25 September 2000
Mr. Jonathan G. Katz
Mail Stop 0609 -- Room 6507
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549-0609
Reference: File No. S7-13-00
Dear Mr. Katz:
PricewaterhouseCoopers LLP ("PwC") appreciates this opportunity to comment on the revisions to the auditor independence requirements proposed by the Securities and Exchange Commission ("SEC" or "Commission") in Release 33-7870 (the "Release"). PwC is the largest public accounting and professional services firm in the world, and the Commission's proposals would have a significant impact on our firm, our people, our clients and their stakeholders.
In this letter, we provide our general observations with respect to the Release. Since the Commission issued the Release, we have discussed with the SEC staff our reactions to it and provided the staff with additional background information concerning the accounting profession and the challenges facing our profession. We believe this has been a constructive dialogue, and our comments herein are intended to summarize the information that we have shared with the staff.
We also respectfully submit as Attachment A to this letter an alternative proposal (the "Proposed Amended Rule") that we have developed with Ernst & Young LLP regarding particular provisions of the Release. We previously submitted this document to the Commission under separate cover on September 19, 2000. The Proposed Amended Rule reflects specific changes that are necessary to address the concerns that we have raised with the Commission's staff. In our view, the Proposed Amended Rule would meet the Commission's objectives, and establish a framework under which accounting firms could provide, consistent with principles of auditor independence, the services that we anticipate clients will require in the future. Accordingly, we would support revised SEC independence requirements that are consistent with the Proposed Amended Rule.
I. Introduction and Summary
The SEC has stated that its purpose in proposing new auditor independence rules is to enhance investor confidence and protect the public interest. PwC has publicly supported the Commission's rulemaking process and, in particular, the goal of modernizing outdated rules and safeguarding and improving the quality, significance, and reliability of information upon which the investing public relies.1 In our view, the Release, read in its entirety, represents an ambitious and wide-ranging effort by the Commission to create a modern, codified approach to promoting auditor independence. We commend the Commission for initiating this critical dialogue.
We believe that any final rules that the Commission adopts in this area should have the following attributes:
Finally, at the completion of this process, we urge the Commission to recognize the importance of corporate audit committees and the recent efforts undertaken both to improve the information that they receive and to strengthen their role in the audit process. In addition, we urge the Commission to acknowledge expressly the continuing role of the Independence Standards Board in setting future independence standards and resolving independence issues and the role of the Public Oversight Board in monitoring the quality of audits.
Our comments on the Release fall into five major areas:
First, the Commission's proposal to limit design or implementation of certain information systems has received much public commentary. We accept that changing market forces are making it increasingly difficult for accounting firms to provide certain of these services alongside assurance practices. We can support, therefore, a partial restriction on these services. The following services, however, should not be restricted: (a) services that involve the assessment, design and implementation of information systems that do not aggregate source data or that do not have a significant effect on an audit client's financial statements and (b) services in connection with the assessment, design and implementation of internal accounting control systems and risk management information systems.
Second, we are also prepared to support a restriction on internal audit services, but that, too, should not be a complete restriction. Internal audit services that supplement the client's internal audit functions, as more fully described in the Proposed Amended Rule, should not be restricted.
5. Disclosure Rules. We have always believed that transparency and sunshine through disclosure are the most effective means to inform investors and oversee the profession. We suggest that the Commission adopt a disclosure requirement similar to that of the United Kingdom under its Companies Act.2 That approach is investor-tested and provides an appropriate level of information to shareholders on the extent of the relationship between the independent auditors and the registrant without the potential for confusion and "information overload" that a more detailed disclosure regimen would pose.
II. The Changing Role of Auditors
We strongly affirm the Commission's view that auditors have an important role to play in maintaining the public's confidence in the financial markets of the United States. While our audit opinions can never guarantee the complete accuracy of an issuer's financial statements, investors rely on the critical assurance that financial statements have been thoroughly examined by an objective and skilled professional. We agree that providing this assurance to the investing public is, as the Commission has stated, an auditor's over-arching duty.
Yet today, the accounting profession is at a crossroads. Not only are firms in the throes of unprecedented restructuring, as discussed below, but the New Economy is exerting heretofore unimagined pressures for change in the nature of accountants' core business -- providing assurance services. We are in the midst of a global information revolution as momentous as the agricultural or the industrial revolution. This revolution is moving at Internet speed, and the profession must be free to seize the initiative and adapt to its demands.
We believe that the accounting profession's core mission must continue to be the protection of investors and the public interest - an especially important role in times of dynamic change and economic transformation. Our standard deliverables - reports on financial statements coming 60 to 90 days after year-end - serve as an important "report card," but become less relevant on a day-to-day basis to investors and managers, who increasingly require and gain access to instant financial and non-financial information.
We are entering an era in which real-time, daily closing of the books will be standard and websites will offer assured financial and non-financial information of unprecedented scope. A decade ago, or even two years ago, most investors formed economic judgments based on historical financial information. In their attempts to determine true franchise value, investors now demand to know the myriad details relating to such factors as business strategy, economic value added, risks, corporate governance, environmental factors, and human rights. To make decisions in this increasingly complex environment, reliable, contemporaneous information, supported by assurances from a trusted and objective third party, is increasingly necessary.
This evolution will continue to challenge the definition and role of "audit services." Consequently, the overriding need today is not merely the creation of a new set of rules, but also the development of a new accounting and auditing model that reflects the information upon which investors increasingly rely. These developments underscore the pressing need for the Commission and the profession to work together to develop new generally accepted accounting principles for the information age, to replace the accounting model of the industrial age. Such new principles would revamp requirements as to both what information has to be reported and when it is reported.
Not only is the role of the accountant undergoing change, but the accounting profession is in the process of a self-generated restructuring that will go a long way toward achieving a fundamental objective of the Release - the elimination of appearance issues in regard to independence arising from large-scale information technology projects and other enterprise-wide management consulting services. Several firms, including PwC, Ernst & Young, KPMG, and Grant Thornton, have either completed or announced major organizational restructurings that will fundamentally change the mix of services offered by these firms and their identity in the market.
Because of such rapid developments, we urge the Commission not to try to fashion rules that attempt to anticipate every conceivable future conflict or concern. Instead, new requirements should build upon the traditions and intellectual core of the accounting profession, allowing it to grow and innovate to meet developing investor needs. The challenge today should be to create a set of guidelines that will enable the profession to do so, recognizing that no one knows what new assurance services will be demanded a decade from now -- or even a year from now.
In the Release, the Commission asks whether it should consider adoption of measures such as the so-called "exclusionary rule," which would completely ban the performance of non-audit services for audit clients. We believe that such a rule could do irreparable harm to firms, clients and the investing public. The accounting and auditing profession must remain an attractive career opportunity for the most talented individuals. It cannot be rendered stagnant. Accordingly, the SEC and the profession must find a formula that will allow firms to provide services that support and nurture current and future audits, but which do not pose an unacceptable threat to the actual independence of the firm or to the appearance of independence to investors.
