversight board, however, should be allowed to institute additional requirements based upon the issues encountered in its review of the quality control systems.
Quality Control Review Program
Just as in the current peer review program, firms and individuals can be assessed as to whether they are following the firm's quality control document, which should include adherence to professional standards. The PCAOB can reference quality control documents and create a section, as part of the peer review standards, where the reviewer determines through discussion or engagement review that the firm and individual have complied.
If review under an approved review program is permitted, the PCAOB could approve the reviewer for each review. A more restrictive approach would be for the oversight board to assign the reviewer for each review.
The PCAOB should direct and make all key decisions for all the reviews it conducts. It should be allowed to employ individuals to perform peer review or, at a minimum, supervise contract individuals performing peer reviews. These individuals must be independent and rotate every five years among the firms being reviewed or for those firms for which they supervise the review.
Firm-on-firm peer reviews should be allowed, but the PCAOB should have veto power over the selection of the reviewer and the review team should be comprised of members from different firms. Because those from different firms will have been trained differently, their opinions will reflect alternative views on the handling of possible areas of standards' violation. The firms should have someone on staff dedicated to knowing the PCAOB's standards and its quality review standards.
While the scope of the review should be guided by the current peer review programs of the AICPA's SEC Practice Section, firms should not be allowed to exclude reports from being reviewed for any reason, including pending or on-going litigation. The firms should also have every practice office inspected during the year and reports available to the review team.
Supplementary Reviews and Disciplinary Proceedings
A firm should not be allowed to continue issuing audits, reviews or compilations once it has been given an adverse opinion until a supplemental review has been completed and corrective actions taken. The PCAOB should notify the state board(s) of accountancy so that licensing violations may be addressed.
Any likely violation of securities laws discovered by the PCAOB should be reported to the SEC. If violations have occurred, then the Commission needs to move forward with enforcement. The oversight board must move quickly and also provide state boards of accountancy information on proceedings.
NASBA believes it would be useful to add express provisions in the oversight board's rules that it may, upon motion, allow the appropriate state board(s) to participate as a party to the PCAOB's disciplinary proceeding.
The proceedings should require the burden of proof be placed on the PCAOB and its staff before the case moves to a hearing stage. The PCAOB's procedures for supplemental reviews should be defined. If, after supplemental reviews, violations are still determined to be in effect then disciplinary proceedings should begin. The proceedings should be public; however, proceedings should only take place after firms or individuals have been given an opportunity to correct minor infractions of quality control. In the case of egregious violations, proceedings should commence immediately. When dealing with violations, the PCAOB should follow administrative procedure acts. With proper oversight of review procedures and reviewers, disciplinary proceedings would only occur when very serious violations existed and no additional safeguards would be necessary.
The list or proposed sanctions in the SEC proposal seems inclusive enough. If the PCAOB determines that no sanction should be imposed, then this information should not be made public. As is the case with many state accountancy boards, anyone can file a complaint and the PCAOB would presumably investigate the complaint. Only the actions that result in a sanction should be public, or else there should be safeguards against people filing endless complaints that have no merit.
It is critically important that the PCAOB promptly report sanctions to the appropriate state board(s). In addition, the PCAOB likewise should promptly report to the appropriate state board(s) disciplinary proceedings that determine that no sanctions should be imposed. Furthermore, NASBA believes it is very important to have an additional provision that the PCAOB will promptly notify the appropriate state board(s) when the PCAOB commences steps for any disciplinary proceeding and keeps the appropriate state board(s) fully informed during the course of each disciplinary proceeding, including preparation for the formal proceeding. Finally, NASBA believes it is important to have an additional provision that the PCAOB will promptly notify the appropriate state board(s) of the results of each supplemental review (whether or not the PCAOB institutes related disciplinary proceedings).
The provision that the PCAOB would report to the SEC the refusal to provide testimony or documents should have a deadline of no more than a given number of days (for example, 30) after the request. That would allow the firm one chance to change its mind and comply before the PCAOB reports the refusal to the SEC. If the uncooperative party is an accountant, or accounting firm, the PCAOB should also report such refusal to the appropriate state board(s).
