SEC File No. S7-49-02
|Number||SEC Question||CalPERS Response|
|Section II. Discussion of Proposed Rules|
|A. Conflicts of Interest Resulting from Employment Relationships|
|1||Is the one-year cooling-off period sufficiently long to achieve an appearance of independence by the accounting firm? If not, what period would be appropriate?||Yes, at this time, the one-year cooling off period appears to be sufficiently long. However, we believe that the one-year period should begin on the latest date that the person has performed any services on behalf of the audit firm for the client that is hiring the former auditor. We also note that planning for the next year's audit often occurs during the current year audit. Therefore, a person who worked on the Year 2003 audit may be involved in the planning the Year 2004 audit, and the CPA firm may not be independent if that person is working for the client.|
|2||Is the term audit engagement team sufficiently clear? If not, what changes would improve the description to describe the group of accountants who would be covered?||We believe that the engagement team should be defined as the staff members, on-site supervisor(s), managers, partners, engagement partner, reviewing partner, concurring partner, and any other members of the CPA firm who performed or reviewed the audit workpapers and/or audit report.|
|3||Is the phrase commencement of the audit sufficiently clear? If not, what changes would improve the description? Is that the appropriate time to mark the commencement of the period? Is there a better mark?||No, commencement of the audit procedures is not sufficiently clear because planning for next year's audit often occurs while conducting the current year audit and also during interim procedures and while continuous auditing occurs. Therefore, we believe that the one-year period should begin at the time that the person performs the last work of any kind for the client company.|
|4||Is the phrase commencement of review procedures sufficiently clear? If not, what changes would improve the description?||No, commencement of review procedures does not seem to be an appropriate measurement point. The completion of the review procedures or the completion of all work related to the client appears to be a better measurement point to begin the one-year period.|
|5||Is it appropriate that the cooling-off period provisions apply to employment relationships involving audit engagement team members and their audit clients? Should the requirements be limited to audit clients who are issuers as defined in Section 205 of the Act?||Yes, the cooling off period seems appropriate.|
|6||Are the appropriate officers covered by the proposed rule? If not, which additional individuals should be subject to the cooling-off period provision? For example, should national office personnel who would be excluded under the proposal be included?||Persons who approve the audit, such as the reviewing partner and the concurring partner should be included in the one-year cooling off period. Also, the supervisor of the engagement partner should be included. These people would all have a potential lack of independence if as employees of the client they learn items that should have been disclosed during the prior audit(s) and will have to decide whether or not to disclose them as an employee.|
|7||Should the proposed rules apply equally to large firms/companies as small firms/companies? Would the proposed rules impose a cost on smaller issuers that is disproportionate to the benefits that would be achieved? Why or why not? Should there be an exemption to this requirement for smaller businesses?||Yes, it should apply to all companies regardless of size. A conflict of interest is a conflict of interest no matter what the size of the company. Creating exemptions will open the door for potential abuses. The benefit of independent audit firms should be greater than the costs and should improve investor confidence.|
|8||The "cooling off" period applies to all entities in the investment company complex. Is this too broad? Why or why not?||No, it is not too broad. The cooling off period should apply to the parent company, its subsidiaries, all affiliates in which the company has a 10% or more interest, and all creations of the company and its officers such as special purpose vehicles, special purpose entities, and any other creations of the parent and its subsidiaries and affiliates.|
|9||Should the Commission include exceptions subject to certain criteria? If so, what should these criteria be?||No, there should be no exceptions. Creating exemptions will open the door for potential abuse.|
|B. Services Outside the Scope of the Practice of Auditors|
|10||Are there other non-audit services that are incompatible with Rule 2-01(b) or that raise independence concerns? If so, what are they, and why do they raise independence concerns?||We believe that all consulting activities are incompatible with the audit and attest function. We believe that the scope of services performed by the external auditors should be limited to the audit and attest functions, as described in the current Statements of Auditing Standards (SAS) and the Statements of Standards for Attestation Engagements (SSAE). The objective is to achieve an audit profession that is able to stand alone on audit and attest functions without depending on obtaining "additional services."
It is CalPERS' position to oppose all non-audit services with the exception tax form preparation (See Answer to Question 52) and comfort letters.
|11||Is the meaning of the general principles sufficiently clear?||The four general principles seem sufficiently clear. However, if in implementing the principles, there are gray areas, then those activities in the gray areas should generally be prohibited. The objective is to achieve an audit profession that is able to stand alone on the audit and attest functions, without depending on obtaining "additional services."|
|B. 1. Bookkeeping and Related Other Services|
|12||Should the definition of bookkeeping be further clarified? If so, how?||No comment.|
|13||Does the definition cover all the bookkeeping services that would impair an accountant's independence?||No comment.|
|14||Should an auditor be permitted to provide bookkeeping services to an audit client if it is not reasonably likely that the results of those services will be subject to audit procedures during the audit of the client's financial statements? Why or why not?||No, because there is no bookkeeping that should not be within the scope of the audit, and all bookkeeping should have a finite probability of being included through the audit sampling. Moreover, if the audit firm is using continuous auditing with embedded audit software, the 100% sample would include these items. This raises the possibility that the auditors would audit their own work.|
|15||Is the standard of reasonably likely sufficiently clear? If not, should we use some other standard? If so, what standard should we use?||No, the standard of "reasonably likely" can never be sufficiently clear. Therefore, the answer to both Questions Number 14 and 15 is NO.|
|16||Is the phrase "preparing statutory statements which form the basis of U.S. GAAP statements" sufficiently clear? If not, how might the phrase be revised?||No, we believe that the phrase should read, "preparing statutory statements which form a portion of the basis of U.S. GAAP statements, " because these statements may be only one part of the consolidation of information from several countries.|
|B.2. Financial Information Systems Design and Implementation.|
|17||Is an auditor's independence impaired when the auditor helps select or test computer software and hardware systems that generate financial data used in or underlying the financial statements? Why or why not?||Yes, because there is a clear conflict of interest in so doing. The auditor will be relying on and auditing their own work as to the functioning of the system. This clearly violates the first test that you cannot audit your own work.|
|18||Whether a system is used to generate information that is "significant" to the audit client's financial statements may depend on the size of the engagement. Does the magnitude as a percentage of either audit fees or total fees of the fees for such services make a difference on whether performance of the service impairs independence?||No. A prohibited activity is prohibited, period. This proposal raises the possibility that the exceptions will grow in size until the prohibition becomes meaningless. This proposal is also problematic as to what level is "significant" to the financial statements for use in the definition.|
|B.3. Appraisal or Valuation Services, Fairness Opinions, or Contribution-in-Kind Reports|
|19||Does providing valuation or appraisal services that are unrelated to the financial statements, such as for certain regulatory purposes, impair an accountant's independence?||Yes. We are not clear what valuation or appraisal services would be unrelated to the financial statements. The fair value or market value should be similar for both regulatory and financial statement purposes. Therefore, we believe that this would impair an auditor's independence. Further, this would increase the client relationship, which potentially impairs the auditors' objectivity.
