Anchin, Block & Anchin LLP
Accountants and Consultants
New York, New York 10018
FAX (212) 840-7066
January 13, 2003
Via e-mail: email@example.com
Mr. Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549-0609
Re: File Number S7-49-02
Dear Mr. Katz:
Anchin, Block & Anchin LLP is pleased to have the opportunity to comment on the above-referenced proposed rules. We believe it is important that the Commission and its staff receive input from a broad range of practitioners, corporate executives, investors and other users of financial statements in order to fully assess the impact of the rules and their effectiveness in carrying out both the letter and the intent of the Sarbanes-Oxley Act of 2002 (the "Act").
We further believe that the rules, as proposed, are unnecessarily more onerous and far reaching than the requirements of the Act. In general, we are concerned that certain provisions of the proposal will have ramifications which go beyond the intent and possibly beyond the specific terms of the Act. Because the extremely short time frame for issuing these rules contained within the Act necessitated an accelerated comment period and, more importantly, leaves little time for the Commission and its staff to fully digest, understand, weigh the merits of and incorporate the suggestions made in the numerous comment letters received, we believe the initial set of rules enacted by the Commission should be in strict conformity with the letter of the Act and should not seek to expand the scope of the Act without careful study of all of the issues. Then, after an appropriate period of time has been allowed to evaluate the effectiveness of those rules, additional rules could be adopted which would serve to correct any of their shortcomings. If the rules are enacted as proposed, it would be impossible to reverse the turmoil and negative effects which will result.
We have limited our comments to those areas which have the most significant impact on our clients, the investing public and our firm. Our comments are summarized below and are presented in detail in the discussion which is attached to this letter. We have also endeavored to respond to certain of the specific questions raised by the Commission in their commentary to the proposed rules.
Summary of Key Comments:
- Partner Rotation
- The expansion of scope to include all audit engagement team partners is unnecessary and because it includes so many individuals, may effectively require firm rotation which was specifically not required by the Act.
- The prohibition against a partner who has been rotated off an engagement from having any contact with the engagement team may have the unintended effect of reducing the quality of audits by eliminating the possibility of the engagement team drawing on the specialized knowledge of the former engagement partner. Further, any partner with specialized knowledge, who had consulted with respect to issues raised by the audit team, might be precluded from taking a role as a partner on the audit engagement due to his prior, de minimis contact to the audit.
- The requirement that, when an entity is part of an investment company complex, all time spent by a partner on any aspect of any entity within such complex shall be counted toward the five year period for all entities within such complex is unnecessarily restrictive.
- The requirement of a five year "time-out" is unnecessarily long and will have the effect of significantly reducing the pool of available, qualified audit partners available to companies in specialized industries.
- A reasonable transition period should be adopted from the prior partner rotation requirements which exist under the AICPA SECPS to the new SEC rules to avoid the unplanned, wholesale change of audit partners which would inevitably lead to reduced audit quality.
- The apparent presumption that audit partners are fungible commodities is fallacious and ill conceived.
- Services Outside the Scope of Practice as Auditors:
- The prohibition on providing "any internal audit services..." creates a problem for any auditor attempting to complete an audit in accordance with Generally Accepted Auditing Standards ("GAAS") where the client does not expend its resources to provide an effective internal audit function or where such function is determined by the external auditor to be insufficient or unreliable. GAAS require the auditor to obtain an understanding of the company's internal controls in order to determine, in part, the level of reliance the auditor can place on those controls in planning and performing the audit. We believe the definition of those services which constitute the prohibited internal audit function is not sufficiently clear. We question whether any tests of internal controls when performed by the external auditor, for example, which might assist the external auditor in performing his audit, would be prohibited under the Act since those same tests could have been performed by an internal auditor.
- Clarification is required to define "Expert Services" such that, an auditor is able to defend his conclusions or appear as a fact witness with respect to a certified financial statement without violating this rule. While the text of the staff commentary which accompanies the proposed rules seems clear on this point, the text of the rules is not.
- If certain tax services are allowable while others are not, and the penalty for non-compliance, which could be determined long after the issuance of the auditors' opinion on the financial statements, could be a criminal matter, we believe it is meaningful to categorize tax services into permitted and disallowed activities.
- Partner's compensation with respect to non-audit services should be unaffected by this rule-making.
- General Comment:
- The rules as proposed would not apply equally to all publicly traded entities. We believe that distinctions are being made between those companies registered under the Securities and Exchange Acts of 1933 and 1934 and those investment companies registered under the 1940 Act. We recognize that investment companies are by their nature different. They are subjected to significantly more governmental and industry oversight than other entities. The body of knowledge and skill set necessary automatically limits the number of people qualified to audit them. By including all entities within the investment company complex, even when only minimal connections exists, the Commission is reducing the number of qualified auditors available to this industry beyond that which is required of other industries. As such, if not done for all registered entities, we recommend that the Commission consider allowing for certain exceptions to the "all partner" rotation rules for investment companies.