Should an individual be subject to sanction, then he or she would have to notify any public accounting firm that engages him or her of the restriction on attest services. If a sanctioned individual is engaged to perform attest work, the PCAOB must assume that the individual did not tell the new firm about the PCAOB's sanctions.
The proposed public reporting is sufficient. The specified reports should achieve an adequate level of transparency. More frequent reporting should be considered -- such as quarterly updates. A more frequent flow of information to the Commission and the public may be necessary to demonstrate that transparency is continuous and not just on an annual basis. For instance, continuous reporting of the quality control review and disciplinary actions, PCAOB discussions with standard-setting bodies and referrals of matters to state boards of accountancy or standard-setting bodies would assist in demonstrating ongoing oversight and would be of great interest to the public, investors and regulators.
The structure and scope of the Commission's oversight should only be as extensive as necessary to determine the oversight board's accomplishment of its responsibilities and no more. Actual day-to-day management of the oversight board should be guided by its mission statement and policy directives from the SEC. The oversight board should propose, consider and adopt its own rules following an open public process in which the SEC participates.
Since it is responsible for the overall mission and framework of operations of the oversight board, the Commission should have the authority to change the mission and framework to the extent permitted by Public Law 107-204 (the Sarbanes-Oxley Act).
As members of the oversight board will be highly regarded individuals who can be left on their own to properly run the board, the SEC should not micromanage the activities of the board. The relationship between the SEC and the oversight board should be much like the one between Congress and the SEC. To do otherwise would make the oversight board unnecessary and indicate that it is purely a staff function of the SEC.
Commission staff should have on-site access to all PCAOB reviews. They should have access to observe the review procedures, the documents reviewed, the meetings between the reviewed firm and the reviewers, etc. In short, they should have on-going operational access to the entire review process.
SEC staff involvement would be most productive all the way down to the fieldwork of the review. By participating in issue development, discussion and response, the SEC would have firsthand knowledge of the oversight board's review activities. Such a system could serve as a model for state boards of accountancy to follow as they oversee the peer review process of accounting firms that are not registered with the oversight board.
Thirty days seems like a sufficient time to file an application for review of a disciplinary action. There should be no review of a delinquency action, since such appeals will just stall the proceedings and delay the oversight board's final action, making it appear less effective. An application for review should be able to stay the operation of a disciplinary action only if the SEC's review takes place within a reasonable period of time.
If the SEC provides sufficient policy and disciplinary guidance to the oversight board as its procedures are being developed, it will not be necessary for the SEC to alter the sanctions imposed by the board. So as not to diminish the authority of the oversight board, the SEC should avoid overturning the oversight board's determinations.
The SEC should be able to remove an oversight board member for appropriate reasons following due process. Removal must not be based on unproven allegations or assertions. Oversight board members owe their allegiance to the public interest and should not be subject to partisan whims of individuals.
NASBA strongly agrees with the view expressed in the discussion section of the proposing release that "a more thorough and extensive oversight of a PCAOB's processes than existed under the prior self-regulatory structure" is called for. The oversight role of the SEC should be no less than that described in the proposed rules.
Confidentiality and Immunity
It is appropriate that the PCAOB be immune from private liability. State boards of public accountancy possess such immunity, which is critical to the ability of state boards to conduct a full and effective investigation. For the PCAOB to be effective, it must have the same immunity.
We concur with the SEC's exercise of its exemptive authority as set forth in proposed Rule 13-06.
The definition of "foreign accountant" should refer to an accountant who (among other matters) is not licensed nor required to be licensed by any state or territory in the United States (in addition to having place of residence and principal office outside the United States and its territories). An accountant whose place of residence and principal office are outside the United States and its territories but who is subject to licensing by a state board by virtue of "practicing" in the United States or its territories should not be considered to be a "foreign accountant" for purposes of this exemption if the accountant fails to be licensed as required.
