December 19, 2002From: Dan R. Kalp [d_r_kalp@worldnet.att.net]
Sent: Friday, January 03, 2003 3:26 PM
To: rule-comments@sec.gov
Subject: re: File No. S7-49-02

January 3, 2003

Mr. Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC, 20549-0609
E-mail address: rule-comments@sec.gov

Re: File No. S7-49-02    
Strengthening the Commission’s Requirements Regarding Auditor Independence
Release Nos. 33-8154; 34-46934; 35-27610

Dear Sir;

I am writing to submit my comments related to the proposed rules, comments, 
and questions released relative to the above-cited subject.  

First, I want to congratulate the staff of the SEC on the extraordinary job 
they have performed on the issuance of this and the very substantial body of 
earlier guidance related to such an extremely complicated and complex body of 
legislation.  The unenviable task was further complicated by the recent turmoil 
tearing through the Agency.  They are to be highly commended for their efforts 
and results.

The Sarbanes-Oxley Act has been hailed by many sources as one of the most 
sweeping and dramatic changes affecting the financial community in decades.  
Justifiably, there has been a tremendous amount of attention directed to the 
impacts of the Act on audits, financial statements, certifications, and new
responsibilities/dangers for key corporate officers as well as their companies.  
However, there are very critical implications for the corporate tax function 
brought about by the Act that have not received much, if any, attention.  

I am a corporate tax professional who has specialized in large corporate tax 
matters with over twenty-five years experience designing, building, and managing 
large corporate tax departments for Fortune 500 companies and large private 
companies of Fortune 500 size.  Over fifteen years of my experience has been 
as the senior tax executive for publicly traded corporations of the type 
affected by this legislation.  I have actively participated in Tax Executives 
Institute organization as well as several excellent industry specialized tax 
organizations during my career and recently had an article I wrote on the 
Sarbanes-Oxley Act impact on corporate tax functions included with the monthly 
bulletin for ACT, the Association for Computers and Taxation.  However, I 
emphasize the contents contained herein reflect my personal views and are not 
necessarily the views of any company I have worked for or any organization I 
have participated in during my career.  

My comments in this document focus on the “tax services” portion of the proposed 
rules along with requesting clarification on the definition of “Expert Services” 
and the effective date of the audit committee pre-approval rules.

A.     NON-AUDIT TAX SERVICES
 
During my career I cannot recall a single instance where periodic financial 
statements issued by the companies I worked for were not impacted by some 
significant tax issues either by positions taken on filings for the current 
period or the accumulation of amounts related to positions taken on prior 
period filings.  The clear statement of the tax expenses and liabilities 
reserves were critical to the fair presentation of the company’s financial 
condition.  There were always some elements of possible controversy involved, 
usually complicated and involving varying degrees of risk.  It was essential 
that those issues be reviewed in detail and evaluated by the company’s auditing 
firm to provide the independence necessary to guarantee the accuracy of the tax 
reserves.

Discussions with other corporate tax professionals over the years have convinced 
me that it is very common for large corporations, of the nature targeted by this 
legislation, to have several, very significant tax issues involving substantial 
impacts on their companies’ financial condition.  I have been troubled by the 
statements made, first in the proposed rules issued in June, 2000, then echoed 
in the final rules issued in 2000 and again in this body of proposed rules that, 
“As discussed in our previously proposed rules62 on independence, tax services 
are unique, not only because there are detailed tax laws that must be consistently 
applied, but also because the Internal Revenue Service has discretion to audit 
any tax return.63 In addition, the Congressional intent behind the above quoted 
reference to "tax services" would appear to be that auditor independence is not 
impaired by an accountant providing traditional tax preparation services to an 
audit client or an affiliate of an audit client.” [II. B. 11. Tax Services]

However, I believe the seeds for the proper treatment of non-audit tax services 
are contained in the statement contained in these proposed rules that, “Classifying 
a service as a "tax service" however, does not mean that the service may not be 
within one of the categories of prohibited services or may not result in an 
impairment of independence under Rule 2-01(b). The accounting firm and the 
registrant's audit committee should consider, for example, whether the proposed 
non-audit service is an allowable tax service or constitutes a prohibited legal 
service or expert service. As part of this process, the accounting firm and the 
audit committee should be mindful of the three basic principles which cause an 
auditor to lack independence with respect to an audit client: (1) the auditor 
cannot audit his or her own work, (2) the auditor cannot function as a part of 
management, and (3) the auditor cannot serve in an advocacy role for the client.64 
[II. B. 11. Tax Services]
 
