Office of the Chief Accountant:
Letter to BDO Seidman LLP
Regarding Retired Partner
August 16, 2001
Mr. Larry Shapiro
BDO Seidman, LLP
330 Madison Avenue
New York, New York, 10017
Dear Mr. Shapiro,
We greatly appreciate BDO Seidman's (BDO) consultations with the staff on independence issues described in your letter of July 10, 2001. As you know, when solving problems it is often easier to formulate a solution in the early stages of an emerging situation, rather than at the end of the process.
The staff has reviewed the facts and circumstances outlined in your letter dated July 10, 2001 and in our phone calls.
We understand that:
- The partner (retired partner) retired from the firm on June 30, 2000 and that he was appointed to the Board of Directors of the BDO client on May 1, 2001.
- No Board meetings or actions have taken place since the May 1, 2001 appointment, nor has the retired partner/board member been involved in the affairs of the Company since his/her appointment.
- The BDO client is undertaking actions to file a registration statement for its initial public offering.
- BDO has historically operated under the premise that the firm is not required to "cash out" the retirement benefits owed to a terminated partner who joins the Board of Directors of an audit client. BDO's analysis is based on the pre-February 5, 2001 Codification of Financial Reporting Section 600.02.f.
- Historically, BDO has utilized a trust other than a rabbi trust to fund its retired partners' capital balances and retirement benefits.
- In the present case, BDO and the retired partner agreed to the terms of the trust fund, including funded amounts, in early 2001, and BDO had the funds available for transfer to the trust
- BDO would like the staff's views with respect to: the transition provisions of Rule 2-01(e)(1)(ii) and 2-01(e)(3) of Regulation S-X, BDO's interpretation of the pre-February 5, 2001 Codification of Financial Reporting Section 602.02.f, and BDO's funding of the retired partner's benefits after he/she was appointed to the Board of Directors.
The following are specific portions of Rule 2-01, including defined terms which are in italics, that are relevant in performing an analysis of the above facts and circumstances:
Rule 2-01(c)(2)(iii), provides that an accountant is not independent if, at any point during the audit and professional engagement period, the accountant has an employment relationship with an audit client, such as:
A former partner, principal, shareholder, or professional employee of an accounting firm is in an accounting role or financial reporting oversight role at audit client, unless the individual:
(A) Does not influence the accounting firm's operations or financial policies;
(B) Has no capital balances in the accounting firm; and
(C) Has no financial arrangement with the accounting firm other than one providing for regular payment of a fixed dollar amount (which is not dependent on the revenues, profits, or earnings of the accounting firm):
(1) Pursuant to a fully funded retirement plan, rabbi trust, or, in jurisdictions in which a rabbi trust does not exist, a similar vehicle; or
(2) In the case of a former professional employee who was not a partner, principal, or shareholder of the accounting firm and who has been disassociated from the accounting firm for more than five years, that is immaterial to the former professional employee.
Rule 2-01(f)(5) defines the audit and professional engagement period to include both:
(i) The period covered by any financial statements being audited or reviewed (the "audit period"); and
(ii) The period of the engagement to audit or review the audit client's financial statements or to prepare a report filed with the Commission (the "professional engagement period"):
(A) The professional engagement period begins when the accountant either signs an initial engagement letter (or other agreement to review or audit a client's financial statements) or begins audit, review, or attest procedures, whichever is earlier; and
(B) The professional engagement period ends when the audit client or the accountant notifies the Commission that the client is no longer that accountant's audit client.
(iii) For audits of the financial statements of foreign private issuers, the "audit and professional engagement period" does not include periods ended prior to the first day of the last fiscal year before the foreign private issuer first filed, or was required to file, a registration statement or report with the Commission, provided there has been full compliance with home country independence standards in all prior periods covered by any registration statement or report filed with the Commission.
Rule 2-01(f)(6) defines an audit client as the entity whose financial statements or other information is being audited, reviewed, or attested and any affiliates of the audit client, other than, for purposes of paragraph (c)(1)(i) of this section, entities that are affiliates of the audit client only by virtue of paragraph (f)(4)(ii) or (f)(4)(iii) of this section.
Rule 2-01(f)(3) defines the accounting role or financial reporting oversight role as a role in which a person is in a position to or does:
(i) Exercise more than minimal influence over the contents of the accounting records or anyone who prepares them; or
(ii) Exercise influence over the contents of the financial statements or anyone who prepares them, such as when the person is a member of the board of directors or similar management or governing body, chief executive officer, president, chief financial officer, chief operating officer, general counsel, chief accounting officer, controller, director of internal audit, director of financial reporting, treasurer, vice president of marketing, or any equivalent position.
Rule 2-01(f)(16) defines a rabbi trust as an irrevocable trust whose assets are not accessible to the accounting firm until all benefit obligations have been met, but are subject to the claims of creditors in bankruptcy or insolvency.