We note that there are no items of value that should not be included in the audit. All items should have a finite probability of being sampled during the audit. This may be another example where exceptions could be created, and then the exceptions may grow uncontrollably.
|20||Does providing valuation or appraisal services for tax purposes impair an accountant's independence?||Yes. These appraisals would also be relevant to the financial statement audit, particularly since income tax expense and deferred income taxes are integral parts of the financial statements. Further, this would increase the client relationship, which potentially impairs the auditors' objectivity.|
|21||Are there certain types of appraisal or valuation services, or certain instances in which they are provided, that do not raise auditor independence concerns? Are there circumstances in which an accounting firm may be required by law or regulation to provide such services, either in the United States or abroad?||No. There are no types of appraisal or valuation services, nor are there certain instances in which they are provided, that do not raise auditor independence concerns. We feel strongly that auditor should perform audit and attest services only. Any additional relationships potentially impair independence and objectivity.|
|22||Should we provide an exemption for such services provided to a foreign private issuer by its accountant where local law requires such services (e.g. contribution in-kind reports)?||No, generally, we do not favor making any exceptions to auditor independence rules. We feel that the lessons learned regarding the importance of maintaining independence of the auditor apply universally. With this position in mind, we recognize that the SEC must balance the need to provide adequate investor protection with a desire to maintain the attractiveness of the United States capital markets. We would support reasonable transition periods and minor exceptions only when absolutely necessary. In order to raise capital in the United States markets, the issuer should abide by the rules of the United States.|
|23||The Commission staff, when providing interpretations of the application of the auditor independence rules to contribution in-kind reports, has worked with foreign jurisdictions to accommodate the statutory requirements in those jurisdictions. Should the Commission's rules provide that similar practices or arrangements be permitted where contribution in-kind reports are required by foreign statute?||No, generally, we do not favor making any exceptions to auditor independence rules. We feel that the lessons learned regarding the importance of maintaining independence of the auditor apply universally. With this position in mind, we recognize that the SEC must balance the need to provide adequate investor protection with a desire to maintain the attractiveness of the United States capital markets. We would support reasonable transition periods and minor exceptions only when absolutely necessary. In order to raise capital in the United States markets, the issuer should abide by the rules of the United States.|
|B.4. Actuarial Services|
|24||Are there certain circumstances under which an accountant can provide actuarial services to an audit client without impairing independence?||No, not in our opinion.|
|25||Have we appropriately described the actuarial services prohibited by the Act?||Yes.|
|B.5. Internal Audit Outsourcing|
|26||Is the definition of the "internal audit function" sufficiently clear?||No, the definition of internal auditing promulgated by the Institute of Internal Auditor Auditors should be used. Also, reference should be made that internal auditing should be performed under the Standards for the Professional Practice of Internal Auditing (SPPIA).|
|27||We solicit comment on whether an exception should be provided for small businesses. If so, what criteria should we consider in providing such an exception?||No, there should be no exceptions. A conflict of interest is a conflict of interest, no matter what the size of the organization.|
|28||Does it impair an auditor's independence if the auditor does not provide to the client outsourcing services related to the internal audit function of the audit client, but rather performs individual audit projects for the client?||Yes, it does impair the external auditors' independence if the external auditor is performing internal auditing in any capacity, way shape or form. The external auditor should be performing only audit services (per the SAS's) and other attest services (per the SSAE's).|
|29||Are there safeguards that can be established by the auditor that would allow the audit client to outsource the internal audit function to the auditor without impairing its independence?||No, there are no safeguards that can be established so that an audit firm could provide internal audit services to an audit client because a auditors cannot audit their own work.. The ENRON example where Arthur Andersen was both the external and the internal auditor makes this very evident.
In addition, we note that WorldCom is the only instance we know of in the United States where massive fraud has been uncovered by auditors, and this was done by the internal auditors (in-sourced). Moreover, to our knowledge, no CPA firm has ever alerted the nation's investors to a major bankruptcy or to a massive fraud, either in the capacity as the external auditor or in the capacity as the outsourced internal auditor (See the article by H. W. Jenkins in The Wall Street Journal, January 16, 2002). Since there have been numerous opportunities to alert the nation's investors, it seems unlikely that CPA firms will provide this information in the near future.
|30||Would it impair the auditor's independence if the auditor performs only operational audits that are unrelated to the internal controls, financial systems, or financial statements?||Yes, it would impair the auditor's independence. Operational audits are an internal audit function, and should not be provided by the external auditor (See our answer to Questions No. 26, 27, and 28). Moreover, it is impossible to perform an operational audit that is unrelated to the internal controls, financial systems and/or the financial statements. Operational audits routinely result in recommendations to improve internal controls and systems that feed information to the accounting systems. Many companies are so highly mechanized and integrated that the manufacturing equipment directly feeds information to the accounting systems.|
|31||Is additional guidance necessary to distinguish the services that would be prohibited under this proposed rule from those services that would be permitted as operational audits?||No additional guidance in necessary because these operational audits should not performed by the external auditor (See the answer to Question No. 30).|
|B.6. Management Functions.|
|32||Do services related to designing or implementing internal accounting controls and risk management controls result in the auditor auditing his or her own work? Would such services impair an auditor's independence when the auditor is required to issue an opinion on the effectiveness of the control systems that he or she designed or implemented?||Yes, to both questions.|
|33||Do services related to assessing or recommending improvements to internal accounting controls and risk management controls result in the auditor auditing his or her own work? Would such services impair an auditor's independence when the auditor is required to issue an attestation report on the effectiveness of the control systems that he or she has assessed or evaluated for effectiveness?||Yes, the auditor would be auditing his or her own work if this is performed as a separate engagement (separate from the financial statement audit). This would impair the independence of an auditor preparing an attestation report, such as a SAS #70 Type II report, for the same company. We reiterate that audit firms should be performing only the audit and attest services as described in the current SAS's and SSAE's.
If, during normal audit and attest work, the auditor discovers internal control weaknesses, then this information and recommendations should be reported to management and the audit committee.
|34||We request comment on whether there are circumstances under which an accounting firm can perform or assume management functions or responsibilities for an audit client without impairing independence?||There are none.|
|B.7. Human Resources|
|35||Are there additional types of human resource and employee benefit services that impair an auditor's independence?||All human resources and employee benefit services impair an auditor's independence. Human resources and personnel management is clearly a management function.|
|36||Would an auditor's independence be impaired if the auditor provided personnel hiring assistance for only non-executive or non-financial personnel?||Yes. Hiring personnel of any type is a management function, so independence would be impaired.|
|37||Does it impair an auditor's independence if the auditor provides consultation with respect to the compensation arrangements of the company's executives?||Yes. This is a function that impairs independence because the auditor is involved with the compensation paid to audit clients.|
|B.8. Broker-Dealer, Investment Advisor or Investment Banking Services.|
|38||We solicit comment on the scope of the proposal. Are there other securities professional services that the rule should expressly identify as impairing independence?||Yes, the external auditor should not be giving advice or performing due diligence for any type of investment, including real estate and alternative investments.|
|39||Would an auditor's independence be impaired if the auditor acted as a securities analyst covering the sector or industry of an audit client?||Yes.|
|40||Should we adopt rules that would clarify when the auditor is acting as an unregistered broker-dealer? If so, what should those rules be?||Yes. The rule on not recommending (buy, hold or sell) stock of an audit client should be clarified. We believe that if Multi-Office Audit Firm X audits Company Y, then none of the offices of Audit Firm X should be making any recommendations (buy, hold or sell) about Company Y stock to anyone from any of their offices, nation-wide and world-wide.|
|B.9. Legal Services.|
|41||Are there any particular legal services that should be exempted from the rule?||No. We agree that lawyers are paid advocates for the client, and providing legal services makes the auditor an advocate and violates the fourth principle. There should be no exceptions to this principle.|
|42||Would making the rule's application depend upon the jurisdiction in which the service is provided leave the rule subject to any significant uncertainty, or pose the prospect of any significant complexity or unfairness?
|43||Should there be any exception for legal services provided in foreign jurisdictions? For example, in some countries only a law firm may provide tax services. Should a foreign accounting firm be permitted to provide, through an affiliated law firm, tax or other services that a U.S. accounting firm could provide to a U.S. audit client without impairing the firm's independence? Why or why not?||No. Please note that we believe that providing legal or tax services creates a conflict of interest. This conflict of interest exists and is independent of the country in which the work takes place. Please see our answers to Questions #50, 51 and 52.