In response to the question raised for comments in the Tax Services section of 
the proposed rules, “Is it meaningful to categorize tax services into permitted 
and disallowed activities?” my response is yes.  I believe through the consistent 
application of the three basic principals recited above it is possible to generate 
“…categories and related definitions [that] would make the demarcation meaningful.”  
In fact, I believe such amplification of the original proposed rules is essential 
to provide guidance to the respective audit committees who are charged with 
evaluating whether or not the service may cause an impairment to auditor 
independence.

I believe the development of meaningful guidance regarding which tax services 
should be permitted and which should be disallowed should begin by looking at the 
tax accruals for the audited company.  As indicated in the body of proposed rules, 
“…many engagements will require that an auditor review the tax accrual that is 
included in the financial statements.  Reviewing the tax accruals is part of audit 
services and is not, in and of itself, deemed to be a tax compliance service.” 
[II. B. 11.  Tax Services]

Obviously, review of the tax accruals is an audit function, which is normally 
required and should not be subjected to limitation as a non-audit tax service.  
However, it is this very same review that generates most, if not all, the 
potential for impairment of the auditor’s independence when non-audit tax 
services are performed by the auditor.  Each non-audit tax service must then 
be measured applying the three basic principals against the auditor’s 
responsibility to review the company’s tax accruals.

Certainly, if there were a situation where the auditor is not required to 
review the company’s tax accruals to certify the company’s financial statements, 
it would appear any non-audit tax service could be permitted to be performed by 
the auditor.  Certainly no impairment of independence could exist where the 
auditor is not called upon to review the tax reserves.

In the common situation where the auditor is required to review the tax reserves 
in order to certify the financial condition of the company, it seems clear that 
the auditor should not be involved in the generation of those tax reserve numbers, 
either assisting in the preparation of the reserves or generating the reserve 
numbers themselves.  Beyond these two near certainties, the rest of the application 
of the rules to non-audit tax services appears to become more complicated.

For example, what is the implication for auditor independence where the auditor 
is required to review the tax reserves and those reserves are generated using 
software designed, implemented, and maintained by the audit firm?  Would it be 
proper to look to the rules regarding Financial Information Systems where the 
proposed rule stating “Further, paragraph (c)(4)(II)(B) of the proposed rule 
provides that an accountant is not deemed independent of the accountant designs 
or implements a hardware or software system that aggregates source data underlying 
the financial statements or generates information that is significant to the audit 
client’s financial statements taken as a whole.”?[II. B. 2.  Financial Information 
Systems Design and Implementation]

I believe so.  In fact, I believe this provision under the Financial Information 
Systems section of the rules offers an excellent vehicle to amplify the non-audit 
tax services rules to provide more clarity and guidance for audit committees in 
considering the application of the new rules.

Because non-audit tax services may represent issues generating significant 
impacts on some company’s tax reserves while not generating significant impacts 
on another, a service-by-service approach to determining “permitted” versus 
“allowable” services would seem impracticable and unworkable (unless the service 
almost always had a significant impact).  However approaching the determination 
of the impact created by a non-audit tax service by looking to the significance 
of the result of that service on the tax accruals of the company makes much 
more sense. 

Therefore, I would recommend that the rules relating to the determination of 
whether or not a non-audit tax service would be permitted be amplified to 
provide that:

If the outcome/result of the performance of the proposed non-audit tax service 
has the potential to result in a significant impact on the company’s tax accrual 
and/or financial condition when considered on a cumulative basis the service 
should be prohibited.

The phrase “when considered on a cumulative basis” is a critical element in 
the measure!  It means that all non-audit tax services provided by the auditor 
must be combined to determine whether or not they have a significant impact on 
the tax reserves in order to determine possible impairment of independence in 
reviewing those balances.  It also means that the cumulative impact of non-tax 
services provided by the auditor in earlier periods resulting in unresolved 
issues or accumulated balances flowing into the current financial statements 
must be included in the analysis.

The impact analysis could be prepared by the auditors for consideration by the 
audit committee.  Such an analysis would also prove useful in determining 
potential disclosure items related to tax services provided by the audit firm.