III. Governing Standards and Principles
The "Reasonable Investor" Standard
In the Release, the Commission first defines the term "independent" by stating that it "will not recognize an accountant as independent, with respect to an audit client, if the accountant is not, or would not be perceived by reasonable investors to be, capable of exercising objective and impartial judgment on all issues encompassed within the accountant's engagement." In addition, the Release states that an accountant would need to be perceived by reasonable investors as being capable of exercising objective and impartial judgment on all issues encompassed within the accountant's engagement for the accountant to be recognized as independent. This language, focused on the accountant's ability to exercise objective and impartial judgment, coupled with the proposed "reasonable investor" standard, represents a substantive advance from the current formulation in Rule 2-01(b) of Regulation S-X, which states that the Commission will not recognize as independent any accountant who is not in fact independent and includes a limited number of examples.
The goal of an objective analysis of independence would be undercut by the proposed reference to a hypothetical "reasonable investor" without further description of the context in which such a person might assess independence. Accordingly, we recommend that the Commission modify the proposed "reasonable investor" standard to read "reasonable persons, with knowledge of all relevant facts and circumstances." This modification would appropriately clarify the context in which the judgment is to be rendered by a reasonable person. Moreover, it would be more consistent with our understanding of the meaning of the term "independent accountant," as it was understood by Congress when the federal securities laws were enacted in the 1930s and has since been interpreted and understood by the accounting profession.
Paragraph (b) of the Release sets forth four broad principles that would operate as rules. Under the Release, auditor independence would be impaired whenever the accountant (1) has a mutual or conflicting interest with an audit client, (2) would be auditing his or her own work, (3) functions as management or an employee of the audit client, or (4) acts as the client's advocate. We suggest that these broad and general principles not be included in the formal text of the rule. Instead, we believe that the SEC could describe these principles either in its adopting release or in a preamble to the rules, as a basis for the more specific rules and as factors or situations that potentially could raise independence issues. Doing so would recognize that the responsibility for decision-making on independence issues necessarily rests in the first instance with the auditor and its audit client.
No one can foresee the infinite transactions, relationships and variables that may influence auditor independence now or in the future as the economy and the profession continue to transform. Thus, the Commission and the profession will need a flexible framework to deal with these myriad issues, as suggested in our modification of paragraph (b) in the Proposed Amended Rule.
IV. Financial and Business Relationships
Please see Attachment B for our comments with respect to specific rules and definitions included in the Release regarding financial and business relationships with audit clients.
V. Specific Rules on Non-Audit Services
As noted above, we have discussed specific provisions of the Release with the SEC staff and have submitted to the Commission proposed revisions that we believe would meet the Commission's objectives while enabling firms to provide the services we anticipate that clients will require in the future.
We support certain restrictions on the types of consulting services accounting firms provide - including certain information systems consulting - because we believe that changing market forces are making it increasingly difficult for firms to provide these services alongside their assurance practices. The restructuring plan announced by PwC will allow each of our businesses to grow and prosper. We, thus, do not accept the notion that we will not be able to conduct quality audits without a major information technology consulting practice housed within the same firm. In addition, we recognize that the provision to audit clients of certain financial information systems consulting and internal audit services may raise appearance issues in the eyes of some observers. Accordingly, we support certain restrictions on providing those services to audit clients.
Our comments on the proposed scope of services prohibitions are set forth in summary form below. Our proposed language on each such prohibition is set forth in the Proposed Amended Rule.
Financial Information Systems
A central part of the Commission's discussion on scope of services relates to the potential for independence concerns arising from the design or implementation by accounting firms of financial information systems for their audit clients. We believe that our independence has never been impaired by the rendering of these services. We recognize, however, that the Commission is concerned with maintaining not only the fact, but also the appearance of, auditor independence, and that some may view the increase in the number of large information technology engagements by accounting firms for their audit clients as implicating that concern.
In our view, the SEC's concerns can be addressed without unduly restricting technology-related service offerings that may be provided to audit clients. For example, information technology services provided by accounting firms to their audit clients relating to the assessment, design or implementation of internal accounting controls or risk management controls are beneficial to the client and do not implicate independence concerns. In addition, information technology services covering a range of other client activities should be not be restricted where they do not implicate the central concerns expressed by the Commission. Accordingly, we would support a proposed restriction in the form set forth in the Proposed Amended Rule.
Internal Audit Services
Some observers have asserted that performing full-scope internal audit outsourcing services impairs independence. If the services do not involve the auditor assuming management functions on behalf of a client, we would not view independence to be impaired. However, even in that case, we understand that some might perceive that such services impair independence. Nonetheless, we do not agree with a regulatory approach that would prohibit all internal audit outsourcing. As long as sufficient safeguards are in place to ensure that the auditor has not assumed managerial responsibilities for the audit client, we believe that a perception of impairment of independence would not arise if an audit firm provides services to supplement the audit client's internal audit functions. The Proposed Amended Rule would limit such services to no more than 40% of the total internal audit activities undertaken by the client (either directly or through other outside service providers). It also makes clear that this rule should not limit the performance of extended audit procedures or limit the conduct of operational, as opposed to financial, internal audit services.
Except with respect to the two non-audit services described immediately above, we support the codification of existing professional requirements, as specifically set forth in the Proposed Amended Rule, in lieu of the adoption of the restrictions proposed in the Release.
Our comments regarding the remaining scope of service proposals are set forth below:
The Proposed Amended Rule adheres to the current limitations found in existing SEC guidance and would codify interpretations with respect to assisting clients in emergency situations and performing certain limited services for foreign affiliates, investees, and divisions.
Valuation and Appraisal Services
The Proposed Amended Rule would modify the broad prohibition in the Release by essentially incorporating the ISB's tentative positions reached in this area. The ISB's general approach was that audit firm professionals should not provide audit clients with appraisal and valuation services that, in the aggregate, would have a material effect on the client's financial statements.
The Proposed Amended Rule would substantially modify the SEC's proposed broad prohibition, while codifying the current limitations established by the SEC Practice Section ("SECPS") of the AICPA on actuarial services for insurance companies.
The proposed restriction in the Release, which we support, is consistent with current professional requirements.
The Release would impose substantial new limitations on human resource-related services to audit clients. We believe that current standards strike the correct balance in this area, and we would support the restatement of the current SECPS guidance, as set forth in the Proposed Amended Rule.
Broker-Dealer, Investment Adviser, Investment Banking
The Release proposes to expand upon current SEC interpretations that prohibit an accountant from acting as a broker-dealer, promoter or underwriter for an audit client through new prohibitions against acting as a "securities professional" including as an analyst of the audit client's or an affiliate of the audit client's securities, investment adviser, or in any capacity recommending the purchase or sale of an audit client's or an affiliate of an audit client's securities, or designing the audit client or an affiliate of the audit client's system to comply with broker-dealer or investment adviser regulations. In our view, the language in the Release would likely engender confusion since, for example, terms such as "securities professional" are not defined elsewhere in the federal securities laws. Moreover, we believe the current prohibitions, which are restated in the Proposed Amended Rule, are sufficient to promote both the fact and appearance of independence.
Legal services are subject to both regulation and substantial restrictions at the local and the national level, depending on the jurisdiction. It is appropriate for the Commission to be sensitive to the laws of other countries when considering restrictions on the provision of such services to registrants. The Release does not, in our view, adequately allow for the existence of different legal structures in foreign countries or for practices currently accepted and followed in those countries in the provision of legal services. The Proposed Amended Rule provides an appropriate limitation to address the Commission's concerns in this area while not unduly burdening foreign law practitioners or altering permitted areas of practice.
The Release would impose new limits on expert services for audit clients. Such activities are specifically permitted by current professional guidance, and we do not believe there is a need for a separate Commission rule in this area.