In its rule making, we believe the Commission should be focused on two basic questions;
- Does the proposed rule adequately address the requirements of the Act, while fully considering the legislative intent of the implied limits of the Act?
- Does the proposed rule further the interests of the investing public which the Act was designed to protect without arbitrarily and unduly restricting that same public's access to the most qualified, knowledgeable and cost effective firms and practitioners? In other words, is the proposed rule consistent with the long established goals of fair-trade and competitiveness in the market, or are the rules so restrictive as to effectively limit the performance of services to only the largest of service providers?
We do not believe the proposed rules, as drafted, adequately and affirmatively answer these questions.
We would be pleased to discuss any of our comments and any of your questions at your convenience. Please contact Peter L. Berlant (firstname.lastname@example.org) or David J. Lamb (email@example.com) by telephone at 212-840-3456 or by e-mail regarding this document.
Very truly yours,
Anchin, Block & Anchin LLP
Background of Firm
In order to put our comments into perspective, we think it appropriate to provide some information on our firm.
Founded in 1923, Anchin, Block & Anchin LLP has grown into one of the largest single office accounting firms in the United States. We have earned an excellent reputation for the quality of our services which comes in no small part from our insistence on assigning responsibility for each engagement to those partners and personnel who possess the requisite skills and experience to do the job right. Our operating philosophy has always placed a strong emphasis on developing our partners from within. Our track record has proven this approach to be beneficial in maintaining the highest professional standards. As such, it is quite common in our organization to have multiple partners on each engagement. Some are younger partners who are being groomed to take over responsibility for particular engagements, some are specialists in a particular industry or aspect of the job, but ultimately only one partner is the "Lead or Engagement Partner" who is responsible for the final approval of the audit.
Our firm consists of 38 partners, 3 non-CPA principals and approximately 200 professional staff. By any measure; number of partners, professional staff or revenues, we have consistently ranked in the top 100 accounting firms in the country and among the top 25 in the New York metropolitan area.
One must look beyond the surface to realize the implications of the proposed rules on a firm such as ours and how truly onerous they would be on smaller organizations. Of the 41 stakeholders twelve are tax specialists, four are within two years of retirement and two-thirds of the rest have no experience with public company engagements. The primary focus of our SEC engagements has been in the investment company arena. Of the nine partners who concentrate in this area, approximately half have experience with publicly traded investment companies and virtually all have been involved, as a partner, in some aspect of the audits of our publicly traded financial services clients, or other entities within the related investment company complex. This aspect is discussed further, below.
Discussion Related to the Proposed Partner Rotation Rules
While the Act specifies that the scope of partner rotation should include both "the lead (or coordinating) audit partner... [and] the audit partner responsible for reviewing the audit" the proposed rules have been extended to include all partners connected to the audit engagement and, in the case of an investment company, any partner connected to an audit of any entity within the investment company complex. These changes are overreaching and unnecessary. While the merits of partner rotation in achieving the goals of the Act are debatable, the requirement is now the law of the land. However, inclusion of all of the partners enumerated in the proposed rules would cause many serious repercussions and likely result in a lowering of audit quality.
We believe it is appropriate at this point to remind the Commission that the situations which led to the passage of the Act involved the largest accounting firms (the Big Five). However, the enactment of the rules as proposed will more significantly impact medium sized and smaller firms. While the largest firms could arguably rotate all of the positions which are proposed under the rules with equally qualified and experienced partners, in firms such as ours, the pool of experienced and qualified talent in SEC matters and the industries in which our publicly traded clients operate is not infinite. While we would never attempt to provide a service for which we were not qualified, we are concerned that other firms might attempt to retain their clients by assigning less qualified and experienced partners to the engagements. We suspect that many, otherwise qualified firms will choose to resign their public company engagements rather than stretch the limits of their partners' abilities. The unfortunate and unnecessary result will be that there will be fewer firms, and therefore less competition, in the marketplace to service these clients, audit fees will go up while the quality of audits will go down.
