Software Finance and Tax Executives Council
November 25, 2002
Jonathan G. Katz
Re: Comments on Proposed Rules Regarding Improper
Dear Mr. Katz:
I write on behalf of the Software Finance and Tax Executives Council (SoFTEC) to comment on the Commission's proposed new rules regarding improper influence on the conduct of audits of public companies. In its discussion of the proposed rules, the Commission asks whether "the types of conduct that might constitute actions to fraudulently influence an auditor be set forth in the rules." As discussed below, SoFTEC believes that the final rules should not attempt to specify the types of conduct that might constitute actions to fraudulently induce an auditor.
SoFTEC is a national trade association providing software industry focused public policy advocacy in the ears of tax, finance and accounting. Many SoFTEC members are publicly traded and the proposed rules regarding the fraudulent inducement of auditors are of interest to them. The members seek to have their comments on the proposed rules voiced through this letter.
Section 303(a) of the Sarbanes-Oxley Act makes it unlawful, under such rules or regulations as the Commission shall promulgate, for an officer or director of a company to fraudulently influence an auditor in the conduct of an audit for the purpose of rendering the company's financial statements materially misleading. We believe that the operative word of the statutory mandate is "fraudulent." The term "fraudulent" is one of art and its meaning is well know to the common law. The hallmark of fraudulent conduct is scienter which requires some showing of corrupt intent on the part of the fraudulent actor.
The types of conduct that, when accompanied by scienter, rise to the level of fraud are myriad. Any attempt to catalog the various types of such conduct would be fruitless because, as the Commission recognizes, "[t]he facts and circumstances of each case, including the purpose of the conduct . . . , would be relevant to determining whether the conduct would violate the proposed rule. Thus, we think it would be a mistake for the proposed rules to offer any sort of list of the types of conduct that might be relevant in such an inquiry.
There can be little question that offering bribes to an auditor as an inducement to cause corporate financial statement to be misleading would constitute fraudulent conduct because bribery connotes the presence of the requisite scienter. The same could be said of blackmail and the making of physical threats. We see little to be gained by including in the proposed rules as examples these obvious forms of fraudulent conduct.
We are particularly troubled by the proposal set forth in the discussion section of the proposed rules that would include in such a list of relevant types of conduct (1) the seeking to remove an audit partner because the partner objects to the accounting, and (2) providing an audit partner with inaccurate or misleading legal analysis. These types of conduct, in and of themselves, are not necessarily accompanied by the same indicia of scienter that accompany bribery, blackmail and physical threats. The person objecting to the to the audit partner's accounting might have a legitimate objection. Including such an example in the rule might chill legitimate debate regarding appropriate accounting. Similarly, if a corporate counsel provides a legal analysis that is misleading, there exists the possibility that the attorney was mislead or had relevant facts concealed from him or her. After all, fraudulent accounting practices frequently are accompanied by the concealment of relevant information. If the Commission includes these two provisions in the final rules, at a minimum, they should be modified to include appropriate scienter elements.
We also are concerned that the Commission's characterization of the proposed rules as "address[ing] the improper influence" of auditors may be construed as signaling the intent of the Commission to depart from the traditional scienter requirement and to impose a new lower standard. The statute itself speaks in terms of the use of "fraudulent influence" not merely "improper influence." SoFTEC believes that scienter should remain a requirement for showing fraudulent conduct and hopes that the Commission does not intend a lower standard in its proposed rules.
We hope you find these comments helpful in your deliberations in promulgating final rules in this area. I can be reached at (202) 331-9533 with any questions.