Rule 2-01(e)(1)(ii) provides that until May 7, 2001, having the financial interests set forth in paragraph (c)(1)(ii) of this section or the employment relationships set forth in paragraph (c)(2) of this section will not impair an accountant's independence with respect to the audit client if having those financial interests or employment relationships did not impair the accountant's independence under pre-existing requirements of the Commission, the Independence Standards Board, or the accounting profession in the United States.
Rule 2-01(e)(3) provides that to the extent not required by pre-existing requirements of the Commission, the Independence Standards Board, or the accounting profession in the United States, the requirement in paragraph (c)(2)(iii) of this section to settle financial arrangements with former professionals applies to situations that arise after the effective date of this section.
The transition provisions included in the Commission's revised independence rules1 provide relief for certain situations and relationships that existed prior to the effective date of the new rules. The transition provisions should not be relied upon when evaluating auditor independence matters that arise after the defined effective dates. As we have previously discussed, paragraph (e)(1)(ii) of Rule 2-01 provides that until May 7, 2001, having employment relationships set forth in paragraph (c)(2) of Rule 2-01 will not impair an accountant's independence with respect to the audit client if having those employment relationships did not impair the accountant's independence under pre-existing requirements. Further, Rule 2-01(e)(3) provides that to the extent not required by pre-existing requirements, the requirements in Rule 2-01(c)(2)(iii) to settle financial arrangements with former professionals applies to situations that arise after the effective date of this section.
Notwithstanding the fact that the reference in Rule 2-01(e)(3) to "this section" refers to Rule 2-01 which has an effective date of February 5, 2001, in order to facilitate a smooth transition to the new rules the staff would not object to the use of the three month transition provision outlined in Rule 2-01(e)(1)(ii). Accordingly, since the retired partner joined the Board prior to May 7, 2001, the staff would not object to BDO's use of the transition provision outlined in Rule 2-01(e)(1)(ii). However, the staff expects that where situations arise (i.e. commencing of employment relationship) subsequent to the transition date, the provisions of the revised independence rules will be complied with in all respects, including the definitional requirements of Rule 2-01(c)(2).
As we have discussed, the Commission's revised independence rules clearly require the cashing out of retirement and other benefits of terminated employees who go to work for audit clients. While we acknowledge that there may have been diversity in practice with regard to the funding of fixed retirement benefits for partners joining the boards of directors of audit clients prior to February 5, 2001, the staff is not agreeing or disagreeing with your conclusion that the pre-existing Codification of Financial Reporting (Codification) Section 602.02.f provided that such benefits were not required to be cashed out. This section of the Codification stated,
"...If any circumstances exist indicating that the retired partner in fact retains some influence or participation in the firm or that would give the appearance to an outside party that influence was retained, independence would be impaired. Any payment to the retired partner of salary or retirement benefits which are related to current revenues would indicate continuing influence in the firm..."
The lack of action or objection by the staff should not be construed as the staff's concurrence with the assertions made in your July 10, 2001 communication. While the staff is not commenting on your analysis of the Codification Section 602.02.f, for policy and other reasons the staff is not objecting to the use of the transition provisions outlined in Rule 2-01(e)(1)(ii) in the specific facts and circumstances outlined above.
Because the capital balances and financial arrangements of the retired partner were not cashed out pursuant to Rule 2-01(c)(2)(iii), the staff believes that BDO's independence would be impaired in connection with its association with the financial statements for the 2001 interim periods and fiscal year ended 2001. However, without necessarily concurring with your analysis and because of the unique facts presented to us in your July 10, 2001 letter, including the facts that no Board meetings or actions have taken place since the May 1, 2001 appointment, the retired partner/board member has not been involved in the affairs of the Company since his/her appointment, and BDO's efforts to comply with the independence rules through its ongoing discussions with the staff, the Office of the Chief Accountant would not recommend that new auditors be engaged to review or audit the Company's financial statements for the fiscal year ended 2001 in connection with this matter provided the following actions and undertakings are adhered to by BDO.
- All required benefits are promptly cashed-out pursuant to the provisions of Rule 2-01(c)(2)(iii). Compliance with the provisions of Rule 2-01(c)(2)(iii) is to occur before the next scheduled Board meeting but no later the August 17, 2001.
- BDO is to provide the SEC with a Tandy letter related to the financial statements for the interim and fiscal year end 2001.
Because these positions are based on the facts that have been provided in various phone calls and in your letter as briefly summarized in our understanding set forth above, it should be noted that any different facts or conditions might require a different conclusion. Further, this response expresses the Office of the Chief Accountant's position only on the auditor independence issues noted above, and does not purport to express any legal conclusion on the questions presented.
