United States Chamber of Commerce

January 9, 2003

Mr. Jonathan G. Katz
United States Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609

Re: Release Nos. 33-8154; 34-46934; 35-27610; IC-25838; IA-2088
Strengthening the Commission's Requirements Regarding Auditor Independence
(File No. S7-49-02)

Dear Mr. Katz:

The United States Chamber of Commerce (the "Chamber"), the world's largest business federation, is pleased to respond to the request for comments from the Securities and Exchange Commission (the "Commission") on its proposed rule, Strengthening the Commission's Requirements Regarding Auditor Independence, 67 Fed. Reg. 76780 (December 13, 2002) (the "Release"). The proposed rule is designed to implement Title II of the Sarbanes-Oxley Act of 2002 (the "Act").

The Chamber's constituents are a diverse group, consisting of businesses of every size, in every industry, and from every region throughout the United States. Our membership includes many publicly traded companies that are directly affected by the Commission's actions. Although most of the Title II rules apply primarily to accountants, those rules will inevitably have a great impact on our membership, the vast majority of whom are purchasers of audit and non-audit services from accountants.1

The Chamber and its members share the Commission's goal of strengthening auditor independence and restoring confidence in our nation's capital markets. We believe, however, that many provisions in the Release threaten to impose unnecessary costs on business with no discernable benefit for capital markets or investors. This is especially true where the Commission has exceeded the requirements of the Act and has proposed more restrictive rules than required by Congress or previously adopted by the Commission.

We are particularly concerned about four issues:

  • The Commission's broadening of its 2000 scope-of-services rule will disrupt the balance struck by Congress in the Act, and will extinguish valuable existing business relationships at great cost to public companies and investors.

  • The Commission's expansion of the audit partner rotation requirement beyond that contemplated by the Act will deprive our members of the firm-specific knowledge that auditors acquire through regular auditing of a particular company, thereby raising the cost of audits, and potentially decreasing audit quality.

  • The Commission's rules regarding disclosures to and from public company audit committees are unclear and burdensome, and will hamper the efficient oversight of audits.

  • The Release lacks adequate transition rules to mitigate the severe additional costs of compliance that rigid, immediate implementation would otherwise impose.

We discuss these concerns in detail below.

I. The Restrictions On Non-Audit Services

In 2000 the Commission extensively amended its Regulation S-X to prohibit accounting firms from performing certain non-audit services for their audit clients. The Commission's careful and comprehensive rulemaking was based on "public hearings at which 100 persons testified" and "over 3000 comment letters" submitted to the Commission. 67 Fed. Reg. at 76784. The Chamber itself participated in that comment process.

The Release expands the restrictions on non-audit services imposed by the 2000 rule. We believe that the Commission's new restrictions are inconsistent with Congress's intent to codify this part of the 2000 rule. The proposed new restrictions will impose significant costs on public companies without any benefit sufficient to warrant displacing the judgment of Congress, as embodied in the Act, and the Commission's own prior judgment, as embodied in the 2000 rule.


The Act's text and legislative history demonstrate that Congress intended to codify the Commission's existing 2000 rule regarding the definitions of prohibited non-audit services. With the exception of two new services, the Act's list of prohibited non-audit services was taken nearly verbatim from the Commission's 2000 rule. Indeed, Congress went so far as to list the prohibited services in the same order in which they appear in the rule. Congress was well aware of the fact that the Commission had already issued detailed definitions of these services and chose not to adopt its own set of definitions.

The legislative history confirms Congress's acceptance of the 2000 definitions. The Senate Banking Committee removed a provision that would have required the SEC to adopt definitions of prohibited services more restrictive than those contained in the 2000 rule.2 Moreover, one Senator emphasized Congress's intent to leave the rule unchanged, noting that the legislation meant that "we will live under the current rules."3 An amendment that would have reinserted the more restrictive definitions was not adopted by Congress.

The Release mistakenly assumes that Congress has required the Commission to develop a non-audit services rule more restrictive than the 2000 rule.4 The Release notes the statement of Senator Sarbanes regarding "categorical exemptions" and concludes that Congress required the Commission to eliminate such "categorical exemptions" from its 2000 definitions of non-audit services. Senator Sarbanes's statement, however, has nothing to do with the definitions of the non-audit services listed in the Act. Instead, Senator Sarbanes was discussing the scope of the exemption authority that the Act grants to the new Public Company Accounting Oversight Board and the Commission.5 Indeed, Senator Sarbanes expressly stated that the Act itself-not the to-be-issued regulation-was designed "to draw a bright line around a limited set of non-audit services," indicating that he understood that the services listed were already clearly defined by the Commission. 148 Cong. Rec. at S7363.