We also think that companies may use other legal services to fulfill these requirements. We are not aware of any jurisdiction that requires the company to use a law firm affiliated with their auditor.
|44||Should there be an exception for legal services provided to issuers in foreign jurisdictions? Should any such exception be tailored to avoid undermining the purpose of the restriction? For example, could fees for legal services be limited to a small percentage (e.g., 5% or 10%) of the amount of fees for audit services? Could partners providing audit services be prohibited from being involved in the provision of legal services or from receiving compensation based on such services?||No, such services should be prohibited as stated in the answer to question No. 41.|
|45||Should any such exception have a "sunset" provision that would both allow foreign private issuers a transition period and allow the Commission to review the situation regarding legal services?||We would support reasonable transition periods to achieve compliance with strict independence standards.|
|B.10. Expert Services.|
|46||Are there circumstances in which providing audit clients with expert services in legal, administrative, or regulatory filings or proceedings should not be deemed to impair independence?||No. We agree with the analysis and conclusion that being an expert witness results in being an advocate for the client.|
|47||Should an auditor be permitted to serve as a non-testifying expert for an audit client in connection with a proceeding?||Functioning as a "fact witness" appears reasonable.|
|48||Is the definition of prohibited expert services appropriate? Why or why not?
|49||Is the distinction between advocacy and providing appropriate assistance to an audit committee sufficiently clear?||Yes.|
|B.11. Tax Services|
|50||We request comment on whether providing tax opinions, including tax opinions for tax shelters, to an audit client or an affiliate of an audit client under the circumstances described above would impair, or would appear to reasonable investors to impair, an auditor's independence.||Yes, these activities clearly impair the independence of the external auditor. The tax opinions and shelters affect income tax expense and deferred income tax, and, therefore, the auditors would be auditing their own work.|
|51||Are there tax services that should be prohibited by the Commission's independence rules?||The external auditors should not be involved with strategy, design or consulting in tax. The external auditors should not be involved with the creation of tax shelters or formation of any business entities that are used to change taxation of the audit client, its subsidiaries, affiliates, or any other entity created by the company or its executives.|
|52||Is it meaningful to categorize tax services into permitted and disallowed activities? If so, what categories and related definitions would make the demarcation meaningful?||Yes. In effect, providing tax services results in the auditor being an advocate of the client before the IRS, state tax board, or foreign tax authorities. It is not clear that any of these tax activities should be performed by the external auditor.
However, CalPERS believes that the external auditor may be involved in tax form preparation. We believe that the tax form preparation definition and interpretation should be narrow.
|C. Partner Rotation.|
|53||Should the Commission adopt rules requiring that issuers engage forensic auditors periodically to evaluate the work of the financial statement auditors? If so, how often should the forensic auditors be engaged? What should be the scope of the forensic auditors' work? Would doing so obviate the need to require partner rotation for the audit firm? Alternatively, could the company obtain the necessary expertise by engaging other outside consultants? If so, what type of consultants should it engage?||No, because this approach is not likely to accomplish the objective of evaluating the work of the financial statement auditors. If management is committing massive fraud (for example, as alleged at ENRON and WorldCom), having the audit committee hire another set of auditors will not likely accomplish anything or be cost effective. The fundamental conflict of interest in the audit world is that a company hires an audit firm to watch over it. Adding a second layer of forensic auditors beholden to the same group merely compounds the existing situation.
Moreover, forensic auditors have training in obtaining evidence after the fraud is discovered or the problem is evident. They are not trained to walk into a company and detect problems or find crimes that are not known. Detecting problems and finding crimes is something that should occur during the regular audit. We believe that Statement of Auditing Standards Statement No. 99 (SAS 99) is a positive first step in this direction. We believe that the Public Company Accounting Oversight Board should review SAS 99 and determine if there should be additional standards in regard to encouraging fraud detection by auditors. Audit firms should appropriately reward their employees for detecting problems and finding crimes during the regular audit.
A better approach to checking the quality of financial statement audits is for the Public Company Accounting Oversight Board (PCAOB) to have its own auditors that target companies based upon risk analysis and tips. High risk factors include such items as rapid growth, meeting the "self-styled and so-called analysts" expectations regularly, complex financial structure, high rate of executive turnover, complex deals, special purpose entities, special purpose vehicles, very high PE ratio, and so forth. The PCAOB auditors would have better independence because the auditors are not hired by the company. However, "independence" for the PCOAB auditors assumes that they will be given true independence from Congress and the Executive Branch.
The PCAOB auditors should be adequately funded, allowing these independent auditors to work for the investing public rather than for the special interest groups.
|54||Would the establishment of rules requiring companies to engage forensic auditors periodically provide an opportunity to other firms to enter the market to provide these services?||No, because the largest accounting firms would enter the market and the Big Four firms would be evaluating each other's work. We already have seen the AICPA PEER review process fail, so it would be counter-productive to create a substitute that is probably not significantly different from a process that has already failed.|
|55||Should the Commission establish requirements for firms conducting forensic audits? If so, what should those requirements be?||Yes, the Public Accounting Oversight Board should establish requirements for firms conducting forensic audits. The requirement should be that the persons in the firm should have demonstrated investigative and forensic skills. The Certified Fraud Examiner (CFE) is one certification that is evidence of that ability.|
|56||Should issuers be given a choice between engaging forensic auditors periodically and having the audit partners on their engagement team be subject to the rotation requirements? Why or why not?||No. The proposed use of forensic auditors appears counter-productive, and so it is not an alternative to rotating audit partners. In fact, CalPERS is supportive of audit firm rotation beyond rules applied to audit partner rotation.|
|57||What are the costs and benefits of engaging forensic auditors to evaluate the work of the financial statement audit firm?||It does not appear that the benefits of engaging forensic auditors to evaluate the work of financial statement auditors would justify the costs. Moreover, we believe that adding this layer would result in diminution in the quality of the overall audit system.|
|58||This proposed rule would apply to the audits of the financial statements of "issuers." Should the Commission consider applying this rule to a broader population such as audits of the financial statements of "audit clients" as defined in 2-01(f)(6) of Regulation S-X? Why or why not?||No comment.|
|59||For organizations other than investment companies, the rotation requirements would apply to significant subsidiaries of issuers. Should a different approach be considered? Is so, what approach would be appropriate?||The rotation requirements should be applied to significant subsidiaries of issuers.|
|60||Should the rotation requirements apply to all partners on the audit engagement team? If not, which partners should be subject to the requirements?||Yes, but all partners do not have to be rotated at the same time. National office personnel should also be rotated.|
|61||Is the proposed guidance sufficiently clear as to which audit engagement team partners would be covered by the rule? Is the proposed approach appropriate? If not, how can it be improved?||The proposal appears to be sufficiently clear, but we believe that national office personnel should be rotated whenever possible on a voluntary basis.|
|62||Is the exclusion of certain "national office partner" personnel from the rotation requirements appropriate?||No. We believe that national office partners should also be rotated on a voluntary basis in order to obtain a different perspective on complex issues.|
|63||Is the guidance on national office partners who are exempted from the rotation requirements sufficiently clear?||See the answer to Question No. 62.|
|64||Is the distinction between a member of the engagement team and a national office partner who consults regularly (or even continually) on client matters sufficiently clear?||See the answer to Question No. 62.|
|65||Should certain partners performing non-audit services for the client in connection with the audit engagement be excluded from the rotation requirements?||As long as audit firms are allowed to provide non-audit services in connection with the audit engagement, then the partners should be rotated.