In addition, as noted above, we understand that where applicable BDO has utilized a trust other than a rabbi trust to fund its retired partners' capital balances and retirement benefits. Additional information is necessary in order for the staff to better understand the details of the trust vehicle utilized by BDO, including the use and permissibility of this vehicle to meet the requirements of the independence rules. Accordingly, by August 31, 2001 we request that BDO provide the staff with the following:
- A comprehensive analysis of the use of such a vehicle to meet the requirements of the Commission's independence requirements, both old and new.
- An analysis of the frequency that this vehicle has been used by BDO in the past, including a list of the involved parties.
- A copy of the trust documents.
- A comprehensive comparison of the trust vehicle utilized by BDO to a rabbi trust as defined in Rule 2-01.
We request that you confirm your understanding of the above in writing, including an action plan where applicable. In addition, we ask that you supplementally provide the names of all interested parties. Should you have questions, please call either John Morrissey or me at 202-942-4400.
Samuel L. Burke
Associate Chief Accountant
July 10, 2001
Mr. Sam Burke, Office of the Chief Accountant
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Sent by Fax 202-942-9656
Dear Mr. Burke:
At your request, as a follow-up to our prior conversations, I am submitting this letter to seek clarification with respect to the application of the SEC”s interpretation of the transition provisions of Rule 210.2-01(c)(2)(iii) relating to Employment at audit client of former employee of accounting firm. Lee Graul, of BDO Seidman, LLP, initially consulted with you on this issue in January of this year. At that time, a client of our firm had filed its initial registration statement with the Securities and Exchange Commission (“SEC”), which it had expected to become effective prior tp May 5, 2001, the effective date of the aforementioned transition rule. However, due to the relative “softness” of the market, the registration statement was withdrawn by the client. The client now plans to file another registration statements with the SEC later in 2001 and wishes to resolve the independence issues referred to below.
The partnership agreement of BDO Seidman, LLP (“BDO”) provides that retired partners’ capital be repaid over 5 years and fixed retirement benefits (which are not funded) be paid based on a formula unrelated to the firm’s revenue or earnings.
In the past few instances where a retired partner joined the board of directors of an SEC-registrant client, BDO funded his/her capital prior to joining the board, and continued to pay the fixed retirement benefits based upon the provisions of the partnership agreement. We believe this policy was in compliance with the prior SEC rules - - FRR Section 602.02.f. Retired Partners. (See following paragraph.)
In the matter which is the subject of this letter, one of our partners retired from the firm on June 30, 2000. In of 2000, in connection with the original IPO filing, this former partner was asked to join the board of directors of the client that was in registration with the SEC. At that time, we consulted with you concerning our plans to fund this former partner’s capital into a trust, but not the fixed retirement benefits attributable to him. As noted above, the client expected the registration statement to be effective in early 2001, so we believed we could utilize our aforementioned policy for complying with the existing SEC independence rules (602.02.f). Based upon the earlier consultation with you, we were informed that the Office of the Chief Accountant would not object or recommend enforcement action to the Commission if BDO applied the three-month transition in Rule 2-01 (e)(l)(ii) to the “cashout” or funding provisions of all partners leaving to join audit clients as directors.
Based upon that response, we notified the client and former partner of the situation and the need to fund his capital account prior to joining the board of directors. (Note – rather than pay the capital outright, we agreed to transfer the capital to a trust controlled by an independent trustee so that the capital would be outside the firm’s control as long as the former partner remained on the clients board of directors. The terms of the trust and the funding were agreed to by BDO and the former partner). Funding the trust was to take place prior to the former partner joining the board of directors of the client, which was to occur prior to May 5, 2001.
In 2001, the client withdrew its registration statement. At that time, there were no immediate plans to re-file with the SEC, so the inclusion of the former partner on the board of directors of the client and the funding of his capital account was “put on hold”. In 2001, the client decided to re-file the registration statements later in 2001 and, accordingly, BDO began to implement the actions necessary to fund the former partner’s capital prior to his joining the client’s board of directors. As a result, on May 1, 2001, the former partner was appointed to the board of directors of the client.
On May 2, 2001, the BDO individual handling the arrangements for the trust was informed of that the appointment of the former partner to the board of directors was to occur and acknowledged the importance of effectuating and funding the trust. The former partner had several administrative questions concerning the trust arrangements (none of which detracted from his acceptance of its terms) and the BDO individual was attempting to provide answers to those questions prior to such funding. However, because of the unavailability of the former partner around this time period and the misunderstanding by both parties as to the importance of the May 5 funding deadline, the trust was not funded by that date. On May 10, BDO’s National office inquired as to whether the trust was funded by May 5 and was informed that it had not been done.
