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U.S. Securities and Exchange Commission

SEC Chairman Levitt Proposes Rulemaking, Other Measures To Maintain Quality Of Financial Reporting



Concerned About Auditor Independence

New York, NY, May 10, 2000 – Securities and Exchange Commission Chairman Arthur Levitt today delivered an address on the importance of safeguarding the independence of the accounting profession. Chairman Levitt proposed several measures, including (i) SEC rulemaking to clarify activities that may be inconsistent for an independent auditor of financial statements to perform for audit clients; (ii) support for a plan by the profession's independent overseer, the Public Oversight Board, to enhance its powers and responsibilities; and (iii) a self-evaluation by each of the major accounting firms of past compliance with the SEC's and the profession's financial investment rules and their system of internal controls for monitoring those investments.

Importance of Auditor Independence to Maintaining Transparent, Efficient Capital Markets

In U.S–style capital markets, investors attach great reliance on the role of independent auditors to attest to the accuracy of financial information. Indeed, public companies are required by law to have their financial statements examined under such a review. In today's technological and information driven markets, an increased emphasis has been placed on information verified by independent third parties. With companies under increasing stress to meet their "numbers," the role of and pressures on the independent auditor have significantly increased. Not only must those auditors be independent in fact from their audit clients, but also they must be perceived by investors and the markets to be credible and objective.

Changes Transforming the Profession

The major accounting firms have undergone tremendous changes in the last decades due to globalization, consolidation of the profession and the rapid growth of consulting services. According to information publicly reported by the largest firms, auditing now accounts for 30 percent of total revenues – down from 70 percent in 1977. Consulting and other management advisory services now represent more than half – up from 12 percent in 1977. Since 1993, auditing revenues have been growing by 9 percent per year on average – while consulting and similar services have been growing at a rate of 27 percent each year. These services include corporate finance, large-scale IT planning and installation, in addition to traditional accounting, audit, and tax work.

In recent months, several of the major accounting firms also have announced major reorganizations – including divestitures of significant portions of their consulting businesses through sales to third parties or public offerings. These transactions, the continuing growth in consulting services as well as increasing reliance on strategic alliances and direct equity investments in other businesses all raise significant public policy issues for auditor independence.

Challenges for the Profession, its Regulators and Audit Committees

  • Proposed SEC Rulemaking on Safeguarding Auditor Independence

    The SEC will prepare a rulemaking on how to alleviate the conflicts created by the profession's increasing consulting and other non-audit work to its public company audit clients. The rulemaking also will examine conflicts caused by affiliations with other businesses and strategic alliances. Among the questions that will be considered are:

    • Should there be more appropriate limits on the types of services an audit firm can render to a client?;

    • How should firms be structured to assure independence?;

    • What, if any, are the consequences of public ownership of an accounting firm or an affiliate?; and,

    • Should firms be permitted to affiliate with entities that provide to the firms' audit clients services that the firms themselves would not be allowed to provide?

    Establishing general principles, requiring disclosure, or clearly defining appropriate services are possible answers to addressing these potential conflicts. Each has its advantages and drawbacks, but a careful balance of "bright line" rules, clearly demarcating certain services inconsistent with an independent audit, and greater disclosure of other services rendered to audit clients seem warranted and prudent.

  • Modernization of SEC and Profession's Financial Investment Rules

    The SEC is committed to working with the profession and the Independence Standards Board (ISB) to undertake a modernization of certain of the financial investment rules, which prohibit investment by firm professionals in an audit client. The ISB recently took the first step by issuing proposed rule changes. The SEC intends to issue complementary, modernizing rule changes by early summer on such topics as mutual fund investments, family relationships, and dual-income families.

  • Enhancement of Powers for Independent Oversight of the Profession

    Chairman Levitt expressed support of the overall plan by the current members of the Public Oversight Board, the independent overseer of the profession, for enhanced authority and responsibility over the profession's various standard-setters and professional entities. The need for enhancements to the oversight programs has been highlighted by recent threats to funding for certain POB initiatives. The leaders of the POB include Chairman Charles Bowsher, former Comptroller of the United States, and Melvin Laird, former Secretary of Defense.

    Due to growing business and other financial pressures being exerted on auditors, Chairman Levitt called for the profession's standard setter, the ISB, to undertake a reorganization, resulting in majority representation by individuals unaffiliated with the profession. Currently, the ISB's membership is drawn equally from those affiliated and unaffiliated with the profession. The ISB is chaired by William Allen, retired justice of the Delaware Chancery Court and Director of the NYU Center for Law and Business.

  • Call for Voluntary Firm Financial Investment Review and Upgrade of Internal Controls

    In light of recent events that raised serious questions about the major firms' compliance with the profession's own rules, as well as those of the SEC, prohibiting investments in audit clients, the SEC challenged the leaders of the profession to work with the Commission to develop a plan for constructively assessing the firms' past compliance over the last 15 months. In addition, the SEC requested that the profession undertake a significant enhancement to its procedures and controls, domestically and on a worldwide basis, under POB oversight. The prohibition against members of a firm making a financial investment in a firm audit client is considered one of the "golden rules" of auditing.

  • Challenge to Corporate America's Audit Committees

    Chairman Levitt challenged newly-empowered audit committees to pay close attention to the types of services their auditors are performing and to question whether it is in their investor's interests to have these services performed by someone else.

    Chairman Levitt also encouraged audit committees to inquire about their auditor's past compliance with auditor independence rules and about the firm's program for enhancing safeguards to ensure that conflicts do not arise in the future.

SEC Earnings Management Initiative:

Chronology of Accomplishments

In September 1998, the SEC launched a major initiative against the practice of companies using accounting gimmicks to distort the financial reporting process. In kicking off that initiative, Chairman Levitt issued a 10-point plan for action. In addition, the following significant events took place to help implement that plan:

September 1998 SEC, NYSE & NASD Announce Blue Ribbon Committee to Improve Corporate Audit Committees
September 1998 POB's Panel on Audit Effectiveness Formed
February 1999 Blue Ribbon Committee Announces Ten Point Plan to Improve Effectiveness of Audit Committees
August 1999 Staff Accounting Bulletin 99, Clarifying Concept of Materiality for Financial Statement Recognition
November 1999 Staff Accounting Bulletin 150 on Restructuring Charges
December 1999 Staff Accounting Bulletin 101 on Revenue Recognition
December 1999 Release Numbers 34-42231, 34-42232 & 34-42233 Adopting Changes To Listing Requirements for the NASD, AMEX & NYSE Regarding Audit Committees
December 1999 Release Number 34-42266 Adopting Rules Regarding Disclosure By Audit Committees, Including Discussions With Auditors Regarding Financial Statements
January 2000 Release Number 33-7793 Proposing Disclosure of Restructuring Charges