ELI LILLY AND COMPANY
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549
Re: Proposed Rule: File No. S7-49-02. Strengthening the Commission's Requirements Regarding Auditor Independence
Dear Mr. Katz:
Eli Lilly and Company appreciates the opportunity to respond to the Proposed Rule: File No. S7-49-02, Strengthening the Commission's Requirements Regarding Auditor Independence (referred to as the "Proposed Rule").
Overall, we support the Commission's initiatives to enhance the independence of accountants that audit and review financial statements and prepare attestation reports filed with the Commission. We wish to provide comments on several aspects of the Proposed Rule that we believe will provide practicality to the Proposed Rule while still complying with the intent of the Sarbanes-Oxley Act.
Prohibition On Certain Non-audit Services
- We are concerned over the scope of the "expert" services exception to the Proposed Rule. The term "expert" seems ambiguous and it is unclear how these services would be differentiated from permissible services, such as tax services. The distinction between advocacy and providing appropriate assistance to an audit committee is not clear. We request that the Commission provide an elaboration on the examples of "experts" and cases where providing appropriate assistance is acceptable under the Proposed Rule.
- Tax Services - We have seen from outside advisors drastically different interpretations of the scope of permitted tax services under the Proposed Rule. The Proposed Rule states that the permissibility of tax services rests on their consistency with the three principles outlined in the Proposed Rule. That appears inconsistent with the overall message which states that "nothing in these proposed rules is intended to prohibit an accounting firm from providing tax services to its audit clients when those services have been pre-approved by the client's audit committee." When discussing tax shelters (a prohibited service), the term "tax strategies" is used. That language could be interpreted to include tax planning and consulting which again appears to be in conflict with the overall message discussed above. Please clarify this section and provide specific examples of what is allowed and disallowed.
Mandatory Partner Rotation
- We strongly oppose the rotation of all partners on the engagement. The Sarbanes-Oxley Act clearly states "the lead (or coordinating) audit partner, or the audit partner responsible for reviewing the audit" should rotate every 5 years. In our opinion, the Proposed Rule goes far beyond the original intent by including "the client service partner, and other line partners directly involved in the performance of the audit." We believe this mandate will increase audit risk, increase audit fees and substantially decrease audit quality. Consider the level of expertise that would be lost after each rotation. The amount of time needed to learn complex operations of a multi-national corporation, industry-specific regulations and institutional knowledge regarding complex historical transactions appear too great to justify any extra layer of independence. We believe the decision-making authority rests primarily with the lead or coordinating partner, so mandatory rotation by him/her will achieve the desired result of a "fresh look" without jeopardizing the quality of the audit. Public accounting firms have traditionally had high turnover at the manager and staff levels so companies understand, first hand, the negative impact rotation can have on the audit. It is very unsettling to think about the impact of adding partner turnover to the mix as well.
Consider a tax partner who was involved with an audit client's tax strategies. It is not uncommon, based upon our experience, to have an IRS audit of those related tax treatments commence four to five years after the return was filed, given the backlog of IRS audit activity. As we understand the Proposed Rule, the tax partner would be required to rotate off the engagement and may be prohibited from providing further related tax services to assist in the audit. This scenario does not appear to be the intent of the Sarbanes-Oxley Act and in fact, the Proposed Rule goes beyond what is required by the legislation. Additionally, we do not see the benefit of subsidiary audit partner rotations, especially in international arenas where the number of audit partners in smaller correspondent or affiliated firms may be limited. Given the challenges of doing business outside of the United States, the continuity of the audit partner is an integral part of maintaining audit quality for international accounting and reporting. In summary, we believe the rotation of only the partner in charge of the audit and the independent reviewer, as required by the legislation, achieves an appropriate balance of getting a fresh look without adding too much audit risk because of the time required to get up to speed on a new engagement.
- We believe the concept of "forensic auditors" is interesting and possibly worth exploring, but we oppose its requirement in the Proposed Rule. The process needs to be tried and tested before it should be considered mandatory.
Audit Committee Administration of the Engagement
- In general, we agree with the Proposed Rule's recognition of the critical role played by the audit committee and the importance of the processes surrounding audit committee communication and reviews and approvals of the work of the independent auditors. We are concerned, however, that the stringent conditions attached to the "de minimus" exception in Sarbanes-Oxley severely limit its utility. We strongly support the suggestion raised in the Proposed Rule that the Commission allow audit committees to adopt a policy that specific types of contracts that are recurring and less than a stated percentage of the total revenues paid to the auditor may be entered into by management, subject to review at the next regularly scheduled committee meeting. To prevent abuse, we suggest that the limit be applied in the aggregate. For example, the amount approved by this method in any fiscal year could be limited to 5 percent of the total revenues paid by the issuer to the auditor in the previous fiscal year. In our view, this is consistent with both the letter and spirit of Sarbanes-Oxley because it requires the audit committee to affirmatively conclude, in advance, that certain services (in this case, recurring small-dollar services) will not impair the auditor's independence.
Communications with Audit Committees
- With regard to communication of alternative accounting treatments we are concerned with the term `preferred treatment' by the accounting firm. We believe this `preference' should be based on current accounting literature and not any personal preference the auditor might have. In addition, this requirement needs to be limited to material or significant matters. As drafted, it apparently requires communication about all discussions of alternatives, no matter how insignificant.
Conflicts of Interest Resulting from Employment Relationships
- We are concerned with the potential broad interpretation of the "financial reporting oversight role". The term seems too broad and may inadvertently include those individuals who lack the decision-making responsibility that would truly impair independence. The Sarbanes-Oxley Act cites the CEO, CFO, Controller and CAO as those with a significant financial decision making role. The proposal to expand the definition could potentially include managers and financial analysts who have closing or financial statement reporting responsibilities. We do not feel that these latter examples should be considered significant decision-makers in the preparation of the issuer's financial statements and MD&A. The Proposed Rule also uses the term "audit client" which could encompass those at a subsidiary level with local reporting oversight responsibilities. In summary, we feel the expanded definition and the inclusion of these additional individuals appears to be beyond the scope of what is intended by the Sarbanes-Oxley Act. We would prefer that the final rules reflect the language as it was originally written in the Sarbanes-Oxley Act.
Disclosure of Fees Paid to Auditors and Pre-Approval of Fees
- We are concerned with the disclosures regarding "audit-related fees" and "all other fees". The definition and the distinction between the two are unclear and needs to be further explained.
Effective Dates and Transition
- We are concerned with the ambiguity of the transition period and fear that if the rule were to be effective on the day it is adopted it would cause chaos to the audit engagement. Specifically we are concerned with the required dates for audit partner rotation. If the Proposed Rules are implemented as written, then we request that the Commission allow for a staggered implementation over (1) a two-year period for domestic engagements and (2) a three to four year period for international engagements. If the Proposed Rule were adopted as currently stated, then having all partners rotate off of the engagement at the same time would be disruptive to the registrant and the audit firm.
- We also believe there should be a reasonable transition period for the proxy statement disclosures. Like many other companies, we are well into "proxy season" and our document must be essentially complete by mid-February. We request that the new disclosure rules be effective for proxy statements filed more than 90 days after the final rule is published.
We appreciate the opportunity to express our views and concerns in regards to this Proposed Rule. If you have any questions regarding our response or would like to discuss our comments, please feel free to call me at (317) 276-2024.
ELI LILLY AND COMPANY
Arnold C. Hanish
Executive Director, Finance and
Chief Accounting Officer