- Since the former partner was appointed to the board of directors of the privately held client on May 1, 2001, prior to the effective date of the transition rule:
- Can BDO continue to apply its interpretation of the former rule (FRR 602.02.f) under which it would fund only the capital account, but not the fixed retirement benefits; or , in the alternative,
- Since the client will not actually become an SEC registrant until after May 5, 2001, is the new SEC rule even applicable; such new rule requiring the funding of both capital and fixed retirement benefits?
- Would the aforementioned transition rule apply to the client prior to its registration statements becoming effective, since it had previously filed an initial registration statement?
- Assuming the answer to either questions 1(a) or 2 is “yes”, would the SEC staff object to a conclusion that, notwithstanding the unintentional delay in the actual funding of the capital account into a trust, the agreement prior to May 5th by BDO and the former partner with respect to the terms of the trust and the subsequent funding of the trust under the former rule would be sufficient to comply with the then existing independence rule?
Based upon our earlier discussions, you indicated the SEC staff would use the later of: (i) the date upon which a company became a registrant, or (ii) the date upon which the former partner became a director, to apply the transition rule. Based upon those prior discussions, because the client would become a registrant after May 5, 2001, due to the anticipated effective date of its registration statement, it would seem that the SEC may deem the new rule as being applicable to the former partner rather than the transition rule. However, as I noted during our discussion, this position does not seem to be logical or evenhanded for the reasons set forth below.
As a consequence of the staff’s view, it is BDO’s contention that private companies intending to go public would be held to a more restrictive standard than existing SEC registrants. That is, if a former partner of BDO had been appointed to the board of directors of an existing registrant prior to May 5, 2001, the firm would only have had to fund his/her capital by that date, but would not have had to his/her fixed retirement benefits by said date. On the other hand, if a former partner of BDO had been appointed to the board of directors of a private company that filed an IPO which become effective after May 5, 2001, both the former partner’s capital and fixed retirement benefits would have had to have been funded prior to May 5, 2001.
It is certainly understandable that independence standards applied to auditors of SEC registrants may need to be more restrictive than those applied to privately-held companies. In fact, in the situation described in this letter, BDO had agreed to fund the former partner’s capital account to comply with the existing SEC rule, which is more restrictive than Rule 101-2 of the AICPA Code of Professional Conduct. However, it does not seem necessary in protecting the public interest to apply a more restrictive independence standard to a privately-held company under any circumstance.
The three-month transition rule for funding former partners capital accountant appropriately reflects the need to consider arrangements between companies, former partners and the accounting firms which are under consideration during that period. Section F3 of the discussion section of the new independence rules states that the three-month transition provision, “which essentially grandfathers existing employment relationships” was included “because out intention was not to require former firm employees who are currently in …financial oversight roles at audit clients to leave their positions to preserve the accounting firm’s independence.”
There in no reference in the transition rule or the related discussion which would apply different standards to a company which was not yet an SEC registrant. From an investor’s standpoint, there should be no distinction between (1) an individual who, before May 5, 2001, became a director of a privately-held company, which became an SEC registrant after May 5th and whose capital was funded pursuant to the SEC independence rules which existed prior to that date, and (2) an individual in the same circumstances, except that the company was an existing registrant on May 5, 2001. From the standpoint of the company, its stockholders and the director in situation (1) above, there would be no less a hardship in requiring the director to leave his position to preserve firm’s independence than there would be in situation (2).
Based upon the above logic, we believe the appropriate way to interpret the transition rule is to tie its applicability to the date when the former partner was appointed to the client’s board of directors (regardless as to whether the company was public or private at such time). In our opinion, this would result in a logical and consistent application of the rules to all registrants.
The SEC staff has consistently applied SEC accounting and independence rules and interpretations to companies which have filed initial registration statements. It would appear that the transition provisions relating to Rule 210.2-01( c)(2)(iii) should be similarly applied. That is provided an IPO was filed prior to May 5, 2001, and the former partner was a director of the then privately held company on that date, the funding requirements of the then existing independence rules would be acceptable.
Assuming the staff does not object to our conclusions with respect to Questions 1 and 2 above, we request the staff to consider this third question. Since all parties agreed to the terms of the trust to fund the former partner’s capital in early 2001, and BDO had the funds available for transfer to the trust, funding the trust after May 5, 2001, should not preclude the application of the former SEC rules, which we believe would not prohibit payments of capital through a trust and would not require the funding of fixed retirements benefits. As explained above, the failure to fund the trust by May 5th resulted from inadvertent miscommunication due, at least in part, to the complexity of, and confusion with respect to, the interpretation of transition provisions, which in our view are not substantive reasons to require BDO to apply the funding requirements of the new independence rules rather than the transition rules to the issue at hand. If the staff does not object to our position on this question, the trust will be funded immediately.
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We appreciate your consideration of the issues addressed in this letter and look forward to a prompt response. If you have any questions, or need any additional information call me at 212-885-8560.
Very truly yours,
CC: Wayne Kolins