Financial Executives International
January 14, 2003
Mr. Jonathan G. Katz
Subject: File No. S7-49-02
Dear Mr. Katz:
The Committee on Corporate Reporting ("CCR") of Financial Executives International ("FEI") appreciates the opportunity to respond to the Securities and Exchange Commission's (the "SEC") Proposed Rule to Strengthen the SEC's Requirements Regarding Auditor Independence ("Proposed Rules").
In general we are in agreement with the proposed rules on auditor independence as the SEC implements the requirements of the Sarbanes - Oxley Act ("the Act"). We feel that the SEC has generally been true to the letter and substance of the Act and that auditor independence and/or the public opinion of auditor independence will be enhanced.
In several areas where the proposed rules have gone beyond the Act we feel that the incremental restrictions do not carry with them a sufficient incremental benefit in auditor independence. In addition to the three observations below we have also commented on provisions regarding transition and disclosure.
We agree with the concept of a "cooling off " period as proposed in the rules. However we disagree with the proposal to expand the definition from the Act to include all "financial reporting oversight roles" at an audit client. We also disagree with extending the restrictions beyond the "Issuer" (as provided in the Act) to include all affiliates of the registrant. Encompassing affiliates would possibly cover positions at subsidiaries, parents, investees and investors, some of which may not even be audit clients of the firm that audits the "Issuer". As we understand the intent of the Act was to prohibit an audit team member from taking on a significant financial decision making role at an audit client without this "cooling off" period. Accordingly the CEO, CFO, Controller, and CAO were cited in the Act along with anyone in a similar role. The definition in the proposed rule, however, of a "financial reporting oversight role" would encompass many more people in a large corporation who may not have significant influence on decision-making responsibility. For instance the proposed definition would include the manager in charge of the worldwide consolidation and the financial analyst that drafts MD&A. Neither of these positions, while important, would be considered significant decision makers in the preparation of the issuer's financials. We feel that the positions defined in the Act appropriately encompass the significant decision makers with respect to the financial statements of the issuer, and the final SEC rules should revert to this original language.
Another area where we believe the proposed rules go beyond the Act, and create unnecessary ambiguity instead of clarity is tax services. While the proposed rule acknowledges that tax services are allowed, it goes on to impose a vague and conflicting concept for audit committees to follow about the application of three principles that are not even alluded to in the Act. This is counter to the intent of Congress, which clearly stated that tax services were not a prohibited service if they had audit committee approval. In fact this was the only such service mentioned in the Act in this manner, clearly indicating that Congress did not see this as a service per se that impaired the independence of an auditor.
In many cases audit firms by their deep knowledge of a Company's business operations, organization and geographic diversity, coupled with their tax expertise can be a great source of knowledge to a Company in areas of tax planning, tax compliance and tax recovery. To impose a vague standard as written would possibly prohibit Companies from using this resource, with no offsetting change in the independence of the auditor with respect to the Company.
We feel that the final SEC rules should delete the examples cited, not discuss advocacy and maintain that tax services are acceptable services. The true governance of this issue will be, and needs to be at the audit committee level. If a Company decides to consider engaging a firm for both audit services and a specific tax service, the audit committee can weigh the benefits of their knowledge of the business versus differing forms of advocacy that may be placed upon the auditor for the engagement.
With regard to partner rotation, while we agree with the concept already in place for partner rotation as mandated by the AICPA SEC Practice Section, we also agree with the SEC proposal to decrease the requirement for rotation from seven years to five years. However, we disagree with the SEC's proposed inclusion of rotation beyond the lead audit partner and concurring partner as provided in the Act. Going beyond the intent of the Act in this instance will result in a significant loss of valuable experience and client and industry knowledge. The lead audit partner and concurring partners as set forth in the Act are the ultimate decision makers and set the tone and direction of the audit engagement. Rotating them will achieve the desired results as they relate to increased independence of the auditors. Extending this rule to a lower level as proposed will not provide additional benefits in independence, but will only prove to be very costly to a company from both a fee perspective as well as level of expertise, especially in instances of specialty partners. Costs would be greatly increased for international engagements as well, where partners may need to be moved internationally to supply adequate service to a Company, given language barriers, expertise, etc. Additionally, the opportunity exists for greater errors or inappropriate accounting on the part of the client in the first few years following a change. The SEC should also consider that for many multi-national companies with smaller affiliates, many of these affiliates do not have full audits and in some cases statutory audits. Under these circumstances, it would again not be beneficial to rotate audit partners responsible for these smaller affiliates. We also feel that decisions related to partner rotation, rather than being mandated, can always be taken at the audit committee level to require more rotation beyond the two partners if they believe the audit team needs a new audit approach, which occurs with a new leader.
With regard to alternatives to partner rotation, we do not agree with the suggestion that forensic auditors be periodically engaged. It has been suggested that such an effort could be seen both as a substitute for partner rotation and as a method of auditor quality control. Consistent with the intent of the Act, establishing a system of partner rotation introduces a fresh perspective and ensures professionals do not spend their careers on a single engagement. In addition, the Public Company Accounting Oversight Board has already been established to address audit quality. We do not believe duplication of these efforts, such as through the use of forensic auditors, will provide significant incremental benefit to either shareholders or issuers.
In the area of disclosures we generally agree with the proposed rules as written. The one area of disagreement is on disclosures relating to pre-approvals. This implies that services engaged under a pre-approval process are somehow inferior or not as well scrutinized as those done by a specific approval. This is an unfair label and most likely untrue. One issuer (A) may have 100% pre-approved fees and another issuer (B) may have all specific approvals. This would somehow imply issuer (A) had an audit committee that was not as engaged as it should be. The reality may be that issuer (A) only engages its auditors for very routine services where issuer (B) engages its auditors in services that are not routine and need further review. The ratio of how an audit committee approves these services is not meaningful information to a reader. We feel that the audit committee should disclose its procedures and policies with respect to specific approvals and pre-approvals, the services approved and the dollar amounts. Discussions of the approval limits, percentages approved under specific methods, etc. are not information from which a reader could draw meaningful conclusions.
Finally in terms of transition we feel that if all rules are in place immediately that several areas could cause significant disruption to a company and its audit. Listed below are the areas where we feel transition timing needs to be considered:
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FEI is a leading international organization of 15,000 members including Chief Financial Officers, Controllers, Treasurers, Tax Executives, and other senior financial executives. CCR is a technical committee of FEI, which reviews and responds to research studies, statements, pronouncements, pending legislation, proposals, and other documents issued by domestic and international agencies and organizations. This document represents the views of the CCR and not necessarily the views of FEI.
We appreciate the SEC's consideration of these important matters and welcome the opportunity to discuss any and all issues with the SEC at its convenience. If you have any questions regarding this letter, please feel free to call Frank Brod at (989) 636-1541 or David Sidwell at (212) 270-1892.