BDO Seidman, LLP
Accountants and Consultants
330 Madison Avenue
New York, NY 10017
November 25, 2002
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609
Re: Release No. 34-46685
Improper Influence on Conduct of Audits
File No. S7-39-02
Dear Mr. Katz:
This letter is the response of BDO Seidman, LLP to your request for comments regarding the above-captioned proposal.
We support the Commission's objective of ensuring that an issuer's management makes open and full disclosures to, and has honest discussions with, the auditors of the issuer's financial statements. We are concerned, however, that proposed Rule 13b2-2(b)(1) is too broad and not sufficiently clear. Also, we disagree with the idea of broadening the language in the rule to indicate that an officer or director could violate the rule without giving specific direction to another person. Our more specific comments about the proposal and our recommendations for alternative approaches are set forth below.
Actions Covered by the Proposed Rule
Proposed Rule 13b2-2(b)(1) would prohibit officers and directors, and persons acting under their direction, from fraudulently influencing, coercing, manipulating or misleading the auditor of the issuer's financial statements for the purpose of rendering the issuer's financial statements materially misleading. As indicated in footnote 16, the word "fraudulently" applies only to influencing an auditor. We believe that the proposed rule is too broad with respect to the actions it might cover.
The words "coerce," "manipulate" "and mislead" are quite broad. Further, the Release indicates that pressuring an auditor in certain ways can be a violation of this rule. We believe that there are many real-life examples of communications by companies to their auditors that do not constitute coercing, manipulating or misleading the auditor but might, under the proposed rule, be interpreted as violations. For example:
- For legitimate business reasons, clients sometimes pressure auditors to complete an audit by a tight, but achievable, deadline. In other situations, clients with abrasive personalities sometimes communicate in ways that cause the auditor to feel pressure. Could these actions be viewed as violations of the proposed rule?
- Clients and auditors sometimes come to different conclusions about applying generally accepted accounting principles to a transaction or event. A spirited debate may ensue, during which both sides may strongly, even heatedly, communicate their views. If the client is correct and convinces the auditor, then the process produces the desired result, i.e., financial statements that are fairly presented. But even if the client is wrong, healthy debate is still a necessary and appropriate part of the process. If the client is wrong, could his or her actions viewed as manipulating, misleading or pressuring the auditor? And perhaps more importantly, will the fear of appearing to violate the proposed rule discourage clients from arguing positions they honestly believe in?
We think the broad language in the proposed rule could inappropriately chill legitimate communications between an issuer and its auditor. Further, even if such communication does occur, if financial statements certified by an auditor are later found to be misstated, we fear that it will be unfairly easy to use this rule in hindsight to find fault with people who acted in reasonable ways.
To address these concerns, we think the Commission should narrow the definition of prohibited behavior by requiring fraudulent intent in connection with all four of the actions listed. The final rule should clearly communicate that the normal give and take between issuers and auditors would not constitute violations without scienter.
The Release provides a list of actions that might constitute improper influence. We think it would be useful to provide a similar list in the release covering the final rules, provided, once again, that it is clear that the actions are predicated on an intent to defraud. In that regard, we believe the Commission should consider expanding it to better illustrate how the language in the rule should be applied. Items the Commission should consider adding to the list include:
- Verbal abuse
- Creating undue time pressure
- Not providing information to auditors on a timely basis
- Not being available to discuss matters with auditors on a timely basis
People Covered by the Proposed Rule
We think the Commission should make proposed Rule 13b2-2(b)(1) clearer regarding the people it might cover. The Rule clearly applies to an officer or director who directly or indirectly takes action to try to render the financial statements misleading. However, it is not clear (1) how another person's actions might affect the guilt or innocence of the officer or director, or (2) how the Rule might apply to other people. Our concerns arise primarily out of the phrase "or any other person acting under the direction thereof" in the proposed Rule.
