Background Information:
Auditor Independence

June 27, 2000

Public accounting firms have played a significant role in maintaining the integrity of the financial reporting process for more than 60 years. The independent inspection and certification of a company's financial statements that an auditor provides is central to maintaining investor confidence.

Rules that define and regulate auditor independence have been an integral part of the securities laws since the 1930s. Maintaining and enforcing those rules have been longstanding public policy goals of the federal government, particularly the Securities and Exchange Commission.

Highlights of the Federal Government’s Efforts to Preserve, Modernize, and Enforce the Rules Governing Auditor Independence

1970s: The Commission and Congress (Moss-Metcalf Report) stepped up concerns about auditor independence as the number of highly visible financial reporting failures increased. Congress seriously considered limiting the services independent public accountants could provide that were not directly related to accounting, even though at that time non-audit services, including tax services, constituted only about 30 percent of audit firms' revenue.

In 1977, the Subcommittee on Reports, Accounting and Management of the Committee on Governmental Affairs issued a report that said, "[T]he accounting profession must improve its procedures for assuring independence in view of the public's needs and expectations." It added, "The best policy . . . is to require that independent auditors of publicly owned corporations perform only services directly related to accounting."

1979: John McCloy, chairman of the Public Oversight Board, warned the public about the dangers arising from the growth of non-audit services. He said, "Investors and others need a public accounting profession that performs its primary function of auditing financial statements with both the fact and the appearance of competence and independence. Developments which detract from this surely will damage the professional status of CPA firms and lead to suspicions and doubts that will be detrimental to the continued reliance of the public upon the profession without further and more drastic governmental intrusion."
1984: In an opinion, the Supreme Court emphasized the role of the independent auditor under the federal securities laws, saying, "It is therefore not enough that financial statements be accurate; the public must also perceive them as being accurate. Public faith in the reliability of a corporation's financial statements depends upon the perception of the outside auditor as an independent professional."
1988/89: The Commission considered and rejected a petition by three major accounting firms to modify certain independence rules to allow expanded business relationships with their audit clients. A more narrowly focused supplemental petition was submitted to the Commission in mid-1989 by all of the Big 8 accounting firms. Chairman Ruder responded, saying, " . . . it would be inadvisable to consider the narrower topic without also considering the broader policy issues."
1994: An SEC Staff Report on auditor independence found that much of the growth in non-audit services until then could be attributed to services provided to parties other than audit clients. Accordingly the Staff Report concluded that no change in Commission rules or the federal securities laws was warranted at that time, but the staff promised to "continue to be alert to the development of problems of independence that may be caused by [non-audit services]."
1994: Public Oversight Board's Advisory Panel on Auditor Independence (Kirk Panel) issues a report describing the trend toward non-audit services as "worrisome," because, "growing reliance on non-audit services has the potential to compromise the objectivity or independence of the auditor by diverting firm leadership away from the public responsibility associated with the independent audit function ... ."
1994: The AICPA Special Committee on Financial Reporting (Jenkins Committee) found that users of financial statements believed that non-audit service relationships could "erode auditor independence." It said, "[Users] also are concerned that auditors may accept audit engagements at marginal profits to obtain more profitable consulting engagements. Those arrangements could motivate auditors to reduce the amount of audit work and to be reluctant to irritate management to protect the consulting relationship."
1996: A General Accounting Office report noted, "The accounting profession needs to be attentive to the concerns over independence in considering the appropriateness of new services to ensure that independence is not impaired and the auditor's traditional values of being objective and skeptical are not diminished."
1999: An Independent Standards Board-commissioned report (Earnscliffe) found that "[m]ost (interviewees) felt that the evolution of accounting firms into multi-disciplinary business service consultancies represents a challenge to the ability of auditors to maintain the reality and the perception of independence ... ."
2000: Independent consultant Jess Fardella released report outlining widespread independence violations at a Big 5 accounting firm. The report said, "Particularly as accounting firms have grown larger, acquired more clients and provided more services, and as investment opportunities and financial arrangements have increased in number and complexity, well-designed and extensive controls . . . are needed both to facilitate Independence compliance and to discourage and detect non-compliance."
2000: The Panel on Audit Effectiveness's May 2000 report and recommendations (O'Malley) "highlights the importance and wide-ranging perspectives about the issue of non-audit services to public audit clients in two statements of views discussing the subject. Members of the Panel were of two minds on this issue: one view supports (with limited exceptions) an exclusionary ban on those services; the other opposes such a ban. The Panel did not fully support either view. However, it foresees considerable public debate as the SEC pursues its planned rule-making initiatives to address the subject."

Dramatic Change in the Accounting Profession Highlights Need To Ensure Independence Rules Remain Effective and Fair

  • Firms becoming primarily business advisory service organizations as they increase the number, revenue from, and types of non-audit services provided to audit clients.
  • Firms merging, resulting in increased firm size, both domestically and internationally.
  • Firms divesting portions of their consulting practices or restructuring their organizations.
  • Firms offering ownership in parts of their practices to the public, including audit clients.
  • Firms needing increased capital to finance the growth of consulting practices, new technology, training, and large unfunded pension obligations.
  • Non-CPA financial service firms acquiring accounting firms, and the acquirers not being subject to profession's independence, auditing, or quality control standards.
  • Firms and their audit clients entering into an increasing number of business relationships, such as strategic alliances, co-marketing arrangements, and/or joint ventures.
  • Firms' professional staffs becoming more mobile, and geographical locations becoming less important due to advances in telecommunications and Internet services.
  • Audit clients hiring increasing number of firm partners, professional staff, and their spouses for high-level management positions.

Last modified: 6/27/2000