Disclosure by Directors, Executive Officers, Promoters, and Control Persons
We concur with the proposed addition to item 401(f) of Regulation S-K to require the disclosure of violations of professional standards or the PCAOB's rules or membership requirements resulting in sanctions by the PCAOB during the previous five-year period. In addition, item 401(f) should require the disclosure of such violations resulting in sanctions, license suspensions or license revocations by a state licensing authority during such five-year period.
Many of the time estimates presented in this section of the proposal compare themselves to procedures and activities currently performed by other reviewing bodies. Since the purpose of the PCAOB is to provide more thorough quality review of firms, one would expect the amount of time expended to far exceed that of the current procedures. A superficial review of stated quality control procedures at the central office may not sufficiently describe the activities occurring in the many offices of a large firm. Also, without performing a sufficient workpaper review of a sample of the 16,242 public companies and 5,587 investment companies, one cannot reasonably judge the effect that the stated quality review is having on the specific audit process of these registrants. Accordingly, any significant change that the PCAOB would provide over the current system is not evident, other than establishing more rules and penalties that are punitive rather than preventative in nature.
Little was discussed regarding the funding of a body to produce generally accepted auditing standards. The apparent role of the FASB would be to establish generally accepted accounting principles for publicly-traded companies while likely disregarding the needs of non-public companies.
No procedures were presented in this report that would necessarily result in fewer audit failures, although the proposal would establish disciplinary action in cases of audit failure. This anticipates accountants will be more diligent in the audit process out of fear of such disciplinary action.
Although the PCAOB is pictured as a non-profit corporation, due to the control that the SEC would have over its rules, regulations, formation, agenda, meetings and funding, the PCAOB will be viewed as a regulatory agency directly controlled by the SEC. Regulatory agencies by their nature issue rules and regulations to govern those for whom they are responsible. Rules and regulations are subject to interpretation and, in some cases, manipulation. The PCAOB should consider approaching the profession in terms of guiding principles which, though subject to interpretation, would encourage integrity into the audit process and resulting financial reports.
No amount of rules and regulations and reviews of quality control systems can prevent audit failures. On the surface, the estimate of revenues seems insufficient due to the many tasks involved, ranging from rule setting, to conducting quality control reviews to taking disciplinary action.
The potential costs that would be imposed on registrants and the accounting firms is difficult to quantify since the PCAOB is likely to issue many rules and regulations that will require interpretation not unlike the US Tax Code. Firms will have to wrestle with the requirements of the central office, where the technical and review functions of the firm are to be performed, as opposed to the need to have such technical services at the office where the specific client is being served. Unfortunately this central office function concept could result in greater audit failure due to separating the technical expertise within the firm from the audit of the client.
From a cost-benefits perspective, the cost of implementing this rule, including the PCAOB, seems to be similar to that of other existing review bodies. Accordingly, any additional benefit, other than punishments that would occur after a reported audit failure, is not obvious.
Costs of Complying with Collection of Information
The estimated cost of the information collection requirements for this proposal would be approximately $680,000 total for the approximately 859 firms. Because of revamping of systems for the information collection and expected rule changes that occur by regulatory bodies, this estimate would seem to be low. Only upon defining the information that would need to be collected could an estimate be made based on experiences of numerous firms of differing sizes.
This cost-benefit analysis is provided without sufficient guidance as to the type of information that is needed to be collected, the sufficiency of a quality review by the PCAOB, the cost of establishing an entity to develop generally accepted auditing standards, the additional costs necessary for the FASB to be more responsive to rule making of generally accepted accounting principles mandated by the SEC, the process for establishing an entity to provide sufficient rule making of non-public companies' generally accepted accounting principles and associated litigation costs.
The Sarbanes-Oxley Act of 2002 provides an excellent vehicle for strengthening public protection through cooperation among federal and state regulators of the accounting profession. We trust as the new act is implemented, the PCAOB and the SEC will anticipate and accept input from the state boards of accountancy to aid in the efficacy and transparency of the new procedures.
Barton W. Baldwin, CPA
David A. Costello, CPA
President and CEO, NASBA