VI. Definition of "Affiliate"
The Release contains extremely broad definitions of an "affiliate" of the accounting firm and "affiliate" of the audit client. The Commission's proposals in these areas go far beyond what we think is necessary to safeguard independence and would unduly hamper the profession's flexibility in fulfilling its professional obligations in the New Economy. The Proposed Amended Rule offers no new definition of "affiliate of the accounting firm", and in that regard, we urge continuation of the status quo. For the definition of "affiliate of an audit client", the Proposed Amended Rule would instead incorporate the current definition of "affiliate" found in Regulation S-X, which turns on the existence of a control relationship. Further, the Proposed Amended Rule makes clear that under existing professional and SEC rules, investments in non-clients that are related to clients are governed by rules that are separate from rules that require independence broadly of client affiliates.
VII. Disclosure Requirements
We have always believed that transparency and sunshine are the most effective means of educating investors and overseeing the profession. Accordingly, we would support the disclosure of information that clients, investors, and regulators would find useful, that is, aggregate audit fees and aggregate non-audit fees paid by the same client.
In our view, such aggregate disclosures would be accessible and meaningful to investors. In contrast, we are concerned that the proposal in the Release to require public companies to provide detailed descriptions of each non-audit service runs counter to the Commission's "Plain English" initiatives. We believe that investors might be confused by detailed disclosure of services provided by an accounting firm to its client, which would be required even though the firm, the client's audit committee, and the Commission had determined that the provision of such services was appropriate.
We urge that the Commission adopt the more targeted U.K. model requiring a one-line disclosure of all audit and non-audit fees paid for the last two years.3 Disclosure of this information would allow investors to assess the overall materiality of non-audit services provided. Since the SEC will have already prohibited services which adversely affect audit independence, the only disclosure with respect to other non-audit services that could be relevant is the magnitude of such services, since the total amount might impair the appearance of independence, regardless of the nature of the non-audit services.
VIII. Contingent Fees
We believe that, if the SEC is to issue guidance in this area, it should not go beyond the existing guidance with respect to contingent fees found in Rule 302 of the AICPA's Code of Professional Conduct.
* * * * *
We would be pleased to provide further information or respond to any questions the Commission or the staff may have in the course of their deliberations.
We thank the Commission and the staff for affording us the opportunity to participate constructively with respect to the proposed rules.
/s/ PRICEWATERHOUSECOOPERS LLP
|1||Testimony of James J. Schiro, Chief Executive Officer, PricewaterhouseCoopers, before Securities and Exchange Commission, Washington, D.C., September 20, 2000.|
|2||The Companies Act, 1989, ch. 40, sch. 14, para. 17 (Eng.)(Disclosure of Remuneration for Non-Audit Work).|
PROPOSED REVISED INDEPENDENCE RULE
[submitted by Ernst & Young LLP and PricewaterhouseCoopers LLP on September 19, 2000]
§ 210.2-01 Qualifications of accountants
(b) The Commission will not recognize an accountant as independent, with respect to an audit client, if the accountant is not, or would not be perceived by reasonable persons, with knowledge of all relevant facts and circumstances, to be
, capable of exercising objective and impartial judgment on all issues encompassed within the accountant's engagement. In determining whether an accountant is independent, the Commission will consider all relevant circumstances, including all relationships between the accountant and the audit client, and not just those relating to reports filed with the Commission.
(c) An accountant is not independent under the standard of paragraph (b) of this section if, during the audit and professional engagement period, the accountant has any of the financial, employment or business relationships with, provides any of the non-audit services to, or receives a contingent fee from, the accountant's audit client as specified in paragraphs (c)(1) through (c)(5) of this section
paragraph (b) of this section.
(1) Financial relationships. An accountant is not independent if the accountant has a direct financial interest or a material indirect financial interest in the accountant's audit client, such as the financial relationships specified in this paragraph (c)(1).
(i) Investment in audit client. An accountant is not independent when:
(A) The accounting firm, any covered person in the firm, or any of his or her immediate family members, has any direct investment in an audit client, such as stocks, bonds, notes, options, or other securities.
(B) Any partner, principal, shareholder (hereinafter referred to as partner), or professional employee of the accounting firm, any of his or her immediate family members, or any group of the above persons has filed a Schedule 13D or 13G with the Commission indicating beneficial ownership of more than five percent of an audit client's equity securities, or controls an audit client or a close family member other than an immediate family member of a partner has control of an audit client.
(C) The accounting firm, any covered person in the firm, or any of his or her immediate family members, serves as voting trustee of a trust or executor of an estate containing the securities of an audit client.
(D) The accounting firm, any covered person in the firm, any of his or her immediate family members, or any group of the above persons has any material indirect investment in an audit client.
The term "indirect investment" means an investment in one or more audit clients through a non-client intermediary, such as a mutual fund or unit investment trust, unless:
(i) The holder of an interest in the intermediary has control over that entity or its investment activities, in which case the investment in the audit client is considered to be direct; or
(ii) The intermediary has an investment in the audit client that amounts to 20% or more of its total investments at the time of investment, in which case the investment in the audit client is considered to be direct.
The materiality of an indirect investment is measured on a flow-through basis - i.e., as if the holder's prorata share of the intermediary's underlying investments belong to the holder. Materiality is based on the accounting firm's net worth or the combined net worth of a covered person and his or her immediate family members.
(E) (i) The accounting firm, any covered person in the firm or any of his or her immediate family members has any direct or material indirect investment in a non-audit client where an audit client has the ability to exercise significant influence (as defined by generally accepted accounting principles) over the non-audit client and the audit client's investment in the non-audit client is material to the audit client; or
(ii) the accounting firm, any covered person in the firm or any of his or her immediate family members has any direct or material indirect investment (A) in a non-audit client where the non-audit client has the ability to exercise significant influence over the audit client and the non-audit client's investment in the audit client is material to the non-audit client; or (B) that would enable the firm, any covered person or any of his or her immediate family members to exercise significant influence over a non-audit client if the non-audit client has significant influence over the audit client.
(ii) Other financial interests in audit client
(A) An accountant is not independent when the accounting firm, any member of the audit engagement team,
covered person in the firm, or any of his or her immediate family members has:
(A) (1) Loans/debtor-creditor relationship
Any loan (including any margin loan) to or from an audit client,
an affiliate of an audit client, or an audit client's or an affiliate of an audit client's officers, directors, or record or beneficial owners of more than five percent of the audit client's or affiliate's equity securities stockholders who have the ability to exercise significant influence over the audit client, except for the following loans obtained from a financial institution under its normal lending procedures, terms and requirements:
1) Automobile loans and leases collateralized by the automobile;
2) Loans fully collateralized by the cash surrender value of an insurance policy;
3) Loans fully collateralized by cash deposits at the same financial institution; and
4) A mortgage loan collateralized by the accountant's primary residence provided the loan was not obtained while the borrower was a member of the audit engagement team covered person in the firm or an immediate family member of a member of the audit engagement team covered person in the firm.
(B) (2) Savings and checking accounts.
Any savings, checking or similar account at a bank, savings and loan or similar institution that is an audit client
or an affiliate of an audit client, if the account has a balance that exceeds the amount insured by the Federal Deposit Insurance Corporation or any similar insurer except that a firm account may have an uninsured balance provided that the firm has concluded that the likelihood of the bank, savings and loan, or similar institution experiencing financial difficulties is remote.