We believe that the external audit firm should not be engaged in consulting and non-audit services. We believe that the external audit firm should be limited to performing audit and attest functions only. This goal might be achieved by applying Sarbanes Oxley Section 201(g)(9) as appropriate.
|66||Should additional personnel (such as senior managers) be included within the mandatory rotation requirements?||Yes. Note that an on-site supervisor may become the senior manager who may then become the engagement partner for a particular client. The natural progression may tend to negate the effects of "partner rotation." For example, the engagement partner may rotate off and be replaced by the recently promoted senior manager. So the net effect is that there is minimal change to the engagement team despite the "rotation."|
|67||Is it appropriate to provide transitional relief where the proposed rules are more restrictive than the provisions of the Sarbanes-Oxley Act?||Yes, but the transition time should be limited, perhaps no more than one year.|
|68||Are there situations in foreign jurisdictions that extended partner rotation could be modified with additional safeguards or limitations that would recognize the jurisdictional requirements as well as logistical limitations that may exist?||It is not clear why partner rotation would not be needed in foreign jurisdictions. It is not clear that there could be "additional safeguards" that work in one country and not another.|
|69||Should the rotation requirements be different for small firms? What changes would be appropriate and why? If so, how should small firms be defined?||Generally, we do not support exemptions from the independence standards for small firms.|
|70||Would the proposed rules impose a cost on smaller firms that is disproportionate to the benefits that would be achieved||We do not believe so. It seems that small firms would be generally less complex, and the duplicative costs of using separate auditors and advisors is therefore minimized.|
|71||Is the five-year "time out" period necessary or appropriate? Would some shorter time period be sufficient, such as two, three or four years? Should there be different "time out" periods based on a partner's role in the audit process?||A time-out period of three years seems reasonable.|
|72||If a partner rotates off an engagement after fewer than five years, should the "time out" period also be reduced? Why or why not? If so, how much should the reduction in the time out period be?||Yes. It seems reasonable that the time-out period should be reduced if the partner rotates off in less than five years.|
|73||Are the partner rotation requirements, as proposed, for investment company issuer's or other entities in the investment company complex too broad? Should we only prohibit a partner from rotating between investment company issuers within the same investment company complex? Why or why not?||No.|
|74||The proposed rules would not require all partners on the audit engagement team to rotate at the same time. Should it? Why or why not?||The rotations do not have to be all at the same time. There needs to be some continuity.|
|D. Audit Committee Administration of the Engagement|
|75||Should the Commission create other exceptions (beyond the de minimis exception) that would allow an audit committee to adopt a policy that contracts that are recurring (e.g., due diligence engagements in connection with a series of insignificant acquisitions) and less than a stated dollar amount (such as $25,000) or less than a stated percentage of annual revenues (such as 1% or 5%) could be entered into by management and would be reviewed by the audit committee at its next periodic meeting?||No. Little exceptions tend to accumulate and grow in size until the main policy becomes less meaningful. This is not a preferable approach.|
|76||Is allowing the audit committee to engage an auditor to perform non-audit services by policies and procedures, rather than a separate vote for each service, appropriate? If so, how do we ensure that audit committees have rigorous, detailed procedures and do not, in essence, delegate that authority to management?||No. Each category of non-audit services beyond the de minimis should be approved individually by the audit committee. All items of audit and non-audit services, including the de minimis, should be reported to the audit committee. Our position is that the audit committees need to be more directly involved and responsible for the audit function. We think that letting them delegate this responsibility by policy would be inconsistent with the Sarbanes Oxley Act of 2002.|
|77||Should more or fewer aspects be left to the discretion of the audit committee?||The Public Accounting Oversight Board (POAB) should provide the rules. Audit committee discretion should be within a narrow framework of these POAB rules.|
|78||Are there specific matters that should be communicated to or considered by the audit committee prior to its engaging the auditor?||From the positive side, the record of the proposed audit firm in detecting and disclosing problems would be helpful.
From the negative side, the record of the proposed audit firm in not discovering problems prior to a significant fraud or prior to bankruptcy of a client would be very helpful information for the audit committee. We also suggest that the SEC keep a public tally on the failures of each audit firm to detect fraud and/or bankruptcy in their clients.
|79||What, if any, audit committee policies and procedures should be mandated to enhance auditor independence, interaction between auditors and the audit committee, and communications between and among audit committee members, internal audit staff, senior management and the outside auditor?||The contract for the external auditor should be managed by the chief audit executive of the internal audit department per the Standards for the Professional Practice of Internal Auditing (SPPIA) Section 2050, and SPIAA Practice Advisories 2050-1 and 2050-2.|
|80||Our proposed rules do not contain exemptions for foreign filers. Are there legal or regulatory impediments which may make it difficult for certain foreign filers to comply? If so, what safeguards can these foreign filers employ to ensure that they comply with the proposed rules?||Generally, we do not favor exemptions from these rules. Please see our answer to Question #23.|
|81||Our proposed rules requiring the audit committee to pre-approve non-audit services to be provided by the company's auditor do not contain an exemption for foreign filers. Are there legal or regulatory impediments which may make it difficult for certain foreign filers to comply? If so, what safeguards can these foreign filers employ to ensure that there is an authorization process to pre-approve such services that is separate from management?||Generally, we do not favor exemptions from these rules. Please see our answer to Question #23.|
|82||In addition to legal or regulatory impediments, are there practical impediments which would make it difficult for certain foreign filers to comply with the pre-approval requirements? If so, what are these impediments? What safeguards can such an entity establish to better implement the proposed rules (which is to separate the decision to engage the auditor for non-audit services from management)?||Generally, we do not favor exemptions from these rules. Please see our answer to Question #23.
It is not clear that the people on audit committees of foreign filers should be treated any differently than those in the United States. If you wish to access capital in the United States, then you should abide by standards that are as high or higher than those in the United States.
|83||Should the Commission provide additional specific guidance to assist audit committees when deliberating auditor independence issues? What topics would be helpful?||Our position is that the audit firm should be engaged to provide audit and attest services only (with a narrow exception of tax form preparation and comfort letters), and that a bright line test is the most desirable approach.
|84||Our proposed rules would require the audit committee of an investment company to pre-approve the non-auditing services provided by the accountant of the investment company to the investment company's investment adviser and any entity controlling, controlled by, or under common control with the investment adviser that provides services to the investment company. Should the audit committee of an investment company registrant be required to approve any non-auditing services provided to the investment adviser and any entity controlled, controlled by, or under common control with the investment adviser that provides services to the fund? Should the scope of the pre-approval requirement be expanded or narrowed? Why or why not?||Question 84-1. Yes.
Question 84-2. We do not believe so.
|85||Under the proposed rules, the pre-approval of non-auditing services would permit, for purposes of determining whether a non-auditing service meets the de minimis exception, the investment company's audit committee to aggregate total revenues paid to the investment company's accountant by the investment company, its investment adviser and any entity controlled, controlled by, or under common control with the investment adviser that provides services to the fund. Should the de minimis exception be determined separately based on the total revenues paid to the investment company's accountant by each entity?||Yes, the amount for the de minimis exception should be determined separately based on the amount paid to each entity. Otherwise, the aggregate de minimis may be used for a major project for one of the smaller entities. Note that we also believe that the aggregate of the all of the de minimis projects for each of the entities should also be totaled and reported.|
|86||This proposed rule would apply to "issuers." Should the Commission consider applying this rule to a broader population such as "audit clients" as defined in 2-01(f)(6) of Regulation S-X? Why or why not?||No comment.|
|87||In addition to the requirement that a majority of the directors who are not interested persons of the registered investment company appoint the independent accountant of a registered investment company under the Investment Company Act of 1940, the proposed rules would also require the audit committee of an investment company to separately approve the accountant. For registered investment companies, who should approve the selection of the accountant, i.e. independent directors, the audit committee, or both? If both, should the audit committee nominate the independent accountant with the independent directors making the selection?||Since the audit committee should be composed entirely of independent directors, we support selection by the audit committee.|
|General Comment on auditor compensation.||In general, we support the SEC proposal in this area as written. The auditors' attention should be focused entirely on audit and attest work and not on selling additional services to the audit client. Compensation to audit personnel for selling of "other services" creates a conflict of interest that should not be encouraged by the SEC and the investing public. Note that we advocate limiting the external audit firm to audit and attest work under the SAS's and the SSAE's.
We note that investors have literally lost billions of dollars in part because financial statements were misstated because of error and/or fraud. We believe that auditor firms should obtain revenues performing audit and attest work, and that they should be fairly compensated for performing these two related functions. We believe that audit firms should compensate their employees entirely for the quality of their audit work. The definition of "quality of audit work" should also include the following: (1) discovering misstatements due to error, (2) discovering fraud, (3) standing firm when clients propose accounting treatments that do not promote full disclosure (transparency), and (4) locating and disclosing special purpose entities, special purpose vehicles and all other "concocted legal entities and contracts" that have the purpose of hiding debt, hiding losses, inflating revenues, capitalizing expenses, and similar accounting tricks.
