September 21, 2000
U.S. Senator George Voinovich
317 Hart Senate Building
Washington, DC 20510
Re: Securities and Exchange Commission (SEC) Proposed Rule (File No. S7-13-00), Revision of the Commission's Auditor Independence Requirements
Dear Senator Voinovich:
I am writing to you about the Securities and Exchange Commission's proposed revisions to Rule 2-01 of Regulation S-X, which sets forth the requirement for independence of accountants practicing before the Commission.
I am also troubled that the Commission has chosen to tie its long overdue modernization of the financial interest and family relationships rules to a major proposal on the scope of practice and then provide an unreasonably short comment period. Limiting to 75 days the period for commenting on a far-reaching and highly complex proposal, including responding to more than 400 questions, collecting and analyzing a great deal of data and considering alternative concepts for regulating auditor independence, is political gamesmanship, and I find that very disappointing.
The Commission suggests that these revisions are needed because non-audit services `may' or `could' affect auditor independence. The Commission never states that such services `do' affect or `have' effected auditor independence. This is because there is no link between a broad scope of services and any degradation of audit quality. Numerous studies have borne this out.
In fact, the O'Malley Panel on Audit Effectiveness, which was formed at the request of the Commission, concluded that a broad scope of services often improved the quality of an audit, identifying specific instances in which a non-audit service actually enhanced the quality of the audit. The O'Malley Panel identified 37 engagements that involved both audit and non-audit services to clients, none of which resulted in the Panel identifying any instance in which providing non-audit services had a negative effect on audit effectiveness. Further, the Panel is not aware of any instances of non-audit services having caused or contributed to an audit failure or the actual loss of auditor independence.
The Commission's proposal is contrary to the findings of the O'Malley Panel. There are simply no conclusive studies to support such a change. In fact, the Commission's suggestion that non-audit services `may' or `could' affect auditor independence indicates a lack of understanding of the risk model. The consultant's risk of loss on a consulting project is usually limited to fees paid. The auditor's risk of loss for a blown audit can be hundreds or thousands times fees, depending on the losses of creditors, investors or other financial statement users. The belief that I would turn the other cheek on an audit issue to save a consulting assignment ignores the relative risk of those options.
The O'Malley Panel also said that in the final analysis, the most important determinants of audit effectiveness are the personal attributes and skills of the individual auditor. I agree. Auditors, who have a duty to protect the public interest, need to be able to say no to management. The Commission has addressed this concern with the Audit Committee Rules put in place in 1999 and the Commission should give those rules a chance to work.
In 1996, former SEC Commissioner Steve Wallman wrote "If we keep saying that we must guard against appearances being tainted even though there is no tainting in fact, then we confuse the public and ...promote bad public policy." He concluded that a "prohibitive approach focusing on the provision of non-audit services to audit clients...appears to be wholly without any empirical support indicating any lack of objectivity in fact resulting from the provision of non-audit services to audit clients."
I am concerned with the new structure that this change would bring. With firms no longer able to assist audit clients with non-audit services, the audit merely becomes a commodity. I am convinced that audit quality would be compromised from several aspects. Not only would firms lose an important source of revenue needed to invest in improving audit quality and evolving technology changes but may not have access to traditional and non-traditional talent needed for audit projects.
The impact on recruiting and retaining talent in an "audit only" environment will be severe. The "audit-only" firms endorsed by the proposal will have difficulty attracting the necessary talent both from accounting programs and from information technology programs, because the best talent will be drawn toward industries with broader career opportunities. The reason audit firms need these professionals is clear - the businesses and systems that auditors test are growing more diversified and complex, and they need expertise to perform the highest quality audits. A mandated change to the accounting profession is unwarranted and unsubstantiated.
I am a partner in a large accounting firm with 16 offices throughout Michigan and Ohio. We currently provide audit services for only 14 SEC registrants. On the surface, these proposed changes would seem to have an insignificant impact on our practice. On the contrary, we believe the impact to us will be severe because the SEC's proposed rules will surely reach beyond publicly-held companies. With a precedent set by these rules, others, including Department of Labor, General Accounting Office, banking agencies, insurance regulators, and State Boards of Accountancy, are sure to follow suit, affecting all audit engagements, not just those of registrants. The State Boards of Accountancy for New York, California, Colorado and South Carolina have already indicated that they would seek the new proposed SEC rules for their state. If the Ohio State Board of Accountancy adopts similar rules, it would have a dramatic negative impact on businesses all across the state, especially smaller businesses outside the major urban areas, where choices of service providers are much more limited.
The SEC's proposal to restrict the services offered by accounting firms represents a fundamental restructuring of a profession that has successfully given investors the reliable, independent data they need for the past century. A decision by a government agency to tell some business organizations what services they may offer and to tell other businesses from whom they can buy services is an extraordinary economic intervention, and it is being made without any empirical or other basis. The forced restructuring and broad sweeping changes represent a restraint of trade, will compromise audit quality and would impede the progress of our clients that our firm has been serving diligently and conscientiously for over 75 years.
I would be pleased to discuss this with you further. Please contact me at (614) 793-2278.
Very truly yours,
Jeffery J. Heaphy, NHA