January 10, 2003

Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
Via e-mail to: rule-comments@sec.gov

Re: File No. S7-49-02

To the Commission and its staff:

I appreciate the opportunity to submit comments on the proposal in Release 33-8154 (FR-64), "Strengthening the Commission's Requirements Regarding Auditor Independence."

I am a CPA with over 35 years of SEC-practice experience, including experience as an auditor, concurring reviewer, regional accounting and auditing director, national SEC partner in a national accounting firm, and currently as a consultant to local and regional accounting firms regarding SEC practice.  I am author of SEC Accounting and Reporting Manual, published by Warren Gorham and Lamont, and developer and leader of continuing education programs relating to SEC financial reporting requirements.  I have served in professional activities relating to public company financial reporting, including service as a member of the AICPA's SEC Regulations Committee and Accounting Standards Executive Committee.


I agree with the overall objective of supporting, enhancing, and assuring the independence of auditors.  However, some of the provisions of the Act and the proposed rules go beyond what is reasonably necessary to achieve that objective, particularly in the light of substantial changes in the financial reporting and audit environment, including those that the Act has brought about.

For example, a simple but very significant change in the audit environment is the improved separation between the independent auditor and management as a result of changes in the responsibilities and composition of audit committees.  Auditors will report directly to independent audit committees, which will have the sole authority to hire and replace the auditor and determine the amount of the auditor's fees.  When the new audit committee requirements take effect, the audit committee "not management" will be the auditor's client.

It is widely recognized that the major accounting frauds that provided the impetus for change were the result of many factors, among them a loss of independence as evidenced by auditors' lack of objectivity in their judgments and decisions.  In these situations, the factors that contributed to the lack of independence largely arose from circumstances that preceded the effectiveness of the Commissions' most recent amendments to the independence requirements in Rule 2-01 of Regulation S-X.  These amendments became effective generally in February 2001, with delayed effectiveness for certain matters.  The proposed rule changes would impose even more stringent independence provisions when there has not yet been adequate experience with the recent rule amendments.

The Commission should not at this time adopt provisions that go beyond the mandates of the Act. The recent onslaught of changes makes it difficult for those affected by this proposal, particularly small accounting firms, to have the time needed to give adequate thought for appropriate comment on the proposal. This problem is exacerbated by the proposal's addition of requirements that go well beyond the provisions of the Act.  Furthermore, the time provided for responding to the proposal, although imposed by Congress, is extremely limited.  Even worse, many small accounting firm partners, even if they could devote the time necessary for a useful response, believe their comments would not carry much weight and that their efforts would likely be a waste of their time.  Therefore, the Commission is not likely to receive comments from the majority of small accounting firms that will be most affected by the proposal.

Any rules on independence should recognize that some circumstances might not be material.

Role of the Concurring Reviewer

Among the various methods being employed or considered to enhance the auditor's objectivity, which is the principal reason for independence, the one that has great potential with little adverse consequences is enhancement of the role of the concurring reviewer.  A good concurring review performed by a qualified person is an effective way to assure that the audit is done correctly.  While a concurring review is not a substitute for independence, its benefits and ways to strengthen its effectiveness should be examined before imposing more-stringent independence requirements.  The Public Company Accounting Oversight Board should make this a priority.

Also, good concurring reviews should obviate the need for any "forensic" audit of the audit, an alternative that does not seem practical and is unlikely to be employed except for investigations.

Effects on Small Companies and Small Audit Firms

The accounting frauds that were the cause for Congressional action involved very large companies and large national accounting firms.  Yet, there is little in the Act to reduce the burdens of compliance on small companies and small audit firms.  The Commission would do well to balance the extent of its rule changes with both the benefits to be achieved and the burdens imposed.  The Release appropriately recognizes this matter.

In particular, the Commission should proceed cautiously and with full consideration of the adverse consequences before adopting any rules that could potentially force hundreds of accounting firms to discontinue providing audit services for public companies.

Partner Rotation

Many small accounting firms will not be able to comply with the proposed partner rotation requirements.  This will drive a significant number of competent accounting firms out of the market from which registrants currently choose auditors.  Some registrants, particularly the younger and smaller ones, and those not yet public, may be unable to obtain an audit at a reasonable cost.  This problem will be exacerbated in non-metropolitan regions and in specialized industries.

The Commission should exempt small audit firms from the partner rotation requirement.  There is already support for such distinction among firms; for example, Section 104 of the Act distinguishes between firms with more than 100 SEC clients and those with less.  The small business issuer reporting system is another distinction.  Still another distinction has been provided by the AICPA's SEC Practice Section, which for years has exempted from partner rotation requirement those firms with fewer than five SEC clients and ten partners.

If the Commission adopts the partner rotation requirement without any exemption for small audit firms, it should delay as long as possible the application of the requirement to those firms.

Further, and in any case, the "time-out" period should be reduced.  The length of the time-out period must be balanced against the increase in costs and audit risks that result.  I do not agree that a newly-assigned partner with responsibility for the audit during a time-out period of one or two years would have less professional integrity and objectivity than if assigned for a longer period.  Any partner who would subordinate his or her integrity and objectivity simply because of a one or two-year assignment is equally likely to resort to improper professional behavior regardless of the period of assignment.  Weeding out such partners is an issue for firms' quality controls rather than a matter that should be addressed by across-the-board partner rotation requirements.

To preserve continuity, there should be only staggered rotation, as is recognized in the Release.  It is neither desirable nor necessary to rotate both the lead audit partner and the concurring reviewer at the same time.  Rotating just one provides a fresh view while preserving some continuity.  As written, however, the proposed rule does not accommodate that objective.  Even better, the rotation requirement should apply to both the lead audit partner and the concurring reviewer as a single unit, but not to the individual partners.  Thus, rotation of one or the other would be required only if both have been on the engagement for the five-year period.  This would provide flexibility for smaller firms, considering the costs of rotation in relation to the expected benefits, by allowing firms to rotate only the concurring reviewer without also rotating the lead audit partner.

Pre-Approval of Services

Although the pre-approval of services is required to help assure that independence is maintained, it does not by itself create independence.  Likewise, the failure to obtain such approval, while a violation of a specific requirement, does not in fact impair the auditors' independence (nor has it ever).  Therefore, the rules should not be written in a way that independence is automatically impaired for such non-compliance.  Such a result would create considerable hardship for the audit firm, the reporting company, and the shareholders, because presumably the only recourse would be for the company to obtain new auditors and a new audit.  At the very least, the problem should be cured if the audit committee approves the service before the audit report is issued.


The proposed rule would make an audit firm not independent if any partner or shareholder on the audit earns or receives compensation attributable to non-audit services.  That rule would effectively prohibit an audit firm from providing any non-audit services to the audit client, because the partner or shareholder would earn or receive compensation merely by sharing in the profits of the firm. The rule should make it clear that merely sharing in the firm's profits will not impair the auditor's independence.

Final Comments

The Sarbanes-Oxley Act has imposed significant and far-reaching changes for registrants and their auditors.  Further changes affecting auditors are on the way with the creation of the Public Company Accounting Oversight Board.  Adjusting to these changes will entail great effort, time, and costs.  The Commission can help in the efforts to implement and comply with the new requirements by adopting rules that are clear and that impose the least amount of burden while at the same time achieving the important objectives of the Act.


Robert F. Richter, CPA