September 25, 2000
Arthur Levitt, Chairman
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
Dear Chairman Levitt,
We understand your interest in the very important issue of auditor independence, and believe that your focus on this matter is both timely and relevant. We agree with many of the provisions in the proposed regulation. However, we are concerned about whether the use of SEC regulatory authority, which will radically change market dynamics, is necessary in accomplishing your goals with respect to improving auditor independence and thereby helping to maintain the integrity of the financial markets. If your concern truly lies in the area of auditor independence, why not focus your efforts on the audit activity rather than wondering far a field in non-audit activities?
We offer two proposals that would advance auditor independence while at the same time minimally interfering with market dynamics. Our proposals deal with audit fees and auditor interaction with audit committees.
First, we urge the SEC to focus on insuring that auditors of public companies are adequately compensated for their audit services. For instance, we believe that the use of a $1000 audit fee for a dot.com audit engagement in hopes of gaining future management advisory service revenues more seriously imperils auditor independence than many of the issues you raise in your proposed regulation. To curb such activity, the SEC could regulate that auditors would violate independence rules if they make an investment in their clients in the form of significantly reduced audit fees. Regulatory guidance would also be required to prevent auditors from providing these other services at no cost or significantly reduced rates, as a hidden subsidy to the cost of the audit. Firms would be required to self regulate this data and the information would be subject to the peer review program.
Adequate audit fees would not eliminate inefficient audits but would help curb any tendency for auditors to "eat time" or to cut corners in conducting the audit, thus improving audit quality and potentially reducing apparent or real audit failures. Further, realistic compensation may motivate talented people to stay in the audit practice rather than transferring to more lucrative consulting practices or seeking employment with the firms' clients. If the SEC were to prohibit substandard "low ball" audit fees, the other advisory services become less important and the same firm may in fact independently perform the non-audit services for audit clients since audit partners and staff would not be as financially reliant on profits from those other services. A knee jerk reaction to this proposal is likely to be that audit fees are high enough already and we do not need a regulation that may increase them. However, this proposal would have little, if any, impact on the audit fees of most public companies where auditor compensation is already reasonable. What it would affect are low-ball audit fees set primarily to gain non-audit service clients. This is where the independence issue often begins.
Second, the SEC should seek to bolster auditor independence by further strengthening required communications between the auditor and the Audit Committee. Traditionally, the focus of auditor communications has been on the management, with Audit Committee involvement often only at the beginning and end of the audit. This focus should shift to ongoing communications between the auditor and an independent audit committee with management becoming involved only when the Audit Committee seeks input or when the auditor seeks information for analysis that only management can or should provide.
For example, Audit Committees should be required to ask auditors if they will consent to continue as the independent auditor for the company, fees that adequately compensate auditors should be agreed between the Committee and the auditors, and problems encountered during audits should be promptly communicated to the Audit Committee who should be involved in the resolution process. This is not to suggest that management not be involved. Rather, it is designed to continuously remind all parties that the auditors serve the Board of Directors in fulfilling their fiduciary responsibility to shareholders. Critics might say this will require more work on the part of independent directors. This may be true, but only in those instances where problems exist and increased involvement by the Audit Committee is warranted. It will put an end to situations where Audit Committees are surprised when they first find out about problems at the end of an audit.
Thank you for your consideration of our views. We would be happy to provide a more detailed discussion of our proposals should you so desire.
Executive in Residence, University of North Carolina at Wilmington
and Retired KPMG Partner
Cameron Professor, University of North Carolina at Wilmington
Assistant Professor, University of North Carolina at Wilmington