For example, applying the amplification to the question of the audit firm 
providing tax compliance services:

If the service consisted of merely transferring account balances from the 
financial records into the appropriate tax forms, there probably wouldn’t be 
any significant impact from the provision of this service and it could be 
permitted.

However, if the compliance service involved significant exercise of judgment 
by the audit firm regarding the proper treatment of items from the financial 
records and the preparer completed the filings using the position most favorable 
to the client that, if reversed during an audit would constitute a significant 
impact one the tax liability, then the compliance service could possibly result 
in a significant impact and should be prohibited. 

The provision of the impact analysis approach to determining whether or not 
a non-audit tax service would be permissible provides more clarity to the 
rules and provides audit committees greater guidance in applying the rules 
while being consistent with both the intent of the more general statement 
contained in the proposed rules on non-audit tax services and the provisions 
of the proposed rules related to Financial Information Systems.  In fact, it 
would appear such a testing approach could be beneficially applied to the 
evaluation of all non-audit services.

B.     EXPERT SERVICES

My comment in this area is another request for amplification regarding the 
following excerpts from the proposed rules:

The prohibition on providing "expert" services included in this rule proposal 
covers services that result in the accounting firm's specialized knowledge, 
experience and expertise being used to support the contentions of the audit 
client in various adversarial proceedings. Therefore, under our proposed rule, 
an auditor's independence would be impaired if the auditor were engaged by 
the audit client's legal counsel to provide expert witness or other services, 
including accounting advice, opinions, or forensic accounting services, in 
connection with the client's participation in a legal, administrative, or 
regulatory proceeding. For example, an auditor could not provide forensic 
accounting services to the audit client's legal representative in connection 
with an investigation by the Commission's Division of Enforcement. Nor could 
an accounting firm appear as an expert witness in a utility rate setting 
proceeding in support of an audit client's request for an increase in fees.  
[II. B. 10. Expert Services]

An accounting firm that, after receiving appropriate authorization from an 
audit client's audit committee, had prepared an audit client's tax returns, 
also could appear as a fact witness in tax court to explain how the returns
were prepared.  [II. B. 10. Expert Services]

Audits by taxing authorities are “administrative” proceedings necessary to 
administer the respective tax laws.  I request that this area be amplified 
to clarify that tax audits constitute “administrative proceedings” and that 
any activity “defending” a position taken on a filing under audit – which 
involves performing as an advocate for the client (as opposed to the much 
more limited testimony as to the “facts of how the returns were prepared”) 
would be prohibited.  I believe this is a very critical issue and requires 
specific guidance for absolute clarity.


C.     EFFECTIVE DATE OF AUDIT COMMITTEE PRE-APPROVAL RULES

Section 202 of the Act amended Section 10A of the Securities Exchange Act 
of 1934 adding subsection (i) which provides for the pre-approval of all 
non-audit services in advance by either the company’s audit committee (or 
in the absence of an audit committee, the company’s board of directors) of 
any service to be provided to the company by the company’s audit firm.  The 
language of the Act seems quite clear leading me to interpret this portion 
of the Act as being effective on the date the President signed the Act into 
Law, July 30, 2002.

However, many commentators, using various different versions of twisting or 
restating the clear language of the subsection, are advising that the 
provisions of Section 10A(i) are not effective yet and will be activated by 
some future event.  Because of the prevalence of this apparent misinterpretation, 
and the number of companies who may be affected, I believe a clear statement 
on the effective date of this provision is essential.

The section of the Act was separated from the other sections dealing with 
“registered accountants” and the 10A(i) language refers specifically to the 
“auditor of the company”.  None of Section 10A(i) provisions depend on the 
existence of “registered accountants” nor the “Public Company Accounting 
Oversight Board” so all the elements necessary for it’s effectiveness 
currently exist and existed on July 30.  Therefore, it is my interpretation 
that Section 10A(i) is effective currently and has been since July 30, 2002.  
As a result, all services provided a listed company by its audit firm require 
audit committee pre-approval and that approval has been required for any 
services engaged since July 30, 2002.  Please address this issue specifically 
in the final rules or another appropriate release in order to eliminate this 
serious confusion.

Thank you for considering these comments.  I am available and willing to 
discuss the above comments or related issues via e-mail, telephone, or by 
appearing in person.  Please contact me by replying to this e-mail message 
and request contact information.

Sincerely,

Dan R. Kalp