Independent Community Bankers of America
November 25, 2002
Jonathan G. Katz
Dear Sec. Katz:
The Independent Community Bankers of America (ICBA)1 welcomes the opportunity to comment on the rule proposed by the Securities and Exchange Commission (SEC) that would prohibit officers and directors of an issuer, and persons acting under the direction of an officer or director, from taking any action to fraudulently influence, coerce, manipulate or mislead the auditor of the issuer's financial statements for the purpose of rendering the financial statements materially misleading.
The Sarbanes-Oxley Act of 2002 states:
"It shall be unlawful, in contravention of such rules or regulations as the Commission shall prescribe as necessary or appropriate in the public interest and for the protection of investors, for any officer or director of an issuer, or any other person acting under the direction thereof, to take any action to fraudulently influence, coerce, manipulate, or mislead any independent public or certified accountant engaged in the performance of an audit of the financial statements of that issuer for the purpose of rendering such financial statements materially misleading."
ICBA supports the SEC's efforts to address the fraudulent practices that recently rocked our business world. We recognize the importance of regaining public confidence in financial reporting and auditing. We are supportive of efforts to revise regulations to clarify what practices are fraudulent in an effort to protect the public's interest as long as the burdens of such changes do not outweigh the benefits.
The SEC's proposal defines an "officer" as the company's president, vice president, secretary, treasurer or principal financial officer, comptroller or principal accounting officer and any person routinely performing corresponding functions. In general, ICBA believes that the proposed titles cover the appropriate functions that may be in a position to influence an audit. However, financial institutions (and other companies) may have a number of "vice president" positions that would have little or no ability to influence an audit. Thus, the focus should not be so much on a title as it should be on the employee's function and whether a person truly has the ability to influence an audit.
The proposed rule would cover the activities of not only officers and directors of the issuer, but also "any other person acting under the direction" officers and directors. According to the SEC's proposal, a person can be "under the direction" even if they are not under direct supervision and this may not be limited to the issuer's employees. Also included may be customers, vendors or creditors who, under the direction of an officer or director, provide false or misleading confirmations or other false or misleading information to auditors, or who enter into "side agreements." In our view, "under the direction of" is an appropriate phrase.
The SEC provides examples of actions that might constitute fraudulent influence to coerce, manipulate or mislead an auditor during his or her examination or review of the issuer's financial statements. This includes bribes or other financial incentives including potential future employment; providing an auditor inaccurate or misleading legal analysis; threatening to cancel or canceling existing non-audit or audit engagements if the auditor objects to the issuer's accounting; seeking to have a partner removed from the engagement if he or she objects to the issuer's accounting; blackmailing; or making physical threats. In the view of the ICBA, it is appropriate to list these items. However, we are concerned that canceling an auditing engagement, or any discussion that may be construed as such a threat will automatically be considered as a violation of law and regulation. There may be legitimate reasons for a financial institution or company to cancel an auditing relationship, e.g., if the auditing firm is simply not doing a good job. Such a situation may have nothing to do with attempts to fraudulently influence an audit. Yet, an unhappy auditing firm, fearing that it may loose a client may use this language to turn the threats back on the company it is auditing.
Actions that could, if successful, result in rendering financial statements materially misleading include actions taken at any time with respect to the professional engagement period to fraudulently influence, coerce, manipulate, or mislead an auditor: to issue a report on an issuer's financial statements that is not warranted in the circumstances (due to material violations of generally accepted accounting principles, generally accepted auditing standards, or other standards); not to perform the audit, review or other procedures required by generally accepted auditing standards or other professional standards; not to withdraw an issued report; or not to communicate matters to an issuer's audit committee. We believe that this is an appropriate list.
The terms "independent public" or "certified public accountant" have been commonly used in securities laws and SEC regulations to refer to the accountant providing audit and review services to an SEC registrant. The Sarbanes-Oxley Act changed some, but not all, of the references in anticipation of accounting firms registering with the new Public Company Accounting Oversight Board (Board). Once firms are required to register with the Board, the SEC expects the term "independent public" or "certified public accountant" as used in the proposed rule, would include registered public accounting firms and persons associated with such a public accounting firm. The SEC should conform its definitions to those used in the Sarbanes-Oxley Act and by the Public Company Accounting Oversight Board to the extent possible. Defining "certified public accountant" may be problematic since states and localities make determinations about qualifications.
The SEC believes that Congress intended the phrase "engaged in the performance of an audit" to be given a broad reading and it should encompass the professional engagement period and any other time the auditor is called upon to make decisions regarding the issuer's financial statements, including during negotiations for retention of the auditor and subsequent to the professional engagement period when the auditor is considering whether to issue a consent on the use of prior years' audit reports. Thus the SEC proposes that its rules apply throughout the professional engagement and after the professional engagement has ended when the auditor is considering whether to consent to the use of, reissue, or withdraw prior audit reports. In limited circumstances, the proposed rules also may apply before the professional engagement, such as during offers to engage the firm.2 In our view, this is appropriate.
Under the proposed rule, an officer, director, or person acting under the direction of the officer who engaged in conduct to improperly influence an auditor would be culpable if he or she knew, or was unreasonable in not knowing, that the improper influence could, if successful, result in rendering financial statements materially misleading. Rather than stating that no person acting "under the direction of" an officer or director shall improperly influence the auditors of the issuer's financial statements, the SEC is considering replacing the language with a statement that no person acting "at the behest of" or "on behalf of" an officer or director shall improperly influence the audits. The phrase "under the direction of " has a similar meaning to "at the behest of" in that it indicates that an officer of director may be commanding or ordering another person to improperly influence an auditor. "On the behalf of" would include someone who took action to improperly influence that was not based on a direct command or order from an officer or director but a perception (rightly or wrongly) that the superior would want such action. Thus both "behalf" and "direction" should be included.
In our view, the use of the terms "fraud" or "fraudently" are more appropriate than "improper" or "improperly" to describe the actions that the Sarbanes-Oxley Act were intended to prohibit. Also, there may be instances where information was "improperly" provided that is not a case of "fraud." For example, an employee may provide information to an auditor that should not have been given to someone outside the organization, information unrelated to the audit and that would not affect its outcome. In this case, the information would have been given improperly, but not fraudently.
The SEC indicated that it does not expect that the proposed rules would increase significantly costs for issuers or accounting firms. However, community bankers disagree. They expect costs to increase for D & O insurance and more litigation will occur-some that may not be justified. Also, bankers expect accounting fees to increase due to the increased liability exposure for accounting firms.
The SEC states that there is no exemption in the Act for small businesses and the SEC plans to treat small companies the same as large companies for the benefit of investors. As the SEC goes forward with this and other rules, we urge the SEC to be mindful of difficulties some smaller institutions, such as community banks and those located in more rural areas, face in seeking auditing firm alternatives and complying with other new regulatory requirements due to limited staff resources.
We appreciate the opportunity to comment.