Accordingly, the statutory text and legislative history demonstrate that Congress intended the Commission to maintain, rather than to modify, the definitions in its 2000 scope-of-services rule.


Congress's decision to preserve the 2000 rule definitions is important to our members. Public companies have structured their procurement of non-audit services from accounting firms in reliance on the requirements of the Commission's 2000 rule. By using the same list of services restricted in the 2000 rule, the Act itself gave businesses no reason to suspect that the scope of prohibited non-audit services would be expanded, let alone in such a precipitous fashion. Therefore, our members continue to believe, as a matter of both law and policy, that the non-audit service arrangements that were permissible under the 2000 rule should remain permissible today, and that the text and legislative history of the Act confirm that conclusion. The Commission's sudden expansion of the scope of prohibited services will upset the legitimate expectations of public companies that have contracted with accounting firms for the provision of non-audit services.

Even were the Commission to decide to depart from the existing definitions recognized by Congress, the Commission should make any such departure the subject of a separate proposed rule with a longer notice-and-comment period, so that the Commission may fully consider the costs and benefits of its proposal.


In expanding the scope of prohibited non-audit services, the Release creates ambiguities that will make it difficult for our members to determine which non-audit services remain permissible. The clarity of the rules is crucial. Businesses must be able to determine, in advance, whether a non-audit service is permissible, to eliminate any risk that their auditor will be deemed to have impaired independence in the middle of an engagement. Similarly, ambiguous rules may expose public companies to unfair, unfounded, and expensive litigation by the professional plaintiffs' bar regarding the independence of an audit, even if the company's audit committee engaged in a good faith application of the rules.

Of particular importance is the Commission's treatment of tax services. Historically and uncontroversially, tax services have been considered a "unique" type of non-audit service that categorically did not pose auditor independence concerns. As the Commission recognized in its 2000 Release, "tax services generally do not create the same independence risks as other non-audit services." 65 Fed. Reg. at 76052.

The Act reflects Congress's intent to preserve a special status for tax services. Section 201(a) provides that: "A registered public accounting firm may engage in any non-audit service, including tax services, that is not described in any of paragraphs (1) through (9) of subsection (g) for an audit client, only if the activity is approved in advance by the audit committee of the issuer, in accordance with subsection (i)." (emphasis added). As Representative Michael Oxley, co-sponsor of the Act, noted, Congress determined that "tax issues are part and parcel of the traditional audit function," and should remain permissible because "[t]here was no evidence in Congress's hearings that indicated that the tax function was untoward or somehow led to fraud."6 The Release seemingly acknowledges the protected status of tax services, stating: "Nothing in these proposed rules is intended to prohibit an accounting firm from providing tax services to its audit clients when those services have been pre-approved by the client's audit committee." 67 Fed. Reg. at 76790.

But the Release also suggests that tax services may be prohibited when they violate the Commission's "three principles."7 These "three principles" are particularly difficult to apply in the context of tax services, and will not provide sufficient guidance to our members and their audit committees in determining whether a tax service would be deemed prohibited. The uncertainty surrounding tax services is compounded by the Release's suggestion that "the formulation of tax strategies"-as opposed to "tax planning"-would be a prohibited non-audit service. Without more guidance, it will be extremely difficult for our members to distinguish permissible "tax planning" services from impermissible "tax strategies" services. After all, any tax planning may be characterized as involving advice to a company on how to act in a tax advantageous manner. The ambiguity created by the Release will force businesses to seek expensive legal advice-advice that, in any event, could never guarantee certainty-or to forego altogether their otherwise beneficial and lawful engagement of auditors to provide tax services.

The confusion created by the Release may amount to a de facto prohibition on auditors performing tax services. This would be exceedingly harmful. Our members often procure tax services from their auditors because the auditors' comprehensive knowledge of the company's financial information makes them uniquely qualified to offer tax advice. Similarly, the quality of the audit is improved by the auditor having extensive knowledge of the company's tax situation. If businesses are effectively barred from obtaining tax services from their auditors, public companies and investors alike will bear the costs of having to hire two separate entities to perform services that can be performed more efficiently, and without any threat to independence, by a single firm. These increased costs and decreased efficiencies are not burdens that Congress intended to impose on our nation's businesses.

In order to avoid the costs of ambiguity and the potential loss of audit quality arising from a de facto bar on tax services, the Commission should clarify its commentary regarding the "three principles" and "tax strategies," and explain that tax services remain fully permissible-a conclusion that is consistent with the 2000 rule and the congressional directive set forth in the Act.


