820 N. Michigan Ave.
Chicago, IL 60611
September 25, 2000
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549-0609
RE: Proposed Rule S7-13-00
Dear Mr. Katz:
I am an academic teaching auditing, but one who keeps close ties to the business world in the Chicago area. In reading the exposure draft on auditor independence requirements, I have become convinced that an auditor, in attempting to perform an audit in accordance with GAAS, will soon be deemed non-independent under the new guidelines. The areas that seem to be connected with this are the specific non-audit service prohibitions of valuation services and actuarial services.
In auditing accounting estimates, one of the accepted methods to judge the reasonableness of client-generated estimates in the financial statements is to create a separate estimate to which the client's estimate will be compared. A simple example involves the allowance for uncollectible accounts. The auditor might generate an estimate and decide that the client's estimate is too far off to be considered fair. The auditor would try to convince the client to adopt the auditor-generated estimate for the financial statements. If the client does, an auditor-generated estimate is now embodied in the client's financial statements. Under the proposed guidelines, it would seem that the auditor has provided valuation services for the client, and would not be independent. The same issue would arise in many other accounts, such as pension plan liabilities and in trying to apply the provisions of FASB 121 on impairment in value of long-lived assets. The auditor would again be providing either actuarial services or valuation services.
On a broader scope, I would ask the SEC to seriously consider doing research on the "reasonable investor" who is used as the measuring stick for independence judgments. We unfortunately have little empirical research to know the characteristics of this ideal person or how this person makes independence decisions. Without this knowledge, there is a real risk that independence rules may not protect the interests and indeed may hurt the interests of the very population that the SEC is mandated to protect.
I applaud the SEC's changes in the independence rules concerning financial relationships and employment relationships. While I may not agree with each detail, I do concur with the direction of these changes.
I would ask the SEC to slow down and more carefully consider the new rules concerning non-audit services. Otherwise, more harm than good may result.
Thank you for this opportunity to respond.
Very truly yours,
Assistant professor of Accounting
Loyola University Chicago