(C) (3) Broker-dealer accounts.
Any brokerage or similar accounts maintained with a broker-dealer that is an audit client
or an affiliate of the audit client, if:
1) Any such accounts include any asset other than cash or securities (within the meaning of "security" provided in the Securities Investor Protection Act); or
2) The value of assets in the accounts exceeds the amount that is subject to a Securities Investor Protection Corporation (SIPC) advance, for those accounts, under Section 9 of the Securities Investor Protection Act.
(D) (4) Futures commission merchant accounts.
Any futures, commodity, or similar account maintained with a futures commission merchant that is an audit client
or an affiliate of the audit client.
(E) (5) Credit cards.
Any aggregate outstanding credit card balance
in excess of $10,000 owed to a lender that is an audit client or an affiliate of an audit client that is not reduced to $10,000 or less on a current basis taking into consideration the payment due date and any available grace period.
(F) (B) Insurance products. An accounting firm is not independent when any member of the audit engagement team, or any of his or her immediate family members, has any individual policy issued by an audit client that is obtained by the accountant, or by his or her immediate family member, while the accountant is a member of the audit engagement team. Previously obtained policies will not impair independence provided that the likelihood of the insurance company becoming insolvent is remote. Such policies may be renewed and coverage increased if done pursuant to the pre-existing contractual terms of the policy. Any individual policy or professional liability policy originally issued by an insurer that is an audit client or an affiliate of an audit client.
(G) (C) Investment companies. An accounting firm is not independent where the firm, any covered person, or any of his or her immediate family members have Aany investment in any entity that is part of an in an investment company complex if the audit client is also part of an entity in the same investment company complex and if the audit client is an investee it is material to the non-client investor or if the audit client is an investor the non-client investee is material to the audit client investor, When the audit client is an entity that is part of an investment company complex, the accountant must be independent of each entity in the investment company complex. except as follows: (i) When the audit client is the investment advisor or sponsor of a unit investment trust, members of the audit engagement team and their immediate family members may not invest in non-client funds or unit investment trusts advised or sponsored by the audit client notwithstanding that such funds or trusts are not deemed to be material to the audit client; (ii) when the audit client(s) is an investment company or unit investment trust advised or sponsored by a non-client advisor or sponsor, members of the audit engagement team and their immediate family members may not invest in the non-audit client advisor or sponsor, or in funds or trusts advised or sponsored by the same advisor or sponsor, notwithstanding that such funds or trusts are not deemed to be material to the audit client.
Notwithstanding paragraphs (c)(1)(i) and (c)(1)(ii) of this section, the accountant will not be deemed not independent if:
(A) Inheritance and gift.
Any person acquires a financial interest through an unsolicited gift or inheritance that would cause an accountant to be not independent under paragraphs (c)(1)(i) or (c)(1)(ii) of this section, and the financial interest is disposed of as soon as practicable, but no longer than 30 days after the person has the right to dispose of the financial interest.
(B) New audit engagement.
Any person has a financial interest that would cause an accountant to be not independent under paragraphs (c)(1)(i) or (c)(1)(ii) of this section, and:
(1) The accountant did not audit the client's financial statements for the immediately preceding fiscal year; and
(2) The accountant is independent under paragraphs (c)(1)(i) and (c)(1)(ii) of this section before the earlier of:
Accepting the Signing an initial engagement letter to provide audit, review, or attest services to the audit client; or
(ii) Commencing any audit, review or attest procedures (including planning the audit of the client's financial statements).
[THE FOLLOWING SECTION WAS FORMERLY DESIGNATED AS "210.2-01(d) Quality controls."]
(C) Inadvertent Violations Where Firm Has Quality Controls in Place
An accounting firm's independence will not be impaired solely because a covered person in the firm is not independent of an audit client provided:
(1) The covered person did not know
, and was reasonable in not knowing, of the circumstances giving rise to the lack of independence;
(2) The covered person's lack of independence was corrected promptly under the relevant circumstances after the covered person or accounting firm became aware of it; and
(3) The accounting firm has a quality control system in place that provides reasonable assurance, taking into account the size, and nature of the accounting firm's practice, that the accounting firm and its employees do not lack independence. For an accounting firm that annually provides audit, review, or attest services to more than 500 companies with a class of securities registered with the Commission under section 12 of the Securities Exchange Act of 1934, a quality control system will not provide such reasonable assurance unless it has at least the following features:
(i) Written independence policies and procedures;
(ii) With respect to partners and managers, a
An automated system to identify their financial relationships (i.e., investments in securities) that might impair the accountant's independence;
(iii) With respect to all professionals, a system that provides information about entities that require independence;
(iii) (iv) An annual or on-going firm-wide training program about auditor independence;
(iv) (v) An annual internal inspection and testing program to monitor adherence to independence requirements;
(v) (vi) Notification to all firm members, officers, directors, and employees of the name and title of the member of senior management responsible for compliance with auditor independence requirements;
(vi) (vii) Written policies and procedures requiring all firm professionals partners and all covered persons to report promptly to the firm when they are engaged in employment negotiations with an audit client, and requiring the firm to remove immediately any such professional from that audit client's engagement and to review promptly all work the professional performed related to that audit client's engagement; and
(vii) (viii) A disciplinary mechanism to ensure compliance with this section.
(iv) Audit clients' financial relationships.
An accountant is not independent when:
(A) Investments by the audit client in the auditor.
An audit client
or an affiliate of an audit client has, or has agreed to acquire, any direct investment in the accounting firm or its affiliate, such as stocks, bonds, notes, options, or other securities, except that as to accounting firm affiliates that do not provide any accounting or auditing services, independence is not impaired by investments that are not material to the audit client, but in no event may such direct investments exceed ten percent of the outstanding shares of the accounting firm affiliate.
The accounting firm engages
Aan audit client or an affiliate of an audit client to act as an underwriter including a broker-dealer or other entity, performs any service for the accounting firm related to underwriting, offering, making a market in, marketing, promoting, or selling with respect to securities issued by the accounting firm , or issues an analyst report concerning the securities of the accounting firm.
(2) Employment relationships.
An accountant is not independent
under the standard of paragraph (b) of this section if the accountant has an employment relationship with an audit client or an affiliate of an audit client, such as the employment relationships specified in this paragraph (c)(2). An accountant is not independent when as follows:
(i) Employment at audit client of accountant.
A current partner
, principal, shareholder, or professional employee of the accounting firm is employed by the audit client or an affiliate of an audit client or serves as a member of the board of directors or similar management or governing body of the audit client or an affiliate of the audit client.
(ii) Employment at audit client of certain relatives of accountant; Employee Benefit Plans and Compensation Programs
(A) A member of the audit engagement team has (i) a close family member, other than an immediate family member, who has a known material (to both the relative and the professional) investment in the audit client, or (ii) a close family member who is in an accounting or financial reporting oversight role at the audit client, or was in such a role during any period covered by the audit for which the accountant is a member of the engagement team;
(B) A partner who is in a position to influence the audit has a close family member who is in an accounting or financial reporting oversight role at the audit client, or was in such a role during any period covered by an audit that the partner is in a position to influence;
(C) Notwithstanding the provisions of (c)(1)(i) above, immediate family members of covered persons who are not precluded under this paragraph from having an employment relationship with the audit client may fully participate in the client's employee compensation programs, including receiving stock, stock options, and restricted stock and participate in stock purchase plans, 401(k) plans, etc., provided they are not immediate family members of a member of the audit engagement team or a partner in a position to influence the audit. When the immediate family member is no longer employed by the client and there are no restrictions that preclude the disposition of the investments obtained as a result of participation in the employee compensation program, such investments must be disposed of within ninety days of termination of employment or the cessation of restrictions whichever is later, if the person is still a close family member of a covered person in the firm.
