American Federation of Labor and Congress of Industrial Organizations
January 13, 2003
BY ELECTRONIC AND U.S. MAIL
Jonathan G. Katz, Secretary
Re: File No. S7-49-02
Dear Mr. Katz:
On behalf of the American Federation of Labor and Congress of Industrial Organizations, I welcome this opportunity to offer our comments on the Securities and Exchange Commission (the "Commission") proposal, S7-49-02, to strengthen the Commission's Requirements regarding auditor independence.
The AFL-CIO is the federation of America's labor unions, representing more than 66 national and international unions and their membership of more than 13 million working women and men. Union members participate in the capital markets as individual investors and through a variety of benefit plans. Union members' benefit plans have over $5 trillion in assets. Union-sponsored pension plans account for over $400 billion of that amount.
The AFL-CIO and worker pension funds have actively sought to enhance the independence of outside auditors ever since the collapse of Enron exposed, with devastating consequences for investors, major weaknesses in the existing auditor independence regulatory regime. Because we believe regulatory reform is essential to address these weaknesses, the AFL-CIO petitioned the Commission on December 11, 2001 to strengthen the rules governing auditor independence. In addition, worker pension funds have sought to enhance auditor independence on a firm-by-firm basis by sponsoring shareholder resolutions at dozens of companies seeking to limit the non-audit services performed by the company's auditor.
We are very pleased, therefore, that in response to our petition and to the subsequent requirements of the Sarbanes-Oxley Act, the Commission has formulated a comprehensive proposal to strengthen its auditor independence rules. We commend the Commission for its proposal and want to take this opportunity to both voice our support for the proposed rules and to offer some specific comments on how the Commission could further enhance them.
II. Specific Comments on Commission Proposal
In our December 11, 2001 petition, we called on the Commission to (A) limit the services accounting firms may provide to their audit clients, (B) require mandatory rotation of audit firms every seven years, and (C) require additional proxy statement disclosure regarding the role of the audit committee in approving both audit engagements and non-audit consulting agreements with the audit firm. While we believe that the Commission's proposed rule generally responds to each of these requests in a thoughtful and substantive manner, we would like to offer the following comments.
A. Limitation on Non-Audit Services
The proposed rule appropriately removes the various exceptions to existing prohibitions on non-audit services such as bookkeeping, legal services, appraisal, human resource consulting, etc. The rule, however, would allow audit firms to provide certain tax and other services so long as the Sarbanes-Oxley Act does not specifically prohibit them.
We recommend that the Commission modify its proposal to conform more closely to the recommendation in the recent report issued by the Conference Board Commission on Public Trust and Private Enterprise.1 That report concludes that there is no conflict of interest in a public accounting firm providing certain income tax and other services, such as preparing corporate tax returns, "provided that these services do not place the auditor in the role of acting as advocate for the company." Consistent with this finding, audit firms should not be permitted to advise companies on "debatable tax strategies and products that involve income tax shelters and extensive off-shore partnerships or affiliates."
B. Auditor Rotation
The Commission's proposal would require that all partners of an auditing firm that service a particular company must be rotated every five years. While this goes beyond merely rotating the lead partner, as required by the Sarbanes-Oxley Act, we continue to believe that rotation of the audit firm, rather than audit partners, would better ensure true auditor independence.
As we stated in our December 11, 2001 petition, such rotation would provide a number of important benefits. First, a new audit firm would bring to bear a skepticism and fresh perspective that a long-term auditor may lack. Second, auditors tend to rely excessively on prior years' working papers, including prior tests of the client's internal control structure, particularly if fees are a concern.2 Relatedly, longtime auditors may come to believe they understand the totality of the client's issues, and may look for those issues in the next audit rather than staying open to other possibilities. Finally, an auditor may place less emphasis on retaining a client relationship even at the cost of a compromised audit if it knows the engagement will end after several years. We note that rotation of audit firms, rather than audit partners, is also consistent with the findings and recommendations contained in the Conference Board report referenced above.
We do not believe that small companies or their auditors should be exempted from this requirement.
C. Additional Disclosure Regarding Audit Committee Involvement
We believe that the Commission's proposal generally recognizes the critical role played by audit committees and mandates changes to ensure active audit committee involvement and oversight. However, we oppose the proposed pre-approval policies and procedures, which we believe to be inconsistent with the intent of the Sarbanes-Oxley Act. In addition, the required discussions between the auditor and the audit committee should be expanded.
We commend the Commission for formulating a comprehensive rule to strengthen auditor independence and support its rapid adoption. We believe that implementation of the proposed rule will go a long way toward restoring investor confidence in the quality and reliability of audited financial statements. We thank you for this opportunity to comment on this proposal, and hope that the Commission will consider our comments in formulating its final rule. If you have any questions regarding our comments, please feel free to contact me at (202) 637-3953.
cc (U.S. Mail only)
Harvey L. Pitt, Chairman