Officers and Directors
With respect to officers and directors, it is not clear to us whether (1) the officer or director is guilty of a violation any time a person acting under his or her direction violates the Rule (regardless of whether the officer or director did anything to request or encourage the other person's act), or (2) the officer or director must take some action to cause the other person to violate the Rule. We believe that the intent of the Rule as proposed and the appropriate approach should be to hold the officer or director in violation of the Rule only if he or she took some action (i.e., the second choice in the preceding sentence). We encourage the Commission to clarify this point in the final rule.
With respect to other people, the Release states, "In appropriate circumstances, persons acting under the direction of officers and directors also may include other partners or employees of the accounting firm (such as consultants or forensic accounting specialists retained by counsel for the issuer) and attorneys, securities professionals, or other advisers who, for example, pressure an auditor to...." We don't understand the meaning of the parenthetical insert in its current placement in the sentence. The insert would make sense to us if the Commission intended for it to follow the phrase "other advisors." We suggest the Commission clarify this in the release covering the final rules.
Wording Changes Being Considered
The Release asks whether the phrase "under the direction" should be replaced with "at the behest of" or "on behalf of" in order to indicate that no specific direction by an officer or director is required to violate the rule. Based on the definitions of these alternatives in Merriam-Webster's Collegiate Dictionary, we don't think the phrase "at the behest of" changes the meaning. We think phrases that better indicate a lack of influence or direction are "in behalf of" or "on behalf of." Webster's indicates that these phrases mean "in the interest of" or "for the benefit of."
However, we do not support broadening the language in this manner. We believe that doing so could have inappropriate consequences. Consider the following example:
The CEOs of Companies A and X each set a poor tone at the top of their companies by not emphasizing ethical conduct by employees. Company X is a customer of Company A. At the request of Company A's Vice President - Sales, a Company X purchasing manager signs a false confirmation and sends it to Company A's auditors. This facilitates rendering Company A's audited financial statements materially misleading. This benefits Company A's Vice President - Sales and its other officers by causing them to receive greater bonuses. We believe Company A's Vice President - Sales and Company X's purchasing manager should be considered guilty of violating the Rule. However, it's not clear whether the CEOs of Companies A and X violated the rule because they set the poor tone at the top.
As stated above, we think an officer or director must take some action that manifests fraudulent intent to violate the Rule. Therefore, even though in our example the Vice President - Sales may have acted for the benefit of the CEO of Company A, we don't think the CEO of Company A should be guilty of a violation, assuming he did not intend to cause and was unaware of the Vice President - Sales' actions.
Similarly, we think a person who is not an officer or director must have fraudulent intent and act at the direction of an officer or director to violate the rule. We don't believe setting a poor tone at the top of Company X should make the CEO of Company X guilty of a violation, even though that action benefited the officers of Company A.
We think using a phrase such as "at the direction of" would more appropriately define the people who should be considered in determining violations of the rule.
We note that the Release does not provide guidance as to what auditors should do if they believe they have been subjected to actions prohibited by the Rule. If the Commission writes the final rule in a manner that is significantly broader than we advocate, we expect that this may make it more difficult for auditors to identify potential illegal acts. This may cause them to struggle with meeting their responsibilities under Section 10A of the Exchange Act. If a broader approach is taken, we urge the Commission to instruct its staff to work with the accounting profession to develop guidance to help auditors identify potential illegal acts and meet their responsibilities under Section 10A of the Exchange Act.
* * * * * * * *
The goal of improving communications between management and auditors is a good one. We hope that the rules adopted will be effective in achieving it. However, the Rule will have the opposite effect if it is so broad that it chills such communications. In addition, the Rule should not be so broad that it holds a person accountable for the improper actions of another simply because he or she is at the top of the chain of command or because he or she unintentionally contributed to rendering an issuer's financial statements materially misleading.
We appreciate this opportunity to express our views to the Commission. We would be pleased to answer any questions the Commission or its staff might have about our comments. Please contact Wayne Kolins (at (212) 885-8595 or via electronic mail at email@example.com) or Lee Graul (at (312) 616-4667 or via electronic mail at firstname.lastname@example.org).
Very truly yours,
/s/ BDO Seidman, LLP