The Release also threatens to prohibit appearances by auditors before foreign taxing authorities by suggesting that an auditor generally may not "serve in an advocacy role for the audit client" and by modifying the definition of "legal services" in the 2000 rule. 67 Fed. Reg. at 76790, 76813. The previous "legal services" definition prohibited only those services that required the auditor to be admitted to practice before U.S. courts. By including within the definition any service that requires admittance to the practice of law in a foreign jurisdiction, the Release threatens to extinguish numerous tax services in foreign countries historically provided by accounting firms.

Our members have operations throughout the world. It is impracticable for public companies to maintain knowledgeable tax personnel in every country in which they do business. Accounting firms have traditionally resolved this dilemma by preparing foreign tax returns and representing businesses before foreign tax authorities as needed. This practice benefits both the foreign tax services and the audit: the foreign tax services are more accurate because of the auditor's comprehensive knowledge of the audit client's financial information, and the auditor harvests additional information about the audit client's global operations for use in the audit.

Accordingly, the Commission should clarify that the representation of audit clients before foreign tax authorities is not a prohibited non-audit service. Without such clarification, our members will be forced to retain a host of separate accounting firms. Each firm will then be required to obtain detailed knowledge regarding a public company's operations-knowledge already possessed by an auditor-at the expense of public companies and their shareholders. The result will be wasteful and inefficient duplication, and a likely decrease in audit quality.

II. Audit Partner Rotation

Section 203 of the Act prohibits the "lead" and "reviewing" audit partners from providing audit services to a particular issuer for more than five consecutive fiscal years. The Release dramatically expands this provision by mandating that any audit partner rotate off the engagement after five years, and that the partner not return to the engagement for another five years.

The Commission's expanded rotation requirement threatens the quality of audits and will impose increased costs on our members with no comparable benefit to auditor independence. Performing a quality audit requires that audit partners have a comprehensive understanding of a company's business and financial data. That body of knowledge is generally developed through experience auditing the company. Consequently, by prohibiting any partners from performing audit services for more than five consecutive years, the proposed rule may result in less informed and less effective audits.

In addition, new audit partners will have to spend time getting up to speed on the particulars of a company's business. This will inevitably drive up the cost of audits. The burden will be particularly acute for the Chamber's members in highly specialized industries. Because such industries are typified by complex and unique transactions, a rotating partner with generalized accounting knowledge may need to develop, or to obtain from others, the requisite particularized knowledge at the expense of the public company and its shareholders.

The expanded rotation requirement will also penalize our members in smaller geographic markets. Because there is not a sufficient amount of audit business in those locations, accounting firms do not maintain enough partners in such areas to enable the complete rotation contemplated in the Release. In order to meet the rotation requirement, Chamber members in smaller markets will be forced to bear the expense of partners traveling from remote larger markets. In addition, smaller-market members will be forced to pay larger-market professional fees, in addition to the associated travel expenses, in order to procure the necessary audit services.

We acknowledge that these concerns about increased costs for businesses and diminished audit quality could be raised about the rotation of lead and reviewing partners that Congress mandated in the Act. But Congress recognized the increased audit costs that partner rotation would impose on public companies, and carefully balanced such costs with rotation's benefits by targeting a more limited set of audit personnel whose rotation would most increase the independence of the audit. Congress did so for a reason: it is those partners who have the most contact with audit client management, and therefore are most at risk for developing the type of relationship with the audit client that may be perceived to threaten their independence. Because the lead or reviewing partner will be involved in making the most significant audit decisions, requiring rotation for only those partners most efficiently ensures that "fresh and skeptical eyes" review the company's numbers. Expanding partner rotation beyond the lead and reviewing partners is subject to quickly diminishing returns in terms of auditor independence. Such slight marginal benefits are not worth, in Congress's judgment, the increased costs and diminished audit quality threatened by such an expansion. These costs are compounded by the Commission's expansion of the post-rotation "time-out" period to five years, from the current professional standard of two years that was left in place by Congress.

The Commission should not displace Congress's careful judgment by so greatly expanding the rotation requirement. At a minimum, the Commission should not overturn that judgment without a more extensive process of notice-and-comment, more thorough study, and a more developed factual record.

III. Audit Committee Activities

The Release requires certain disclosures by the auditor to the audit committee, and by the audit committee itself in various securities filings. Section 204 of the Act requires auditors to disclose several general types of information to audit committees, and the Release adopts these requirements largely verbatim.

The provisions of Section 204, however, threaten to overwhelm audit committees with irrelevant information. Without workable definitions of key terms such as "critical accounting policies" and "alternative treatments of financial information," auditors will likely pass vast amounts of largely useless information to audit committees, in an overabundance of caution. Such excessively broad productions, in attempted compliance with unclear or open-ended regulatory requirements, will inundate audit committees with information and prevent them from efficiently monitoring the audit. Accordingly, the Commission should issue rules defining the terms of Section 204 to require the disclosure of that limited set of information that will best assist the audit committee in evaluating the auditors' decisions.