We finally note that rewarding an auditor for bringing in an audit on time and under budgeted hours is not necessarily a positive incentive if the work performed is substandard, and the items mentioned in the last sentence of the prior paragraph are not reviewed.
|88||What economic impact will our proposal have on the current system of partnership compensation in accounting firms?||Within reason, we are supportive of increased economics for audit and attest functions. From the investor standpoint, we believe that audit function is just as important as the consulting function, but the current economics do not reflect this.|
|89||Are there other approaches that should be considered with respect to compensation packages that pose a concern about auditor independence? If so, what are they?||No comment.|
|90||Would the proposed rule change be difficult to put into practice? If so, why? How could it be changed to be more effectively applied?||We are much more concerned with ensuring the quality of the audit and maintaining independence than we are with difficulty of implementation. Reform should not be stalled in any way because of this point.|
|91||Should managers, supervisors or staff accountants who are members of the audit engagement team also be covered by this proposal?||Yes.|
|92||Does this proposal cover the appropriate time period or should a measure other than the audit and professional engagement period be considered||The time period should cover the audit and a period of two years following the last audit/attest/review work performed for the client.|
|93||Does the proposed rule cover the entire component of an audit partner's compensation that gives rise to independence concerns?||No comment.|
|94||Will this compensation limitation disproportionately affect some firms because of their size or compensation structure? If so, how may we accomplish our goal while taking these differences into account?||No, the same rules should apply to all firms.|
|95||Our proposal references compensation based on the performance or sale of non-audit services. Is there a better test that permits partners to participate in the overall success of the firm while addressing the influence that such services might have on a particular auditor-client relationship?||If there was a simple ban on all non-audit services, this would be much simpler. We propose that the auditor be limited to audit and attest services only.|
|96||Is this proposed definition sufficiently clear? If not, what changes would make the definition clearer and more operational?||Yes.|
|97||Is this proposed definition sufficiently clear? If not, what changes would make the definition clearer and more operational?||Yes. We also note that this passage includes "management discussion and analysis" as part of financial reporting. We concur with this, and we further note that it would be beneficial to make the MD&A part of the required supplementary information, and that it should appear after the auditor's opinion and not before it.|
|98||Some registrants may not have designated boards of directors or audit committees (e.g. benefit plans required to file Form 11-K). Does the definition of audit committee sufficiently describe who should serve in this capacity where such situations exist? If not, what additional guidance would be appropriate?||Yes.|
|99||Our proposed rules exempt unit investment trusts and asset-backed issuers from the rule requiring the audit committee to approve auditing and non-auditing services. Should unit investment trusts and asset-backed issuers be subject to these requirements? If so, given that unit investment trusts and asset-backed issuers are not actively managed, who should be responsible for approving the auditing and non-auditing services? Are there other, similar entities that should be exempt from the pre-approval requirements?||No comment.|
|100||Are the existing definitions in Regulation S-X and Rule 2-01 of Regulation S-X of audit client, issuer, and subsidiary sufficiently clear?||No comment.|
|G. Communication with the Audit Committee.|
|101||In light of the requirements for the CEO and CFO to certify information in the company's periodic filings, should the auditor be required to communicate information on critical accounting policies and practices and alternative accounting treatments to management as well as to the audit committee?||Yes. This should have occurred routinely during the audit. Moreover, these items also should be discussed with the chief executive auditor over the internal audit unit. Internal audits should also be reporting to the Audit Committee on these matters.|
|G.1. Critical Accounting Policies and Practices.|
|102||Should the auditor be required to provide additional information to the audit committee regarding the company's critical accounting policies?||No comment.|
|103||When should the communication take place?||Prior to issuance of the financial statements, and the earlier the better if there is a significant disagreement.|
|104||Should the auditor be required to provide the communication in writing?||Yes.|
|105||Is it appropriate that investment companies would be subject to the rules regarding critical accounting policies?||Yes.|
|G.2. Alternative Accounting Treatments.|
|106||Is the discussion of which accounting policies require communication with the audit committee sufficiently clear?||Yes. We also recommend that the chief executive internal auditor be included in these discussions of alternative accounting treatments (three-way discussion among the external auditor, management, and the internal auditor).|
|107||Should additional matters be required to be communicated to the audit committee? If so, which matters?
||We believe that any matter that materially affects the financial statements should be communicated to the audit committee. We believe that the income materiality standard should be "any item which if accounted for differently would cause the company to either exceed or not make the `so-called analysts' expectations" (for as long as this unproductive measure is in place).
We also note that "meeting analysts' expectations" is not a particularly productive goal for a business, nor is it a particularly useful measure for investors. We much prefer that a business focus on meeting the goals of a carefully constructed long-term business plan. To the extent that "meeting analysts' expectations" causes businesses to focus on quarterly results solely to please the analysts rather than focusing on their business plan, then "meeting analysts' expectations" is counter-productive to both the company and the nation's economy.
|108||Is it appropriate that investment companies would be subject to the proposed rules regarding alternative accounting treatments?||Yes.|
|G.4. Timing of Communications.|
|109||Should the timing of these communications be required to occur before any audit report is filed with the Commission or at some other time||Yes, before any audit report is filed with the Commission.|
|110||Should these communications regarding critical accounting policies be required to be in writing? If so, why?||Yes, all important communications should be in writing so that documentation is provided.|
|111||Should we include specific instructions within the proposed rule regarding the nature of communications of critical accounting policies? If so, what instructions should be provided and why?||Yes. In particular, the critical accounting policies are those that if handled differently would materially affect net income, and the various financial ratios commonly used in analyses. We also refer the reader to our comments about the unproductiveness of meeting analysts' expectations in our answer to Question #107.|
|112||Do these required communications fulfill existing GAAS requirements? If not, why?||The required communications appear to fulfill the existing GAAS requirements. However, the question of whether the GAAS-required communications are sufficient is something that should be periodically reexamined.|
|113||Should these communications regarding alternative accounting treatments be required to be in writing? If so, why?||Yes, in order to provide adequate documentation of the issues.|
|114||Do these required communications fulfill the statutory requirements? If not, why?||No comment.|
|115||Should the minimum requirements for discussion of alternative accounting treatments be expanded or reduced? If so, how?||Expanded. Please see the answer to Question #107.|
|116||Should the list of recommended other communications be expanded or reduced? If so, what specific items should be added and why?||No comment.|
|117||Should the list of recommended other communications be required to be communicated to the audit committee? Why or why not?||Yes, in order to make the audit committee aware of all of the possibilities.|
|118||Are the appropriate entities included under the term "issuer" appropriate? If not, what entities should be included or excluded?||No comment.|
|119||Is it appropriate that investment companies are required to make these communications to their audit committees? Why or why not?||Yes. Members of audit committees of investment companies have the same needs for information as anyone else, especially given the diverse types of investments and variety of potential accounting treatments.|
|120||This proposed rule would apply to "issuers." Should the Commission consider applying this rule to a broader population such as "audit clients" as defined in 2-01(f)(6) of Regulation S-X? Why or why not?||No comment.|
|H. Expanded Disclosure.|
|121||Is the proxy statement the appropriate location for this disclosure? If not, why?||Yes. The stockholders should be informed of this information.|
|122||Should we permit incorporation by reference into the company's annual report?||No. It should be reported in its entirety under the principle of full disclosure.|
|123||Would expansion of the proxy disclosure of professional fees paid to the independent auditor from three categories to four provide more useful information to investors?||Yes. Investors need detailed information to assess how companies are using their auditors. "Catch-all" categories should be eliminated. "All other" categories are too broad and have had significant amounts in the past.|
|124||Are the new categories of disclosure appropriate? Are they well defined, or should they be more accurately defined? Should there be additional (or fewer) categories?||Yes. More categories are always helpful in providing additional information. Investors need detailed information to assess how companies are using their auditors. Catch all categories should be eliminated. "All other" categories are too broad and have had significant amounts in the past.|
|125||Is disclosure of two years of fees appropriate? Should the proposed additional fee disclosures be expanded to three years or remain at one year?||Three years of fees disclosure seems appropriate.|
|126||What, if any, additional information about professional fees would be useful to investors?||Separation of fees related to "audit work" and fees related to "other attest work" would be useful to investors.|
