Dixon Odom PLLC
December 20, 2002
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: SEC File No. S7-49-02
Proposed Auditor Independence Rules
Members of Staff of the Commission:
Dixon Odom PLLC ("Dixon Odom") respectfully submits the following written comments on the Securities and Exchange Commission's (the "SEC") proposed rules regarding auditor independence (the "Proposed Rule"). Dixon Odom is a regional accounting and auditing firm based in the southeast with over 180 CPAs serving public and private company clients.
Dixon Odom strongly supports the objectives of the Proposed Rule in strengthening auditor independence, both in fact and in appearance. We do, however, have several comments, observations and questions listed below that we believe the SEC should thoroughly consider in setting the final auditor independence rules. The section numbers below refer to the relevant section of the Proposed Rules.
II.B.1. Bookkeeping and Other Services Related to the Audit Client's Accounting Records or Financial Statements of the Audit Client:
- We believe further clarity is needed as to the definition of bookkeeping services. Many small businesses, including public companies, utilize their external auditors to assist in the financial reporting process. Such assistance can range from drafting the entire financial statements, including footnotes or certain footnotes, such as new disclosures, to merely word processing (typing, printing and binding) the financial statements and regulatory filings from information provided by the client. We understand that the November 2000 SEC rules prohibit an auditor from "preparing financial statements", but even that definition needs further clarity in light of the comment above. Appropriate examples in the final rule would be useful.
- We recognize that the SEC has proposed rules relating to section 404 of the 2002 Sarbanes-Oxley Act that would require management to assert as to the effectiveness of internal controls over financial reporting and auditors to attest to such assertion. In connection with implementation of section 404, many public companies will require assistance in documenting and testing their internal controls over financial reporting in order to be in a position to make the required assertion. We would ask that the final rules specifically address what, if any, assistance the external auditors may provide in this regard. We do not believe such assistance should be prohibited as this assistance would not result in the external auditors either designing or implementing controls which would conflict with proposed rule II.B.6. - Management Functions.
- Also, we could envision scenarios where the scope of either the external audit engagement or the attestation engagement were sufficiently broad to engage the external auditor to prepare such internal control documentation for the client as part of "additional audit scope." We recommend that the final rules address this and similar expansions of audit scope.
II.B.5. Internal Audit Outsourcing:
- The Proposed Rule notes a concern by the SEC for small businesses that have no internal audit department or staff and the effect on such businesses of the proposed rules. We believe that an exception to the proposed rules on auditor independence should be provided for small businesses as such businesses typically do not need a full-time internal auditor on staff but do have periodic needs for a review of internal accounting controls, financial systems, etc. The external party in the best position to assist the client with such internal audit needs, especially if on an ad hoc basis, is the external audit firm. Also, unlike internal audit outsourcing engagements with large public companies where the fees could easily exceed the annual audit fee, fees received from small businesses for internal audit outsourcing typically do not eclipse the audit fee.
- Many internal audit functions could be structured in such a way to be deemed external auditor engagements (such as an agreed upon procedures engagement relating to some financial-related assertion by the client) that would result in an audit or attest report issued under current AICPA standards. For example, for financial institutions, Bank Secrecy Act procedures must be performed. Such procedures are performed by internal audit at some organizations and the external audit firm at others. Therefore, we believe a clear definition of internal audit services should be established with relevant examples provided.
II.C. Partner Rotation:
- The Proposed Rule mandates a five-year cooling off period for any audit engagement team partner. We believe the definition of a partner/principal/shareholder should be more thoroughly defined, especially if the final rules cover all partners who are members of the engagement team. For instance, many auditing firms have both tax partners and tax directors, with little distinction in the work they perform (i.e., both individuals could have final "sign-off" authority on an audit client's tax provision and related accounts and disclosures). If the final rules apply only to partners, the rotation requirements in this case would apply based solely on an individual's ownership in an audit firm and not on the level of responsibility.
- We do not believe the five-year cooling off period is appropriate for many reasons. Instead, the current SECPS rotation requirement of two years is adequate. The concern that such a "short" rotation period might result in partners merely sitting on the sidelines for two years while waiting to rotate back on to the engagement doesn't make economic sense as such partners take on other audit clients after rotating due to current independence regulations. Given these new audit clients and their related need for continuity as well as the pace of change that would occur at the original audit client over a two-year period, it is not realistic to expect the partner to wait in the wings for two years only to jump back in as if nothing had changed.
- Further, should the SEC decide that a five year cooling off period is appropriate for the engagement (signing) partner, we do not believe the cooling off period for other partners on the engagement team should be more that two years. On all but the largest engagements, the concurring reviewer has very limited interaction with the client and oftentimes resides in an office different than the engagement partner's. The concurring reviewer is not typically involved in any of the day-to-day audit work but instead is consulted only on significant auditing and accounting issues. The existence of the concurring reviewer is already meant to add an additional layer of objectivity to the engagement. Extending the concurring reviewer's cooling off period from two to five years does not appear to add any additional independence protection.
- During the cooling off period, whatever that period may be, audit engagement team partners may not provide audit, review or attest services. Based upon the language of the Proposed Rule, it appears such partners may provide non-audit services during the cooling off period. We believe further clarity is needed as to what additional services may be performed by a partner during their cooling off period.
- We agree with the Proposed Rule as it relates to the exclusion of national office personnel from the mandatory partner rotations. Such national office personnel serve as the audit firm's top technical resources, and the ability to access those resources on a continuous basis is crucial to the audit.
- We agree with the Proposed Rule requiring rotation "when an audit engagement team partner ... performs audit, review or attest services for that issuer ... as a partner ... in each of the five previous fiscal years ..." and not requiring other audit personnel, such as senior managers, to be subject to rotation requirements. The level of responsibility for the audit firm's overall audit opinion on a client is significantly different from a partner to a senior manager to a manager to a supervising senior and on down the line. When a member of the audit team is promoted, responsibilities change, which in effect results in a rotation of that member of the audit team. Therefore, we believe the final rule should only require rotation by audit engagement team partners, counting only the years spent by such individuals as partners on the engagement.
- The Proposed Rule, as written, is unclear as to the effect on independence when an audit engagement team partner has performed non-continuous audit services for an issuer. For instance, is independence impaired if an audit partner serves four years as partner, has a two year (or one year) cooling off period, then serves again as audit partner for another four years? Additionally, there are many transition scenarios that need to be addressed in the final rules, such as partners who are currently in a cooling off period and partners who have already served five consecutive years on an audit client. Finally, we believe the final rules should also address how the independence rules relate to partners who have recently joined a new audit firm (either individually or through some sort of merger/acquisition).
II. E. Compensation
- The Proposed Rule notes that the prohibition on compensation for non-audit services would remove the sale of non-audit services from the criteria used to allocate partnership units to the audit partner. We believe more clarity is needed on this point to address direct compensation (i.e., a one-for-one relationship between fees received for non-audit services and partner compensation) versus an indirect relationship. Compensation for the majority, if not all, of public accounting firms structured as partnerships is based on performance of the partnership as a whole as well as individual performance. Thus, the selling of even one non-audit service to an audit client would, theoretically, indirectly increase the audit partner's compensation. This situation would be magnified if that partner also served as a managing partner of an office/region/business unit.
- We believe the SEC should conform the definition of non-audit services with the definitions included in II.H.1. covering audit fees, audit-related fees, tax fees and all other fees to avoid confusion.
Thank you for the opportunity to comment on the Proposed Rule. We would be glad to meet with the SEC and its staff to further clarify any of our comments.
S. Walter McNairy, Jr. CPA
Member, Dixon Odom PLLC