A close family member of a covered person in the firm is in an accounting or financial reporting oversight role at an audit client or an affiliate of an audit client, or was in such a role during any period covered by an audit for which the covered person in the firm is a covered person.
(iii) Employment at audit client of former employee of accounting firm.
A former partner, shareholder, principal, or professional employee of an accounting firm becomes associated with
is in an accounting or financial reporting oversight role at an audit client or an affiliate of an audit client, unless the individual:
(A) Does not influence the accounting firm's operations or financial policies;
(B) Has no capital balances in the accounting firm; and
(C) Has no financial arrangement with the accounting firm other than one providing for regular payment of a fixed dollar amount (which is not dependent on the revenues, profits, or earnings of the firm) which is immaterial to the firm. For individuals who: (1) within five years of disassociation from the firm are employed by an audit client in a position that is required to be disclosed in the client's proxy statement or annual report filed with the Commission, or (2) become non-employee directors of an audit client with which they were closely associated (i.e., a member of the audit engagement team or in a position to influence the audit) within two years of such close association, such payments must be made pursuant to a fully funded retirement plan,
or rabbi trust, or similar vehicle.
(iv) Employment at accounting firm of former employee of audit client.
A former officer, director, or employee of an audit client becomes a partner of the accounting firm, unless the individual does not participate in, and is not in a position to influence, the audit of the financial statements of the audit client
(3) Business relationships.
(a) An accountant is not independent if the accounting firm or any covered person in the firm has any direct or material indirect business relationship
(i) with an audit client,
(ii) with an audit client's officers, directors, or a substantial stockholder, or
(iii) with an entity over which the audit client has significant influence but not control, and the effect of the business relationship is material to the audit firm or to the audit client.
record or beneficial owners of more than
(b) The relationships described in this paragraph do not include a relationship in which the accounting firm or covered person in the firm provides professional services or is a consumer in the ordinary course of business.
(4) Non-audit services.
An accountant is not independent when the accountant provides the following non-audit services to an audit client.
(A) Bookkeeping or other services related to the audit client's accounting records or financial statements.
Any service involving:
(1) Maintaining or preparing the audit client's
or an affiliate of the audit accounting records;
(2) Preparing the audit client's
or an affiliate of the audit client's financial statements that are filed with the Commission; or
Generating financial information to be disclosed by the audit client or an affiliate of the audit client to the public. Preparing or originating source data underlying the client's financial statements.
Notwithstanding the above, the accountant may assist the client in emergency or other unusual situations provided the accountant does not make any managerial decisions. The accountant may perform certain limited services for foreign subsidiaries, divisions, branches or offices of the client provided
(i) the services are limited, routine, or ministerial;
(ii) it is impractical for the client entity to make other arrangements;
(iii) the services relate to accounting entries that are not material to the consolidated financial statements;
(iv) the services performed are consistent with local professional ethics rules; and
(v) the fees for all such services collectively (for the entire group of companies) do not exceed the greater of 1% of the consolidated audit fee or $10,000.
(B) Financial Information Systems.
design and implementation
Designing or implementing a hardware or software system
used to generate information that aggregates source data underlying the financial statements and generates information that is significant to the audit client's financial statements taken as a whole, not including services an accountant performs in connection with the assessment, design, and implementation of internal accounting controls and risk management controls.
(C) Appraisal or valuation services
, and fairness opinions. , or contribution-in-kind reports
Any appraisal or valuation service
for an audit client or an affiliate of an audit client, or any service involving a fairness opinion or contribution-in-kind report that is not required by law to be rendered by the client's auditor where it is reasonably likely that, the results of the valuation would be material to the financial statements, or, in performing an audit in accordance with generally accepted auditing standards, the results will be audited by the accountant. This prohibition does not apply: (1) when a firm valuation expert reviews and reports on the work of the audit client or a specialist, employed or engaged by the client, and the audit client or specialist provides the primary support for the balance recorded in the client's financial statements; (2) to situations where firm actuaries value a client's pension, other post-employment benefit, or similar liabilities as long as the assumptions and data are provided by the audit client; (3) to valuations performed in the context of the planning and implementation of a tax-planning strategy or for tax compliance purposes; or (4) to valuations for non-financial purposes where the results of the valuation do not have a direct impact on the financial statements.
(D) Actuarial services.
advisory service involving the determination of insurance company policy reserves and related accounts for the audit client or an affiliate of an audit client, unless the audit client or its affiliate uses its own actuaries or third-party actuaries to provide management with the primary actuarial capabilities. This restriction does not include:
(i) Assisting management to develop appropriate methods, assumptions, and amounts for policy and loss reserves and other actuarial items presented in financial reports based on the company's historical experience, current practice, and future plans.
(ii) Assisting management in the conversion of financial statements from a statutory basis to one conforming with generally accepted accounting principles.
(iii) Analyzing actuarial considerations and alternatives in federal income tax planning.
(iv) Assisting management in the financial analyses of various matters such as proposed new policies, new markets, business acquisitions, and reinsurance needs.
(E) Operation of the
Iinternal audit outsourcing function or department.
Internal audit services for an audit client
or an affiliate of an audit client, not including nonrecurring evaluations of discrete items or programs and operational internal audits unrelated to the internal accounting controls, financial systems, or financial statements., except that the accountant may provide services to supplement the audit client's internal audit functions by performing evaluations in discrete areas, such as computer auditing, or in certain geographic locations, provided that the accountant conducts no more than 40% of the audit client's internal audit activities. Nothing in this paragraph (i) precludes the auditor from performing extended audit procedures during the period under audit in order to comply with generally accepted auditing standards (for example, when the registrant does not have an internal audit department), or (ii) restricts operational internal audits unrelated to the internal accounting controls, financial systems, or financial statements.
(F) Management functions.
Acting, temporarily or permanently, as a director, officer, or employee of an audit client
or an affiliate of an audit client, or performing any decision-making, supervisory, or ongoing monitoring function for the audit client or affiliate of the audit client.
(G) Executive Recruitment.
Searching for or seeking out prospective candidates for managerial, executive, or director positions; engaging in psychological testing, or other formal testing or evaluation programs; undertaking reference checks of prospective candidates for an executive or director position; acting as a negotiator on the client's behalf, in determining position, status or title, compensation, fringe benefits, or other conditions of employment; or recommending or advising the client to hire a specific candidate for a specific job (except that an accounting firm may, upon request by the client, interview candidates and advise the client on the candidate's competence for financial accounting, administrative, or control positions).
Recruiting, hiring, or designing compensation packages for officers, directors, or managers of the audit client or an affiliate of the audit client; advising about the audit client's or affiliate of the audit client's management or organizational structure; developing employee evaluation programs; or conducting psychological or other formal testing of employees.
, investment adviser, or investment banking services.
Acting as a
securities professional, such as a broker-dealer, promoter, or underwriter , analyst of the audit client's or an affiliate of the audit client's securities, investment adviser, or in any capacity recommending the purchase or sale of an audit client's or an affiliate of an audit client's securities, or designing the audit client or an affiliate of the audit client's system to comply with broker-dealer or investment adviser regulations. on behalf of an audit client.