|127||For a registrant not subject to the proxy disclosure rules, such as foreign private issuers, should we require that the same disclosures be placed in annual reports?||Yes.|
|128||Is there any additional disclosure concerning the activities of audit committees that would be beneficial to investors?||We could consider making the Audit Committee provide a justification for using the auditor for any non-audit service. This should help the audit committee ensure that these other services do not conflict with the audit function, and this should help keep non-audit services to a minimum.|
|129||Should companies be required to provide the information in their quarterly reports? Should it be required that the information be included in other filings such as Form 10-Q or 10-QSB?||No comment.|
|130||Should registered investment companies be required to provide the information in their semi-annual report to shareholders on proposed Form N-CSR?||No comment.|
|131||Registered investment companies are required to provide disclosure of audit fees billed for the registrant only, but are required to disclose other types of fees in the aggregate for the registrant, its investment adviser, and certain other parties. Is this appropriate, or should we also require disclosure of audit fees on an aggregate basis? In the alternative, should we require disclosure of audit-related fees or any other fees for the registrant only and not on an aggregate basis?||The entire set of fees should be disclosed on both an individual entity basis and on an aggregate basis.|
|132||If we adopt such a requirement, should we require or permit registrants to recalculate and report fees already disclosed for more than two years so that all fee information is consistently reported and available?||Yes, we should require it.|
|I. Transition Period|
|133||Would a period of time beyond the adoption date of the final rules be necessary or appropriate for compliance with the final rules by smaller companies or companies with whose securities currently are not listed or quoted? If so, which rules should we consider a delayed effective date?||Immediate compliance is preferred, but a period of no longer than 6 months might be more practical.|
|134||How should an effective date be determined with respect to each amendment?||The timing of the effective date depends up urgency of need for compliance. But short periods of a maximum of a few months are generally preferable.|
|135||Are there special considerations that we should take into account in providing a transition period for foreign private issuers?||We recognize that the SEC faces many challenges in implementation related to foreign issuers. We are supportive of transition periods and exemptions only as absolutely necessary.|
|Section III. General Request for Comments|
|136||We invite any interested person wishing to submit written comments on the proposals or any matters that may impact the proposals, to do so. We specifically request comments from investors, issuers, and accounting firms.||Please see the cover letter.|
|137||We solicit comment on each component of the proposals.||No comment.|
|138||Would the proposals related to audit committees and partner compensation help alleviate the pressure that clients may place on engagement partners or accounting firms to acquiesce to the clients' views on accounting issues? What are some of the other scenarios where such pressures might exist?||These proposals will help. However, there need to be specific incentives by each of the accounting firms that encourage their staff not to acquiesce to the pressures from the client on accounting issues.
Moreover, we believe that the PCAOB should be performing risk-based audits of the registered companies (See the answer to Question #53). These audits should be a check on the work by the CPA firms.
|B. Disclosures of Audit and Non-Audit Services|
|139||Pursuant to 44 U.S.C. 3506(c)(2)(B), we solicit comments to: (1) evaluate whether the proposed collections of information are necessary for the proper performance of the functions of the agency, including whether the information will have practical utility; (2) evaluate the accuracy of the Commission's estimates of the burden of the proposed collections of information; (3) determine whether there are ways to enhance the quality, utility, and clarity of the information to be collected; and (4) evaluate whether there are ways to minimize the burden of the collections of information on those who are to respond, including through the use of automated collection techniques or other forms of information technology.||Investors rely heavily on the quality of audit work. In fact, trillions of dollars are at risk, in part based on the quality of audit work. The information providing insight in the quality of the audit work is critical because it impacts investors' analysis of the objectivity of the auditor, and the performance of the audit committee.|
|D. Request for Comments|
|140||As noted above, we request comments on all aspects of this cost-benefit analysis, including the identification of any additional costs or benefits. We encourage commenters to identify and supply relevant data concerning the costs or benefits of the proposed amendments. We request comments, including supporting data, on the magnitude of the costs and benefits mentioned in this section.||The billions of dollars lost due to corporate fraud represent the cost of not improving the system. Another cost is the loss of investor confidence in the equity markets and the reduced ability of companies to raise capital. Therefore, all other costs should be compared to these problems. We believe that the increased costs are insignificant in comparison.|
|141||Are there any other costs or benefits that we have not identified? For example, would the additional duties on audit committees increase the cost of maintaining those committees? Would the amount of compensation demanded by audit committee members increase? Would there be a shortage of potential audit committee members that would lead to higher costs related to finding and retaining such members? Would the cost of officer/director liability insurance increase? Please describe any such costs and provide relevant data.||We do believe that the proposal may increase the cost of the audit function in numerous ways. However, cost to investors (and others) from poor oversight dwarfs the potential incremental cost of better oversight.
We believe that audit fees have been artificially low because audit work has been used as a loss leader to obtain consulting work. Thus, the quality of audit work appears to have suffered as a result. We believe that auditors should be fairly paid to perform audit and attest work, and that the audit work should be of a high quality and be useful to investors.
|142||Are there additional costs related to the proposed disclosures? If there are, please identify them and provide supporting data.||No comment.|
|143||We request comments on the reasonableness of the burden hour, cost estimates, and underlying assumptions related to the proposed disclosures.||No comment.|
|144||Will the prohibition of certain non-audit services impose greater costs on companies? If so, what will those costs be and how significant will those costs be?||We believe that these costs will be insignificant in relation to the other expenses companies must incur. Further, we feel strongly that cost should not be used as an excuse to weaken reform.|
|145||How much cost will issuers incur from not being able to retain their preferred providers of non-audit service, when that preferred provider happens to also be their auditor?||We believe this to be insignificant. Further, the audit is more important than the other services, and independence should be placed above "preferred provider."|
|146||What will be the impact, if any, on audit fees from the proposal to prohibit certain non-audit services?||We believe that the audit and attest functions should be fairly compensated.
We also note that if consulting continues to pay better than auditing, then if a company has CPA Firm 1 performing the audit and CPA firms 2, 3 and 4 are consulting for more money, there will be no incentive for CPA Firms 2, 3 and 4 to ever bid for that audit work. Projecting this to the SEC Practice audit universe, the losing CPA firm will be the one that does the most audits for issuers, and the other firms will be enriched performing consulting for the issuers. This will adversely affect the quality of audits. Therefore, we believe that the SEC should carefully examine and monitor the long-term impact of having the audit firms perform any consulting for publicly-traded companies.
|147||Are there any economies of scope that will be lost due to implementation of the auditor independence rules?||We believe that audits should not be considered with the concerns of economies of scope as a significant consideration. It is much more important that an audit be thorough, independent, and of high quality. We do not believe that "possible economies of scope" that might be obtained by bundling non-audit services with audit services is a sufficient justification to permit auditor independence to be sacrificed. We reiterate our position that audit firms should be limited to performing solely audit and attest services for the audit client.|
|148||Are there any economies of scale that will be lost due to implementation of the auditor independence rules?||We believe that audits should not be considered with the concerns of economies of scale as a significant consideration. It is much more important that an audit be thorough, independent, and of high quality. We do not believe that "possible economies of scale" that might be obtained by bundling non-audit services with audit services is a sufficient justification to permit auditor independence to be sacrificed. We reiterate our position that audit firms should be limited to performing solely audit and attest services for the audit client.|
|149||Given that only larger clients have more than two partners as part of the audit process, would this provision impose higher costs on mid-tier firms?||No comment.|
|150||We request comment on the anti-competitive effects of the proposals.||To the contrary, we believe that audit firms should be competitive on quality of audit measures. We hope that Public Accounting Oversight Board oversight and additional scrutiny will increase this type of competition. Mandatory audit firm rotation would improve the competition.|
|151||The possible effects of our rule proposals on efficiency, competition, and capital formation are difficult to quantify. We request comment on these matters in connection with our proposed rules.||These losses in the U.S. capital markets occurred in part because the auditing firms did not adequately perform their function in the capital markets. The lack of confidence in the markets makes capital formation more difficult. Therefore, we believe that significant changes must occur in order to restore investor confidence.