We believe that industry and client specific experience are of paramount importance in performing an effective and efficient quality audit. The Commission seems to believe that such experience has no merit. We, on the other hand have always put great value in having our staff gain relevant experience, in significant part, by learning on the job. We believe that the complicated nature of many industries and the accounting rules they operate and report under cannot be learned in a few years or months. The risk of missing important issues is far greater in the early years of an individual's contact with an engagement. As they mature personally and professionally into our partners, we do not immediately give them lead responsibility for their engagements but, continue to have them work for several years under a more experienced partner. While this approach is important with our privately held clients, we think it even more important on our publicly traded clients where the potential risks and more far reaching ramifications of an error are greater. The Commission's proposed rules would substantially reduce the effectiveness of this approach since all time served on the engagement, once a partner, would count toward an individual's five year service maximum. The proposal would effectively cause firms who believe in the value of experience to reduce a partner's time as lead partner to a one or two year period, not the five year period contemplated by the Act. We therefore believe that the rotation requirements should be limited to those partners enumerated in the Act, not those who are serving as de facto senior managers on the engagement. This leads to the obvious conclusion that we do not believe the rotation requirements should be further extended to senior managers or other positions on the audit team.
Similarly, the Commission seems again to favor the largest firms when they carve out an exception for "national office" partners who consult on technical issues with the engagement team. In firms such as ours, the technical services department includes only of one partner who has no direct client responsibility and who had served as a concurring partner. Our system of quality controls requires this partner to perform a technical review every SEC engagement. In addition, where another partner has specific experience or knowledge with regard to a particular technical issue, that partner will be consulted. While we recognize that the Act requires us to change our procedures so that another partner will serve as the reviewing partner, the rules are unclear as to whether we would lose the quality control partner's availability as a resource for technical issues, due his prior service as a concurring (reviewing) partner. Such a requirement would seem to run counter to the legislative intent of the Act; to improve audit quality. Likewise, it would seem that the proposed rules would exclude many of the partners who previously provided any advice to an engagement team from rotating on to any public company audit.
With respect to the additional requirements for partner rotation in an investment company complex, they too are unnecessary and excessive. The broad definition of entities which are included in the investment company complex would preclude many partners, who have the requisite experience gained on other audit clients in the investment company industry from rotating onto other clients simply because the two companies shared a common link in the complex. When the entities within the investment company complex are not served by the same boards of directors and have different audit committees, they should not be deemed to be effectively connected and therefore a partner who is required to rotate off of one account should be allowed to service another despite their being in the same complex. Also, when one engagement is for a registered investment company while another is for an investment company which is exempt from registration whose only link is a common investment advisor (which is not an audit client) or other minimal connection, there seems no reason for precluding the partners who rotate off the public engagement from serving the non-public (non-issuer), and vice-versa.
In short, if the proposed rules are enacted as written, the result will likely be to force firm rotation. The Act was very specific in its requirement that the Comptroller General of the United States study and report on this issue. It would be tragically short-sighted and inconsistent with the clear requirements of the Act for the Commission to usurp the Comptroller General's report by acting in haste to enact these rules.
On the subject of the length of the "time-out" period, we believe the plain language of the Act is clear; "...in each of the 5 previous fiscal years..." [emphasis added]. Thus, the Act would require only a one year "time-out", since, after a one year absence, the subject partner would not have served in each of the previous five years. If the intention of the act is to provide a "fresh look" at the engagement and its audit, this one year off would seem sufficient. Alternatively, continuation of the current SECPS requirement of a two year "time-out" would seem reasonable. There seems to be no rational justification for the Commission's proposed five year period. In addition, because of our strong belief in the value of experience, we believe that the Commission should consider allowing, if not encouraging, a partner who has been "rotated off" of an engagement to be consulted on client specific matters and issues, which will ultimately help the successor partner to provide a more effective audit. To require a clean break with no contact is to completely ignore the value of accumulated experience.
As discussed above, we are not a small firm yet, the proposed rules which seem so skewed in favor of only the largest of firms might force us, many similarly sized and virtually all smaller firms out of the marketplace for SEC engagements. The fact that we have more than twenty-five audit partners does not mean that we have twenty-five partners with the required industry and SEC experience. Contrary to the apparent belief of the Commission, all audit partners are not created or trained equally, they are not a fungible commodity. Further, the suggestion that "smaller firms...would have to accept more partners into the firm" is unacceptable to us and it should be to the Commission, Congress and the investing public. Admission to partnership is not something we take lightly. We believe that the quality of our work has endured for nearly eighty years because we choose our partners carefully and only after a long period of working with them as they develop their professional skills. The Commission's approach encourages a lowering of those standards and would lead to a bidding war for qualified mercenaries which would drive up the cost of SEC engagements while lowering familiarity with firm quality control standards and thus, inevitably, quality. We believe that result would not be in the best interest of the investing public. It seems in their commentary that the Commission is well aware of these issues and has chosen to ignore them. This attitude is in direct conflict with the congressional intent which was to improve the quality of audits.