(I) Legal services.
Providing any service to an audit client under circumstances in which the person providing the service must be admitted to practice before the courts of a U.S. jurisdiction
or an affiliate of an audit client that, in the jurisdiction in which the service is provided, could be provided only by someone licensed to practice law.
(J) Expert services. Rendering or supporting expert opinions for an audit client or an affiliate of an audit client in legal, administrative, or regulatory filings or proceedings.
(ii) Transition. Until [insert date two years from the effective date of this section], providing to an audit client or an affiliate of an audit client the non-audit services set forth in paragraph (c)(4)(i) of this section will not impair an accountant's independence with respect to the audit client if:
(A) The non-audit services are performed pursuant to a written contract in effect on or before [insert the effective date of this section]; and
(B) Performing those services did not impair the auditor's independence under pre-existing requirements of the Commission, the Independence Standards Board, or the accounting profession in the United States.
(5) Contingent fees.
(A) An accountant is not independent if the accountant provides any service to an audit client for a contingent fee, or receives a contingent fee from an audit client
(B) Except as stated in the next sentence, a contingent fee is a fee established for the performance of any service pursuant to an arrangement in which no fee will be charged unless a specified finding or result is attained, or in which the amount of the fee is otherwise dependent upon the finding or result of such service. Solely for the purposes of this rule, fees are not regarded as being contingent if fixed by courts or other public authorities, or, in tax matters, if determined based on the results of judicial proceedings or the findings of governmental agencies. Fees may vary depending, for example, on the complexity of services rendered.
To the extent the matters covered by (c)(1) through (4) above were not previously prohibited by published rules and guidelines of the Commission or those of the accounting profession in the United States, these rules should be complied with no later than two years from the effective date of this section, except that foreign firms that practice as sister accounting firms are not required to comply with subsections (3)(ii) and (3)(iv) of (C)(1)(iii)(B) above ("Inadvertent Violations Where Firm Has Quality Controls in Place") for a period of three years from the effective date of this section in order for the exception set forth in (c)(2)(iii)(B) to be applicable. Loans, insurance products, and employment relationships in existence on the effective date of this section that are prohibited by these rules, but were not prohibited by previous rules, are grandfathered. The requirement in (c)(2)(iii) to settle financial arrangements with former professionals applies to situations that arise after the effective date of this section.
[THE FOLLOWING SECTION HAS BEEN REDESIGNATED AS "210.2-01(c)(1)(iii)(C) Inadvertent Violations Where Firm Has Quality Controls in Place."]
(d) Quality controls. An accounting firm's independence will not be impaired solely because a covered person in the firm is not independent of an audit client provided:
(1) The covered person did not know, and was reasonable in not knowing, of the circumstances giving rise to the lack of independence;
(2) The covered person's lack of independence was corrected promptly after the covered person or accounting firm became aware of it; and
(3) The accounting firm has a quality control system in place that provides reasonable assurance, taking into account the size and nature of the accounting firm's practice, that the accounting firm and its employees do not lack independence. For an accounting firm that annually provides audit, review, or attest services to more than 500 companies with a class of securities registered with the Commission under section 12 of the Securities Exchange Act of 1934, a quality control system will not provide such reasonable assurance unless it has at least the following features:
(i) Written independence policies and procedures;
(ii) An automated system to identify financial relationships that might impair the accountant's independence;
(iii) An annual or on-going firm-wide training program about auditor independence;
(iv) An annual internal inspection and testing program to monitor adherence to independence requirements;
(v) Notification to all firm members, officers, directors, and employees of the name and title of the member of senior management responsible for compliance with auditor independence requirements;
(vi) Written policies and procedures requiring all firm professionals to report promptly to the firm when they are engaged in employment negotiations with an audit client, and requiring the firm to remove immediately any such professional from that audit client's engagement and to review promptly all work the professional performed related to that audit client's engagement; and
(v) A disciplinary mechanism to ensure compliance with this section.
(e) In determining whether an accountant is independent, the Commission will consider all relevant circumstances, including all relationships between the accountant and the audit client or the affiliates of the audit client, and not just those relating to reports filed with the Commission.
(f) Definitions of terms.
For purposes of this section:
, as used in paragraphs (b) through (e) of this section, means a certified public accountant or public accountant performing services in connection with an engagement for which independence is required. References to the accountant include any accounting firm with which the certified public accountant or public accountant is affiliated.
(2) Accounting firm
means the organization (whether it is a sole proprietorship, incorporated association, partnership, corporation, limited liability company, limited liability partnership, or other legal entity) that is engaged in the practice of public accounting or furnishing accountant's reports with respect to financial statements, reports, or other documents filed with the Commission, and all departments, divisions, parents, subsidiaries, and affiliates of the accounting firm, including its pension, retirement, investment or similar plans.
(3) Accounting or financial reporting oversight role
means that the person
is in a position to, or does influence the contents of the accounting records or financial statements or anyone who prepares them, such as when the person is a member of the board of directors or similar management or governing body, chief executive officer, president, chief financial officer, chief operating officer, general counsel, chief accounting officer, controller, director of internal audit, director of financial reporting, treasurer, vice president of marketing, or any equivalent position.
(4) Affiliate of the accounting firm. (i) "Affiliate of the accounting firm" means:
(A) Any person directly or indirectly controlling, controlled by, or under common control with the accounting firm, including:
(1) Any person or entity directly or indirectly owning, controlling, or holding the power to vote five percent or more of the accounting firm's outstanding voting securities, partnership units, or other interest entitling a person to vote; and
(2) Any person or entity five percent or more of whose outstanding voting securities, partnership units, or other interest entitling a person to vote are directly or indirectly owned, controlled, or held by the accounting firm;
(B) Any officer, director, partner, copartner, or shareholder of more than five percent of the voting securities of a person described in paragraph (f)(4)(A) of this section;
(C) Any joint venture, partnership, or other undertaking in which the accounting firm participates and in which the parties agree to any form of shared benefits, including any form of shared revenue, income, or equity appreciation;
(D) Any entity that provides non-audit or other professional services to one or more of the accounting firm's audit clients, and in which the accounting firm has any equity interest in, has loaned funds to, or shares revenues with, or with which the accounting firm or any covered person in the firm has any direct business relationship;
(E) All persons and entities with which the accounting firm is publicly associated by co-branding; using the accounting firm's name, initials, or logo; cross-selling services; or using co-management; and
(F) If the accounting firm leases, or otherwise routinely acquires on a temporary or continuous basis, the services of personnel employed full- or part-time by another party (the "lessor") and the leased personnel perform a majority of the hours worked on the engagement or supporting the accountant's reports filed with the Commission, the lessor and the lessor's board of directors, executive officers, and all persons with management, supervisory, compensation, or other oversight responsibility for the leased personnel, and shareholders of five percent or more of the lessor's equity securities.
(ii) "Affiliate of the accounting firm" does not include parties that share with an accounting firm training facilities, technical knowledge, databases, or billing facilities but that have no other business or financial relationship with the accounting firm, provided that the accounting firm pays a reasonably proportionate and fair share of the costs and expenses associated with such items, and the party charges all participants no more than the costs and expenses incurred to operate or maintain the shared facility or database.