We recognize that the SEC must balance investor protection with competitiveness factors affecting the United States capital markets. However, the commission should also consider the enormous loss the U.S. capital markets from the loss of investor confidence in our system. Leaning to heavily on the competitiveness issues risks a race to the bottom when it comes to governance standards. The U.S. capital markets will remain an attractive source of capital if the reform measure were more stringent than proposed. The SEC should be guided by the concept that, while being flexible to foreign jurisdictions, generally if companies wish to access U.S. capital markets, they must meet U.S. standards.
|152||We request comment on the number of accounting firms with revenue under $6 million.||No comment.|
CalPERS' Financial Market Reform: 3/02
|Issue1||Board Approval?||Staff Recommendation/ Timing||External Commentary2|
|1. Increase the number of members required to be "financially literate" (at least two, or a majority).||X||2/02, 3/02: Recommended and approved.||No known disagreement; question is how many?
Likely to be among topics considered by exchanges' tasks forces.4
|2. Provide guidelines on what "financial literacy" means.||X||2/02: Recommended and approved.||General agreement, though whether "financial literacy" equates to "audit expertise" is a matter of debate. Should audit comm. members be experts, or simply have the skills to competently question the experts? Need market guidance (perhaps from NACD?) on the types of questions/ scope of inquiry that an audit committee should undertake.
May be among the topics considered by exchanges' task forces.
|3. Impose minimum training requirements on Audit Committee members.||X||2/02: Recommended and approved.||Likely to be among topics considered by exchanges' tasks forces.|
|4. Require Audit Committee approval of any non-audit services by the auditor, and disclosure of the reasons in the proxy. (This applies only to the extent non-audit services are permitted, which is CalPERS' preferred approach; see Auditor Independence #1, below.)||X||2/02: Recommended and approved.||Audit industry and corporate officials prefer this approach to CalPERS' preferred "bright line" ban on non-audit services (see Auditor Independence #1, below).
May be a component of federal legislation, and likely to be among topics considered by exchanges' tasks forces.
|5. Provide that Audit Committees have the power to hire and fire the auditor.||X||2/02: Recommended and approved.||General agreement (subject to the state law requirement that shareholders approve retention of the auditor).
Likely to be among topics considered by exchanges' tasks forces.
|6. Require that Audit Committees meet at least once per quarter, review the company's internal audit functions at least annually, and have at least one meeting per year with the external auditor and without any company employees present.||X||3/02: Recommended and approved.||Consistent with exchange listing standards and NACD guidelines. May be clarified as outgrowth of exchanges task forces.|
|7. Require that Audit Committees have access to their own resources (e.g., dedicated staff).||X||3/02: Recommended and approved.5||None known.|
|8. Require that Audit Committees have full access to company books and records.||X||3/02: Recommended and approved.||None known.|
|1. Prohibit audit firms from providing non-audit services, with the exception preparation of tax forms and registration statements.||X||2/02, 3/02: Recommended and approved.||Part of LaFalce & Oxley bills, but with different definitions of "non-audit":
Likely to be addressed by other federal legislation as well.
Likely to be among SEC proposals, and to be considered by the exchanges' task forces.
|2. Require a mandatory rotation (5 to 7 years) of external auditor.||X||2/02: Recommended and approved.||LaFalce bill: 4 years. Likely to be part of other federal legislation proposed by Democrats.
Strongly opposed by members of the corporate community.
May be considered by SEC roundtable, and/or by the exchanges' task forces.
|3. Prohibit audit firms from providing internal and external audit services for the same client.||X||2/02: Recommended and approved.||Likely to be considered as part of SEC roundtables, and/or by the exchanges' task forces.
In 2000 (in response to former SEC chairman Levitt's proposals), strongly opposed by small and mid-size companies (particularly those trading on NASDAQ).
|4. Establish a "cap" ($ or %) for non-audit services (if bright line test not adopted)||X||3/02: The data necessary to determine the appropriate "cap" is not currently available in the market. Under the approved Reform Package Action Plan, staff will collect this data over the 2002 proxy season and hopes to have a better understanding of the facts by the end of the season (i.e., June).||Preferred by corporate community (leaving to each company the discretion to establish the appropriate "cap"). Consistent with some company's informal policies.7|
|5. Require a cooling off period (of at least one year) before a company can hire any employees from their auditor that worked on their audit.||X||2/02, 3/02: Recommended and approved.||LaFalce bill: 2 years.
Likely to be considered as part of SEC roundtables, and/or by the exchanges' task forces.
|6. Require mandatory liability insurance by all auditors.||X||3/02: Staff continuing to research.||Details to follow.|
|7. Require companies to use two auditors, to double-check each other's work.||X||3/02: Deferred consideration until after the issues described in #1-5, above, are resolved.||Recommended by the Greenlining Institute.|
|8. Support Congressional efforts to amend the Private Securities Litigation Reform Act of 1995 (PSLRA) to restore joint and several liability for auditors, but only for auditors who fail the "independence" bright line test or who fail to comply with the financial fraud reporting provisions within existing securities laws. Consider other amendments that may be necessary to increase auditor accountability.||X||3/02: Recommended and approved. Additional issues to be brought to the Board as they arise.||LaFalce bill: would restore J&S liability for auditors who fail the independence standard (consistent with CalPERS' "bright line" test), or who knowingly commit a violation of the securities laws, or who fail to comply with financial fraud reporting laws, or where the company audited has become insolvent.|
|1. Join forces with other significant users of financial statement to provide concrete and responsible proposals for accounting standards reform, including:
||X||2/02: Recommended and approved.
3/02: The Board President will designate one or more Board member(s) to lead staff in this endeavor. Staff is compiling names of potential participants. Target date for coordinating first meeting is April.
|Agreement that accounting standards have not kept up with the complexities of the market, and that (minimally) standards need to be revised/added under a more streamlined process than is currently the case.
General agreement that financial statements should move toward a "plain English" approach, with end users' needs being paramount. Part of SEC proposals.
General debate centers around whether the US should move more toward a "principles-based" model, or remain with what is described as a "rules-based" approach.
|2. Coordinate efforts with the California State Board of Accountancy, with regard to state-level regulation of the accounting industry.||X||3/02: Recommended and approved.||Note: CalPERS staff testified on 2/27/02 at a CSBA hearing; staff has also met members of the CSBA's legislative oversight committee.|
|3. Specifically promote the adoption of more rigorous accounting standards for the consolidation of Special Purpose Entities (SPEs), such as proposed by the IASB.||X||2/02: Recommended and approved. Will also be discussed as part of the Accounting Standards task force.||General agreement, although tied to overarching question of whether the existing standards model should be reformed.|
|4. Demand broader public exposure (with an annual separate mailing to shareowners) of a company's entrance into forward equity contracts.||X||3/02: This issue will be raised with the Accounting Standards group to be formed (see #1, above).||None known.|
|5. Consider possible criminal sanctions that will help assure fair, accurate and complete financial reporting.||X||3/02: Staff continuing to research.||Details to follow.|
|6. Urge FASB to require that stock options used to attract, retain or compensate employees should be reported as expense in income statements.||X||3/02: Deferred consideration pending additional staff analysis.||Consistent with views of many other institutional investors (particularly those with global portfolios), including TIAA-CREF.
Consistent with the expected approach from the IASB.
Expect the CII to consider this same recommendation at March Spring Conference.