As far as the proposal to require issuers to engage forensic auditors to evaluate the work of the financial statement auditors either as a supplement to or a substitute for the partner rotation requirements, we believe this proposal is misguided and will only add cost without any benefit. An examination under GAAS and a forensic audit are focused on very different objectives. We find the proposal to be objectionable since there is an implied assumption of wrongdoing on the part of the financial statement auditors. An alternative and more effective approach would be to mandate that the Public Company Accounting Oversight Board establish a procedure to review the sufficiency of audit work, and compliance with the Act of registered firms. Whether this takes the form of enhanced peer review or the employment of a staff of reviewers by the Board, would be up to the Board to determine.
If the Commission decides to enact the proposed partner rotation rules, reasonable transition rules must be adopted. In many cases, immediate adoption of the rules, as written, would result in hasty, unplanned transition efforts including removal of all partners from the engagement since previously only the lead partner was subject to rotation. Many rotation plans will need to be revisited since the transition, as originally planned, would have included a partner who was already serving in a subordinate or concurring role on the engagement. We propose that the current lead partner on any subject engagement be allowed to continue in such role until his scheduled rotation under the seven year SECPS requirements and that the period for measuring years of service for non-lead partners begin on the date of adoption of the final rules. The effect of this transition rule would be to allow a maximum of an additional two years for any subject lead partner and allow for a reasonably planned transition rather than the fire drill which would occur with immediate compliance with the new five year requirement. As to the extension of the rotation requirement to the "reviewing partner", we assume that this refers to the SEC mandated "concurring partner". Since rotation of this position is a new requirement, and since this individual likely possesses unique technical knowledge and skills which are not readily replaced, we recommend that service on the engagement be deemed to begin upon adoption of the proposed rules, not the first day of service which, in many cases, may already have passed the five year mark.
Discussion Related to Services Outside the Scope of Practice as Auditors
Internal Audit Services
We believe that the proposed prohibition against providing "any internal audit services..." is in direct conflict with an auditor's requirements under GAAS. An internal auditor can provide numerous services. These include both operational and financial audit procedures. Within the realm of financial audit procedures, an internal auditor's function these procedures might include tests of internal controls and substantive tests. Statement of Auditing Standards (SAS) No. 65 provides that if in the external auditor's judgment, the internal auditor's procedures are sufficient they may, but are not required to, reduce the scope of their testing. Since certain procedures could be performed by an internal auditor, will the performance of those same procedures by the external auditors, which could only improve the quality of their audit, constitute a violation under the Act?
This seems to be an incongruous result. Similar conclusions should be reached where the client does not employ or has an ineffective internal audit staff. Clearly the auditor is not auditing his own work and any additional audit procedures performed by the external auditor should be looked upon favorably, not forbidden.
While the staff commentary which accompanies the proposed rules clearly indicates that the prohibition against providing "Expert Services" does not include an auditor defending his conclusions or appearing as a fact witness with respect to the audited financial statements or, if such services are pre-approved by the company's audit committee, the preparation of the company's tax returns, this exception does not appear in the text of the rule. If auditors are to rely on this intent, we believe it should be clearly spelled out in the rules and not be left to later staff interpretation.
Additionally, we believe the Commission misinterpreted Senator Sarbanes's intent when it included in its prohibitions expert services in connection with legal services. There are numerous instances in which the auditor might cooperate with, or be engaged by the audit client's attorneys in connection with various legal matters. We do not believe such cooperation automatically places the auditor in the position of being an advocate for the client. So long as the auditor is not being directed to a conclusion by the client or the attorney, participation in legal matters should not be a de facto violation of the independence rules. Again, such services would need to be approved, in advance by the company's audit committee which should provide adequate protection for the company and its investors.
Specific "bright line" definitions of acceptable tax services need to be provided within the rules. To do otherwise would leave this vital area open to interpretation in hindsight. The results could be catastrophic if the tax services provided, which had been pre-approved by the company's audit committee, were later determined to be disqualifying in nature. Would the audit firm be deemed to have not been independent and would the previously issued financial statements have to be recalled and re-audited by another firm? What would be the result if the company in question were a large conglomerate which had, through its various subsidiaries, been scrupulous in engaging a variety of accounting firms, other than the one engaged to perform the audit on the financial statements, to provide enumerated disqualifying services such that there were no other qualified auditors available to do perform the required re-audit? Would the statements become unauditable?
Partner's Compensation with Respect to Non-Audit Services
If the types of services to be provided to the attest client are subject to statutory limitation and audit committee pre-approval, then there seems no reason to further restrict such services by denying compensation to the partner who initiated or provided such services. Further, we believe that it would be virtually impossible to monitor compliance with this provision since most accounting firm partner compensation arrangements are not specifically formula driven and thus one could not determine whether an individual partner's compensation package includes such amounts.