(5) (4) Affiliate of the audit client
means an entity that has control
significant influence over the audit client, or over which the audit client has control, or which is under common control with the audit client. significant influence, including the audit client's parent and subsidiary.
(6) (5) Audit and professional engagement period includes both:
(i) The period covered by any financial statements being audited or reviewed (the "audit period"); and
(ii) Tmeans the period of the engagement to audit or review the client's financial statements to be or to prepare a report filed with the Commission (the "professional engagement period"). (A) The professional engagement period:
bBegins when the accountant starts to perform professional services requiring independence pursuant to this section 2-01 provided that the accountant was fully compliant with section 2-01 in the conduct of the audit of the most recent fiscal period, and was not connected with the client as a promoter, underwriter, and voting trustee, or as a director, or officer, or in any capacity equivalent to that of a member of management during any period covered by any financial statements being audited or reviewed (the "audit period"); either signs an initial engagement letter (or other agreement to review or audit a client's financial statements), or begins review or audit procedures, whichever is earlier; and
(B) The professional engagement period (ii) eEnds when the client notifies or the accountant that the accountant is dismissed, or the accountant notifies the Commission that the client that it is no longer that accountant's audit client.
(7) (6) Audit client
means the entity whose financial statements or other information is being audited, reviewed, or attested and any affiliates of such entity, except with respect to the application of (c)(1)(i), it means the entity whose financial statements or other information is being audited, reviewed, or attested and any material affiliates of such entity.
(8) (7) Audit engagement team
means all partners, principals, shareholders, and professional employees participating in an audit, review, or attestation engagement of an audit or attest client, including those conducting, concurring or second partner reviews.
and all persons who consult, formally or informally, with others on the audit engagement team during the audit, review, or attestation engagement regarding technical or industry-specific issues, transactions, or events.
(9) (8) Position to influence Chain of command
means all persons who: a) supervise or have direct management responsibility for the audit, including at all successively senior levels through the firm's chief executive, b) evaluate the performance or recommend the compensation of the audit engagement partner, c) provide technical consultation to, quality control or other oversight of the audit, or d) are partners or managerial employees who provide ten or more hours of non-audit services to the client.
having any supervisory, management, quality control, compensation, or other oversight responsibility over either any member of the audit engagement team or over the conduct of the audit. The "chain of command" includes all partners, principals, shareholders, and managers who may review, determine, or influence the performance appraisal or compensation of any member of the audit engagement team and any other person in a position to influence the audit engagement team's decisions during the conduct of the audit, review, or attestation engagement.
(10) (9) Close family members
means a person's spouse, spousal equivalent, parent, dependent, nondependent child, and sibling.
(11) Consumer in the ordinary course of business means a purchaser of routine products or services on the same terms and conditions that are available to the seller's other customers or clients, as long as the purchaser does not resell the product or service or receive a commission or other fee for selling the product or service.
(12) Contingent fee means any fee where payment, or the amount of the fee paid or due, is contingent, in whole or in part, on the result, including the value added, of any transaction or event, other than completion of the work or delivery of the product giving rise to the fee. A fee is not a "contingent fee" if it is fixed by a court or by any federal, state, or local governmental agency.
(13) (10) Covered persons in the firm
means the following partners
, principals, shareholders, and employees of an accounting firm:
(i) The "audit engagement team;"
(ii) Those in a "position to influence" the audit; and
(iii) Any other partner, principal, shareholder, or professional employee of the accounting firm who is, or during the audit client's most recent fiscal year was, involved in providing any professional service to the audit client or an affiliate of the audit client; and
(iv) (iii) Any other partner, principal, or shareholder from an office of the accounting firm in which the lead audit engagement partner primarily practices in connection with the audit.
(14) (11) Group
means when two or more persons act together for the purposes of acquiring, holding, voting, or disposing of securities of a registrant.
(12) Immediate family members
means a person's spouse, spousal equivalent, and dependents.
(13) Investment company complex.
(i) "Investment company complex" includes:
(A) An investment company and its investment adviser or sponsor;
(B) Any entity controlled by, under common control with or controlling the investment adviser or sponsor in paragraph (f)(16)(A) of this section; or
(C) Any investment company or entity that would be an investment company but for the exclusions provided by section 3(c) of the Investment Company Act of 1940 (15 U.S.C. § 80a-3(c)) that has an investment adviser or sponsor included in this definition by either paragraphs (f)(16)(A) or (f)(16)(B) of this section.
(ii) An investment adviser, for purposes of this definition, does not include a sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser.
(iii) Sponsor, for purposes of this definition, is an entity that establishes a unit investment trust.
(17) (14) Office
means a distinct sub-group within an accounting firm, whether distinguished along geographic or practice lines.
(15) Rabbi trust
means an irrevocable trust whose assets are not accessible to the accounting firm until all benefit obligations have been met, but are subject to the claims of creditors in bankruptcy or insolvency.
PART 240 - GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934
3. The authority citation for Part 240 continues to read, in part, as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll(d), 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
4. By amending § 240.14a-101 to add paragraph (e) to Item 9 to read as follows:
§ 240.14a-101 Schedule 14A Information required in proxy statement.
* * * * *
Item 9. Independent public accountants. * * *
* * * *
(1) Disclose (i) the aggregate fees for the audit of the registrant's financial statements for the fiscal year most recently completed, for reviews of the financial statements included in the registrant's Forms 10-Q, and for other services related to registration statements and reports filed with the Commission; and (ii) the aggregate fees for all non-audit services provided during the fiscal year most recently completed. Describe each professional service provided during the most recent fiscal year by the independent public or certified public accountant (as defined in Article 2 of Regulation S-X, 17 CFR 210.2-01) that is the registrant's principal accountant. A service does not have to be disclosed if the fee for that service was, is, or will be less than the lesser of $50,000 or 10 percent of the fee for the audit of the registrant's annual financial statements. Instruction to paragraph (e)(1). Specifically describe each service. Broad general categories such as "tax matters" or "management advisory services" or "management consulting services" are not sufficient.
(2) Indicate whether, before each disclosed professional service was rendered, the audit committee of the board of directors, or if there is no such committee then the board of directors, approved the service and considered the possible effect of the service on the principal accountant's independence.
(3) Disclose the fee for each disclosed professional service.
(4) Disclose the aggregate fee for the audit of the registrant's financial statements for the fiscal year most recently completed and for the reviews of the financial statements included in the registrant's Forms 10-Q (17 CFR 249.308a) or 10-QSB (17 CFR 249.308b) for that fiscal year.
(5) If greater than 50 percent, disclose the percentage of the hours expended on the principal auditor's engagement to audit the registrant's financial statements for the most recent fiscal year that were attributed to work performed by persons other than the principal accountant's full-time, permanent employees.
* * * * *
By the Commission.
Jonathan G. Katz
Dated: June 30, 2000
We have the following comments with respect to specific rules and definitions included in the Release regarding financial and business relationships with audit clients:
Definition of Covered Persons
We support a revised definition of "member" that would require independence only of those in the firm who are necessarily in a position to influence the outcome of an audit. In that regard, we think the notion of "covered persons" is a significant step in the right direction. However, there are two aspects of this definition that we recommend revising.