S 1940, the "Ending the Double Standard for Stock Options Act" (Levin [D-MI] and McCain [R-AZ]), would disallow tax benefits for stock option compensation unless disclosed in corporate financial statements.
|Accounting Industry Oversight|
|1. Provide for more effective and independent oversight of the auditing industry. Any oversight entity should have an independent funding source and be comprised of a majority of investors.||X||2/02: Recommended and approved.||General agreement that a new body needs to be established, under the oversight of the SEC (as is FASB), and that funding needs to be provided through the private sector but be independent of the accounting industry. Addressed in SEC proposals, and Oxley and LaFalce bills. Expect additional legislation to be proposed as well.
|2. Provide that the oversight entity would have subpoena and disciplinary power.||X||2/02: Recommended and approved.||General agreement.|
|3. Impose criminal sanctions for those who lie to an auditor.||X||2/02: Recommended and approved.||General agreement. Contained in Oxley & LaFalce bills.|
|1. Provide for additional disclosure of each director's financial ties to the board and the company, including personal, family, business, political and philanthropic connections.||X||2/02, 3/02: Recommended and approved.||Consistent with petition for rulemaking submitted to the SEC by the AFL-CIO.|
|2. Require tougher minimum standards for independence (consistent with CalPERS' standard of independence).9||X||2/02: Recommended and approved.||Generally consistent with the definitions adopted by other institutional investors. Current exchange listing standards articulate similar issues, but defer to boards to evaluate the criteria to determine whether directors are "independent" or not.
Likely to be considered as part of SEC roundtables, and/or by the exchanges' task forces.
|1. Form a commission made up of regulators, legislative representatives, and investors to examine the diverse components of the governance system (including ways in which conflicts of interest may influence corporate decision making), considering the role of investment banks, equity analysts, rating agencies, lending institutions, outside attorneys and other consultants.||X||2/02: Recommended and approved.
3/02: Board President to designate one or more Board member(s) to lead staff in this endeavor.
|Oxley & LaFalce bills both call for the SEC to study the role of rating agencies and "equity research analysts."
Generally accepted that various conflicts of interests by third parties advising corporations are common yet not disclosed to the markets.
|Other Governance Issues|
|1. Executive Compensation Disclosure:
||X||3/02: Recommend and approved.||First three bullets generally supported by other investors, and likely to be part of SEC roundtables.
All four bullets recommended by the Greenlining Institute.
|2. Invite CalSTRS to participate on both of CalPERS' task forces (i.e., regarding accounting standards and the governance model).||X||3/02: Recommend and approved.||None known. Many public hearings are being held throughout the country, including legislative and CSBA hearings in California.|
|3. Investigate potential amendments to the PSLRA and related laws to strengthen shareowner rights.||X||3/02: Staff continuing to research.||The LaFalce bill (as well as potentially other federal bills) address components of the PSLRA. LaFalce's bill would restore (under certain circumstances) joint & several liability for auditors (see Auditor Independence # 6); restore aiding and abetting liability to those outside the corporation; and restore the right of plaintiffs to seek discovery before a motion to dismiss.|
|4. Establish minimum corporate governance standards for investing (e.g., for active managers, private equity transactions).||X||3/02: Staff continuing to research.||Staff continuing to research.|
|5. Create a "report card for corporate governance" that is easily understood by the marketplace.||X||3/02: Staff continuing to research.||Staff research includes the corporate governance rating services already available in the market.|
|6. Elevate CalPERS' presence and profile in the financial press.||X||3/02: Staff continuing to research.||Staff continuing to research.|
|1. Support Congressional efforts to provide greater retirement security to 401(k) plan participants.||X||2/02: Recommended and approved.||Various bills (including Boxer/Corzine) have been introduced. General debate seems centered around two issues. First, whether "caps" on the amount of company stock that may be held in an employee's 401(k) plan is contrary to the wishes of most plan participants. Second, whether restrictions on employer matches in the form of company stock will discourage these matches.
President Bush's proposal would require that company executives have the same restrictions on their personal stock sales as are imposed on 401(k) plan participants.
Issues Considered but
Not Included as Part of CalPERS Reform Package
|Date of Board Action/Comments|
|1. Require 100% to be "financially literate."||3/02: Decided to remain with the more general policy position of simply increasing the number to either 2 or a majority. Until the meaning of "financially literacy" is defined, this may have the unintended consequence of diluting the skills that are required to demonstrate "financial literacy."|
|2. Accept successful completion of the General Securities Registered Representative Examination (Test Series 7) as at least one measure of "financial literacy."||3/02: Decided to await further comments from other collaborative organizations addressing this issue; Board may revisit at a later time.|
|3. Review various SEC rules and laws regarding "independence," particularly the Investment Company Act of 1940, and consider whether CalPERS should adopt those definitions.||3/02: Decided to stay with CalPERS' existing definition, which the Board adopted in 1998 after considering a multitude of various possible definitions, including the Investment Company Act's requirement that no more than 60% of a board be an "interested person" (as defined by that Act).|
|4. Take a lead role in urging specific components of 401(k) reform.||3/02: Deferred taking a position on the specifics of possible pension policy positions, at least pending the outcome of the Congressional debate. Thereafter, the Committee should consider whether these issues should fall within the Corporate Governance Program, and whether CalPERS has the appropriate expertise about 401(k) plans to be a credible commentator.|
|5. Conduct a survey of CalPERS' top equity holdings regarding the features of their 401(k) plans.||3/02: CalPERS will rely on research conducted by the Employee Benefit Research Institute (EBRI).|
|1||Issues in bold are those that have, as of the date of this matrix, part of CalPERS' Financial Markets Reform Package.|
|2||The information contained in this column is derived from a variety of sources, including published proposals by (and conversations with members of) the Securities and Exchange Commission (in separate meetings as well as through participation in the SEC's first roundtable of these issues); meetings with Congressional staff and staff of the California State Accountancy Board; public positions by other institutional investors; and discussions with representatives from the National Association of Corporate Directors, Financial Accounting Standards Board, Government Accounting Office, American Institute of Certified Public Accountants, past officials of the SEC and Department of Labor, NYSE and NACD Regulation, National Association of State Auditors, Comptrollers and Treasurers, miscellaneous corporate officials, and retired executives from the Public Oversight Board and Deloitte & Touche.|
|3||Note that CalPERS' U.S. Corporate Governance Core Principles and Guidelines ("Core Principles") call for this committee to be comprised entirely of independent directors. (Core Principles, A.4.)|
|4||Note that the sanction for noncompliance with a listing standard is de-listing, which is rarely in the best interests of shareowners.|
|5||This is comparable to CalPERS' existing Core Principle with respect to Compensation Committees. (See Core Principle B.3.)|
|6||In 2000, CalPERS supported (in writing and testimony) then-chairman Arthur Levitt's proposals to strengthen auditor independence by prohibiting non-audit (as well as internal auditor) services by the company's external auditor. The audit industry, as well as many members of the corporate community widely and strongly opposed this proposal.|
|7||For example, Intel requires that any non-audit services above $25,000 (excluding financial information system design, which its external auditor may not perform) be subject to a special approval process, culminating in approval by the Chair of the Audit Committee.|
|8||CalPERS' Core Principles call for the board to be comprised of a substantial majority (defined in practice to be 75%) of independent directors, and that all committees charged with certain key functions (i.e., audit, director nomination, board evaluation and governance, CEO evaluation and management compensation, and compliance and ethics) be comprised wholly of independent directors. (Core Principles A.1 and A.4.)|
|9||CalPERS' definition (consistent with those adopted by other institutional investors and TIAA-CREF) of an independent director is one who: (a) has not been employed by the company in an executive capacity within the last five years; (b) is not, and is not affiliated with a firm that is, an advisor or consultant to the company or a member of the company's senior management; (c) is not affiliated with a significant customer or supplier of the company; (d) has no personal services contract(s) with the company, or a member of the company's senior management; (e) is not affiliated with a not-for-profit entity that receives significant contributions from the company; (f) within the last 5 years, has not had any business relationship with the company (other than service as a director) for which the company has been required to make disclosure under Regulation S-K; (g) is not employed by a public company at which an executive officer of the company services as a director; (h) has not had any of the relationships described above with an affiliate of the company; and (i) is not a member of the immediate family of any person described above.|