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U.S. Securities and Exchange Commission

Letter From the Chief Accountant:
Issues Related to Independence/Quality Control to SEC Practice Section

November 30, 1998

Michael A. Conway
SEC Practice Section
c/o KPMG Peat Marwick LLP
55 E. 52nd St., Suite 3200 New York, New York 10055

Dear Mr. Conway:

In the last ten years there has been significant growth of accounting firms in areas of business other than traditional auditing services. In connection with that growth, firms have hired increasing numbers of persons who have not typically received the extensive formal training in auditing and ethics required to become certified public accountants. In addition, it is noteworthy that quality control systems required by the profession and implemented by firms were designed many years ago to address the requirements of firms predominantly made up of certified public accountants.

In light of these changes in the public accounting and auditing firms, questions have arisen as to whether firms' quality control systems adequately ensure the independence of members thereby ensuring the integrity and objectivity of today's audits. For example, in discussions I have had with members of the profession, we have discussed whether current training programs need to be changed and whether the current annual independence confirmation process is adequate.

My concern is elevated by the fact that the staff is encountering an increasing number of instances in which accounting firm's quality control systems have not been sufficient to identify and preclude significant independence problems from arising. The staff is seeing problems in areas as basic as ownership of stock in audit clients and in areas which necessitate more careful guidance on a firm wide basis such as providing valuation services or other areas where the auditor is auditing one's own work. It is disconcerting that these matters often arise when a company has filed a registration statement to sell securities and the company is then faced with the potential for having financial statements re-audited in order to resolve the matter.

Additionally, the staff has noted an increase in the number of auditor independence problems that have begun to surface in connection with audit reports included in filings with the Commission by foreign filers. As you may be aware, in recent years there has been a significant increase in the number of foreign companies registering securities for sale ("registrants") in the United States. The increase in foreign registrants inevitably necessitates the increased involvement of foreign auditing affiliates of major U.S. accounting firms.

Foreign affiliates of U.S. audit firms also provide a wide array of non-audit services. Members of these foreign affiliates may not be familiar with U.S. auditor independence requirements. For example, they may not be aware of prohibitions on reports to their audit clients of "valuations of contributions in kind," on the "fairness of exchange ratios in a business combination," and on providing legal advice. In order to provide these services, firms have hired large numbers of non-audit personnel who lack formal education in auditing and auditor independence and, thus, are unfamiliar with the independence requirements in general and the SEC independence requirements in particular.

The staff is concerned that the quality controls of firms with international affiliates may not be adequate to assure that foreign affiliated firms are independent from their audit clients that file audited financial statements with the SEC. It is important to note that the SEC does not accept compliance with foreign independence rules in lieu of or as a substitute for the SEC's independence rules and regulations.

Maintaining investor confidence in the independence of auditors is very important to our capital markets. Accordingly, in view of the aforementioned concerns, I am recommending that the SECPS and its respective members reassess whether the quality controls and training programs of firms and their affiliates that practice before the SEC are adequate to ensure compliance with the independence requirements set forth in the Securities Acts and the Commission's rules and regulations. I am available to discuss this matter with you at your convenience.


Lynn E. Turner
Chief Accountant

cc:    Robert Grafton, Arthur Andersen
  J. Michael Cook, Deloitte & Touche LLP
  Philip A. Laskawy, Ernst & Young LLP
  Stephen G. Butler, KPMG Peat Marwick LLP
  James J. Schiro, PricewaterhouseCoopers LLP
  William T. Allen, Independence Standards Board
  A. A. Sommer, Jr., Public Oversight Board

More recent letter on this topic available:


Modified: 02/18/2000