Daniel P. Steward
2000 West Dorothy Lane ■ Dayton, Ohio 45439
■ TEL 937-298-0201 ■ FAX 937-298-5758
An Independently Owned Member of the RSM McGladrey Network
December 23, 2002
Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Reference to File No. S7-49-02
Dear Mr. Katz:
I am writing to express my concern about the SEC's proposed rule regarding auditor independence. The proposal has numerous facets that radically alter independence requirements for accounting firms that audit SEC registrants. If the currently proposed rule is adopted, non-national CPA firms will be forced to surrender their SEC clients to the national accounting firms. Non-national firms will be unable to absorb the significant costs necessary to comply with the new regulatory requirements. It seems ironic that the new regulations will literally force SEC registrants to use the national accounting firms where lax standards triggered the new wave of regulation. How does this serve the investing public?
As it is nearly impossible to comment on every facet of the proposed rule, I would like to focus on the following issues: (a) Section B - Services Outside the Scope of the Practice of Auditors, Item 11 - Tax Services; (b) Section C - Partner Rotation; (c) Section G - Communication with Audit Committees; and (d) Section I - Transition Period.
Section B - Services Outside the Scope of the Practice of Auditors, Item 11 - Tax Services
I understand that the proposed rule is not intended to prohibit an accounting firm from providing tax services to its auditing clients, as long as those services have been pre-approved by the client's audit committee. However, by taking the position that formulation of tax strategies on behalf of the client may be an impairment of auditor independence is an unnecessary restriction on the provision of tax services.
Many registrants do not have in-house tax expertise to always provide the most cutting-edge tax strategies. Thus, they rely on their auditor/tax compliance specialist to provide this guidance. The auditor does not make decisions on behalf of its clients, but merely provides its clients with alternatives on how to legally minimize their tax obligations. The clients have the ultimate decision and responsibility in regards to implementation of any strategies that are presented. Thus, the auditor is not required to audit its own work, the auditor is not an advocate for the client's tax positions and the auditor has not assumed a management function. As a result, auditor independence is not impaired.
Actually, the shareholders of the company, and possibly the investing public, would be parties that would be harmed the most as their investment returns would be minimized if these strategies go unexplored.
I also do not believe it is meaningful to categorize tax services into permitted and disallowed activities. Any attempt to do so will undoubtedly raise more questions than are answered by such an approach because it is impossible for such a rule to encompass all potential services. Dividing services into permitted and disallowed categories will often result in additional time and effort being expended by the company and the auditor to determine into which category a specific service falls. These costs will either be passed on to consumers or reduce returns to investors. It is difficult to see the benefit of such a division of services to the investing public.
Section C - Partner Rotation
Section 203 of the Sarbanes-Oxley Act of 2002 specifies that:
It shall be unlawful for a registered public accounting firm to provide audit services to an issuer if the lead (or coordinating) audit partner (having primary responsibility for the audit), or the audit partner responsible for reviewing the audit, has performed audit services for that issuer in each of the 5 previous fiscal years of that issuer.
As noted in the proposed rule, the concept of audit partner rotation is not new as the AICPA's SEC Practice Section has had rotation rules in place for years (with exceptions for non-national firms). However, those rules have also never extended to other audit engagement partners and nowhere in Section 203, stated above, does it refer to any other partner besides the lead or concurring partner. The proposed rule expands the partner rotation provision far beyond what is provided for by the legislation. The Act states that the lead partner and the concurring partner should not perform services for more than 5 consecutive years. It does not state anything in regards to other partners performing their required duties.
In addition, nowhere in the Act does it refer to applying these rules to individuals that have not even reached partner status. To extend these rules to senior managers (or equivalent titles) has no rationale. These individuals are employees. They are not ultimately responsible for the decisions that are used to support the audit opinion. That is the responsibility of the lead partner.
Thus, no partner, other than the lead partner and concurring partner, should be subject to the 5 year rotation rules, and time served on an engagement as a senior manager (or equivalent title) should not count towards the five years. In summary, the 5 year rule should only apply to lead partners and concurring partners while serving in those roles.
If the Commission is going to adhere to their original partner rotation assumptions, a viable option may be the Commission's proposal regarding forensic auditors (similar to a peer review). By instituting the option of having a second auditor (forensic) perform services at the request of the audit committee, the issue of audit partner rotation (especially for non-national firms) may be eliminated. The forensic auditor would be able to perform procedures in relation to the client's internal controls, accounting practices, etc. This would create a situation in which the independent auditor would be required to take greater responsibility for detecting fraud, etc., as they know another auditor would be evaluating their work.
Lastly, at a minimum, the Commission should reinstate the audit partner rotation exemption that was previously in place. The rules that are being proposed are extremely onerous for the non-national firms and actually create a new "market" for the national firms (who caused the Act to be written in the first place). These rules, if adopted, could drive the non-national firms out of the public arena. The exemption should be very similar to the old rule in which a firm that has 10 or less audit partners (i.e., majority of time is spent in audit and accounting) and 5 or less SEC registrants (not counting 11-K filers) would not be required to rotate any of its audit partners.
Section G - Communication with Audit Committees
Section 204 of the Act requires the auditor to report, in a timely manner, specific information to the audit committee. Logically, this information should be presented to the audit committee prior to the release of the audited financial statements. However, the onus should not be put on the auditor to determine what information should be reported to the audit committee. Management should report on critical accounting policies and alternative accounting treatments (preferably on a quarterly basis). After all, the financial statements are the responsibility of management, not the auditor.
This list of policies and accounting treatments should be made available to the auditor to ensure that all pertinent items were communicated to the audit committee. The audit committee should assess the need to address these items further with management and/or the auditor.
The Commission asked for comment regarding whether the definition of which accounting policies and alternative accounting treatments that are required to be communicated to the audit committee is sufficiently clear. The answer is NO!! Should it be based upon materiality? Should every single item be brought to their attention? Where do you draw the line? Due to all of these issues, the audit committee could get side-tracked from the critical issues facing the company. It may ultimately require the audit committee to become a full-time position. If that becomes the case, why would anyone want to be a member of an audit committee?
Section I - Transition Period
Due to the vast changes that are inherent in the proposal, a transition period will be necessary. The transition should be focused on audit partner rotation (including audit partner compensation) and audit committee communication. These areas all relate to the issue of transition from one audit partner to another and an attempt to ensure a transparent flow of duties. If this is not taken into account, the risk of an audit failure is immensely increased. That would definitely not serve the investing public.
Very truly yours,
Daniel P. Steward