The Release also requires extensive disclosures by audit committees in an issuer's proxy statements. For example, the Release wisely provides that a non-audit service meets the Act's pre-approval requirement if management approves the engagement through the application of policies and procedures established by the audit committee, in addition to the options of case-by-case pre-approval and the de minimis exception contained in the Act. The Release goes beyond the terms of the Act, however, to require that audit committees disclose the percentage of non-audit services that were pre-approved by each method. 67 Fed. Reg. at 76815. Public companies will be driven to adopt the case-by-case pre-approval method for fear that any other form of pre-approval will be characterized, by the media or the professional plaintiffs' bar, as inadequate. By requiring such disclosure, the Commission defeats the flexibility that the options for pre-approval would otherwise provide. Accordingly, while disclosure of pre-approval policies should be required, disclosure of percentages should not.

IV. Transition Rules

Whether or not the Commission decides to adopt rules that exceed the requirements of the Act, the Commission should adopt transition rules to govern the implementation of each aspect of the new regulation. Such transition rules are necessary to avoid the additional costs and unnecessary disruption that instantaneous implementation of any new requirements would impose.

For example, the Commission should apply any new prohibitions of non-audit services prospectively-to new engagements only-and permit existing engagements to run their course. In addition, the Commission should develop transition rules that phase in any new service prohibitions, granting public companies a reasonable period in which to find alternative vendors for newly banned services.

Similarly, if the Commission adheres to its intent to expand the partner rotation requirement beyond the terms set by Congress, the Commission should issue transition rules for implementing the expanded requirement. Without transition rules, many experienced audit partners would be removed from the audit in short order, leaving potential gaps in the audit team's experience. Moreover, the costs of rotation would be inefficiently frontloaded, as a significant amount of the rotation may need to occur shortly after the rule is finalized.

* * *

The Chamber recognizes that strengthening the capital markets by ensuring auditor independence does not come without expense. The Sarbanes-Oxley Act represents a considered congressional judgment that the benefits of certain reforms exceed their costs. Many of those costs will be borne by the Chamber's members. We are willing to do our part. We are concerned, however, that the Commission's Release goes beyond the requirements of the Act, and, in many cases, imposes additional costs on businesses without a corresponding benefit in auditor independence. That these provisions are being considered on the expedited timetable required by the Act highlights the need for the Commission to proceed with caution.

Accordingly, we respectfully urge the Commission to revise its proposed rule to conform to the text of the Act and the intent of Congress. At the very least, the Commission should withdraw those provisions of the Release that exceed the congressional mandate, and resubmit them at a later date in order to allow the careful consideration such important changes deserve.


Thomas J. Donohue

cc: The Honorable Harvey L. Pitt, Chairman of the Securities and Exchange Commission
The Honorable Paul S. Atkins, Commissioner
The Honorable Roel C. Campos, Commissioner
The Honorable Cynthia A. Glassman, Commissioner
The Honorable Harvey J. Goldschmid, Commissioner

1 Of course, the Chamber is interested in many other features of the Act that are not the subject of the Release, such as the funding of the new Public Company Accounting Oversight Board through issuer payments and the contours of the Act's prohibition on loans to corporate officers. We look forward to working with the Commission in these important areas as well.
2 Markup on the Public Company Accounting Reform and Investor Protection Act of 2002 before the S. Comm. on Banking, Housing, and Urban Affairs, 107th Cong. 34 (2000).
3 Id. (statement of Sen. Bunning).
4 67 Fed. Reg. at 76784 ("It seems clear that Congress did not intend to codify unchanged the current auditor independence rules, as the Commission adopted them in November 2000.").
5 Id. See also 148 Cong. Rec. S7350-05, S7363-64 (July 25, 2002) (statement of Sen. Sarbanes); Act, § 201(b) (granting the Public Company Accounting Oversight Board the discretion to grant exemptions from Section 201(a) prohibitions on a case-by-case basis). Specifically, Senator Sarbanes was responding to comments from Senator Gramm, who had observed that the Act did not permit the Commission or the Oversight Board to exempt certain categories of companies from the prohibition on using their auditors for certain non-audit services. Senator Gramm was not discussing the prohibition of certain services. See 148 Cong. Rec. at S7353.
6 Bloomberg News Service, Oxley Says Governance Law Does Not Seek to Ban Tax Services (Dec. 9, 2002).
7 67 Fed. Reg. at 76790. The "three principles" are: "(1) [t]he auditor cannot audit his or her own work, (2) the auditor cannot function as part of management, and (3) the auditor cannot serve in an advocacy role for the audit client." Id.