Partners located in a significant performing office
We do not agree that partners1 located in an office that participates in a significant portion of an audit are in a position to influence the audit. If they are not involved in the audit in any way, they would generally not have this ability. In addition, as a practical matter, the task of tracking significant performing offices is an extremely difficult one. Client dynamics can necessitate a change in the mix of an audit team, often with little or no warning, such that an office that does not participate in an audit today (or does so in an insignificant way) can become a significant participant tomorrow. Thus, the potential for technical violations of the rules would be increased significantly by such a requirement.
As our Proposed Amended Rule reflects, we recommend changing this aspect of the covered person definition to include only partners in an office in which the lead audit engagement partner primarily practices in connection with the audit. This would appropriately focus the independence requirement on those partners who, because of their proximity to the lead audit partner, could have contact with him or her. And, because the lead office is not likely to change frequently, this would make it easier for firms to identify the offices that will require partner independence.
Chain of Command
The definition of "chain of command" needs to be tightened to avoid what we understand from our discussions with the SEC staff would be an unintended result, i.e., the treatment of a majority of audit professionals in a firm (other than first-year staff people) as covered persons. That is because the definition is broadly written to include "all persons having any supervisory, management, quality control, compensation, or other oversight responsibility over either any member of the audit engagement team or over the conduct of the audit." Taken literally, this would mean that if a senior accountant works on twenty different audit clients for twenty different managers and partners, each of the twenty managers and partners would be considered to be in the chain of command of each of the twenty engagements by virtue of having supervisory responsibility for the senior on their respective audit engagements. The result is further compounded by the fact that many engagements have several professionals at each level with supervisory responsibilities from a second-year staff person to the lead audit partner. As a practical matter, changing assignments and other responsibilities will make it impossible for firms and the professionals themselves to keep track of when someone is in the chain of command for any particular audit client. Numerous inadvertent violations would certainly result.
Further, including individuals who review, determine, or influence the performance appraisal or compensation of members of the audit team is unnecessary. Performance appraisals are conducted by individuals on the audit engagement team, so those individuals will automatically be subject to the independence requirements. Administrative personnel who may thereafter become involved in the performance appraisal or compensation setting process cannot influence the outcome of the audit, regardless of their level within the firm. We would not object, however, to including those who evaluate the performance or recommend the compensation of the lead audit engagement partner.
We think the chain of command concept should be designed to capture those who are not on the audit of a particular client but are capable of influencing that audit through their influence over the members of the audit team during and as part of their conduct of that audit. Thus, for example, a partner on the ABC Co. audit should not be viewed as being part of the chain of command for the XYZ Co. audit if his only connection with the XYZ Co. audit is that he utilizes on his job the second-year staff person who was assigned to the XYZ audit. We therefore suggest that the term "chain of command" be replaced with the term "those in a position to influence the audit," which is a more accurate description of who the rule should be designed to capture. The definition of "those in a position to influence the audit" that we would support is included in our Proposed Amended Rule.
Indirect Investments in Audit Clients
An indirect investment in an audit client arises when an investor has an interest in an audit client that it owns indirectly through its investment in an intermediate non-client entity that owns a direct investment in the client. When an investment in a client is indirect, it does not impair independence under existing rules if it is not material to the investor. Presently materiality is measured based on the investor's pro rata share of the direct investment in the client by the non-client entity. This "flow-through" approach to measuring materiality has worked well in practice, but more importantly makes sense because it recognizes that an independence threat will arise as the investor reaps greater financial returns from the indirect investment in the client. As the Release points out in Section II.C.2.(d), ". . . common sense dictates that the more someone - including an auditor - has at stake, the more likely his or her decision is to be affected."
Under the Release, if the investor owns more than 5% of the non-client entity, his or her independence would be considered to be impaired if the non-client entity has any investment (even one share) in an audit client. While it could be argued that the investor in this scenario has a material investment in the non-client entity, it does not follow that the investor has a material (indirect) investment in the audit client in which the non-client entity has directly invested. Indeed, even the non-client entity does not have a material investment in the client. It does not stand, therefore, that a material investment in a non-client entity that itself does not have a material investment in a client means that the investor in the non-client entity has a material (indirect) investment in the client.
Likewise, a co-investment with an audit client in a permissible non-client investee would not create a question about the auditor's independence if the auditor's investment is not material to the auditor. This would be regardless of the auditor's percentage ownership provided it did not control the investee.
In our Proposed Amended Rule, we have set forth guidance that is consistent with the discussion above. Further, we have incorporated a definition of "indirect investment" that is similar to the definition that the Independence Standards Board tentatively agreed to in its project on family relationships and financial interests.
Interests in a Non-Client Related to an Audit Client
Our Proposed Amended Rule captures the guidance in AICPA Interpretation 101-8, Effect on Independence of Financial Interests in Nonclients Having Investor or Investee Relationships With a Member's Client, and Section 602.02.b.iii., Interests in Nonclient Affiliates and Investee Companies, of the SEC's Codification of Financial Reporting Policies. Under that guidance, whether the firm, a covered person, or a covered person's immediate family member can have an investment in a nonclient entity that is related to an audit client depends on a combination of materiality and significant influence. We believe it is important to include this guidance in the final rule to bring clarity to this subject. It is particularly important because it highlights the fact that a restriction on investing in a non-client entity does not by itself mean that independence of that entity is required broadly with respect to non-audit services, employment relationships, etc.
Other Financial Interests in an Audit Client
We believe the Release in this area goes beyond what is necessary to safeguard auditor independence because it would subject all covered persons to a restriction in connection with relationships that arise in the normal course of business (i.e., loans, savings/checking accounts, brokerage accounts, credit cards, and insurance policies). Because such consumer relationships are different than investment relationships, we recommend applying independence restrictions only to the firm, members of the audit engagement team, and members of their immediate family.
For practical reasons, our Proposed Amended Rule would allow firms to have uninsured depository balances with a financial institution audit client. Under current professional standards, this is permissible provided that the uninsured balance is not material to the firm. However, in addition to that safeguard, our Proposed Amended Rule requires the firm to conclude that the likelihood of the institution experiencing financial difficulty is remote.
With regard to the proposed prohibition of buying professional liability insurance from an audit client, our Proposed Amended Rule does not include such a prohibition. The Big 5 firms are insured through globally syndicated policies which are not held by any one insurer but by a number of insurers, many of which are not audit clients. These policies are not individual policies and they are subject to contract terms and interpretation by all insurers in the syndication in a transparent manner. Accordingly, any one insurer's individual participation is unlikely to be large enough to influence the objective and impartial judgment of the auditor or to create an undue dependence on any individual insurer. Further, as a practical matter, reinsurance activities further dilute dependence on any one insurer. Insurers often have significant reinsurance protection which would limit the financial impact of any one claim on a client/insurer and further mitigate the dependence of the firm on a single client/insurer. In addition, the nature of the claims made coverage purchased by the firms is entirely contingent and uncertain with respect to ultimate claim payments. The firm and the client generally have no idea whether claims will be made during the policy period or if made, whether or not a liability would be established or the claim successfully defended. Nor is there any certainty as to the ultimate settlement value and whether it would exceed the firm's deductibles and therefore have any impact upon the insurer. Accordingly, any dependence (however small or large) by the firm on the client/insurer is uncertain and therefore not likely to influence the auditor's objectivity or judgment.
|1||The more detailed explanation of the covered person definition, set forth in Section I of the proposal, indicates that the definition extends to all professional employees located in a significant performing office. We understand that this more inclusive definition is erroneous and that, as the proposed rule itself provides, only the partners in the significant performing office would be covered.|