September 13, 2000
Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549-0609
Re: SEC File No. S7-13-00
This letter presents the comments of the Texas State Board of Public Accountancy (the Texas Board) on the Securities and Exchange Commission's (Commission) proposed rule amendments regarding auditor independence, File No. S7-13-00. The Texas Board thanks the Commission for the opportunity to comment on these rules.
The Texas Board is composed of fifteen individuals appointed by the Governor of the State of Texas to administer the Public Accountancy Act, Chapter 901 Tex.Occ.Code (Vernon's 2000). This letter presents only the comments of the Texas Board. Individual members of the Texas Board may have different or additional opinions.
The Texas Board has endeavored to consider all of this complex proposal's ramifications within in the time allowed. However, the Texas Board cautions that it may not have been able to assimilate the significance of all aspects of the proposal in the time permitted. The failure of the Board to comment on any part of the proposed rule should not be taken to mean that the Board does not have an opinion or that individual members of the Board do not have opinions.
Rule 2-01(b)(1-4): Four principles
Rule 2-01(b)(1-4)'s articulation in simple terms of the four principles that underlie the Commission's analysis of the situations that compromise independence is admirable. However, these principles, while firmly rooted in the auditing standards, are not stated with sufficient clarity to provide effective guidance in a rule that proscribes conduct in an evolving field. As a result the principles generate uncertainty, and will not permit the Commission or the profession to draw the distinctions crucial to effective compliance and enforcement.
For example, the principles prohibit acting as an advocate, a ban effectively mirrored by the rule's proscription of any service for which a law license is required in 2-01(c)(4)(I). However, CPAs have traditionally served the public in tax matters and
indeed their expertise in this area makes it the leading reason most of the public relies on the profession. In recognition of their expertise, CPAs are admitted to practice in the United States Tax Court. Although the preamble to the rule states in several places that the Commission does not intend to prohibit tax representation, the rule's ban on simple "advocacy" appears to do just that. Although the Commission also states that its does not intend to prevent an auditor from defending its work on an audit, the language in the rule seems to do so.
In addition, all auditors would agree in general with the statement that an auditor should not "review his own work" (a concept one of our committee members described as "Biblical"). However, this plain statement inadequately describes the complex interaction between auditor and client. Auditors often identify corrective journal entries, and where management understands and accepts the auditor's suggested changes, the audit process often results in better financial statements. Often, auditors assist in drafting footnotes to the financial statements of reputable sophisticated clients. This practice is especially common in dealing with newly issued comprehensive pronouncements. Some auditors compile the financial statements. With the consent of knowledgeable responsible management, this drafting means the public is presented with more sound and accurate financial data. In these instances, the Commission's draft principle, especially when read in light of proposed Rule 2-01(c)(4)(i)(A), could unnecessarily prohibit this constructive function.
Therefore the Texas Board suggests that the principles be reworded to include a more accurate description of the complicated concepts they address. Specifically:
We recommend that these principles be removed from the rule and presented in a separate guidance document or preamble. This reorganization would leave the Commission with a stronger rule. The first sentence of subsection (b) of the proposed rule identifies the act prohibited by the rule -- the incapacity of the auditor to exercise objective and impartial judgment. A reviewing court might construe the statement of the principles in the rule as limiting this general standard to only matters specifically within the principles. Presenting expanded statements of the principles in a guidance document would allow the Commission to pursue any incapacity of the auditor's exercise of objective and impartial judgment, not just those within the four principles. The guidance document could also contain specific examples of permissible and impermissible conduct. This form of guidance is well established in the profession and presenting the rule in this fashion would make it easier to understand and follow.
Rule 2-01(f)(13) and (c)(1): "Covered Persons" within the context of Financial Interests
After much discussion, the Texas Board reached consensus on the following points:
Implementation of the rules will present challenges.
Rule 2-01(f)(4): Affiliate of the Accounting Firm
The Texas Board is extremely concerned that the definition of "affiliate of the accounting firm" is dramatically over-inclusive. As a result of the overbreadth of the definition and the use of the term within the rule, the rule itself becomes vague and unintelligible.
For example, the co-branding definition, Rule 2-01(f)(4)(E), includes a number of cooperative ventures that pose no threat to auditor independence and allow smaller CPA firms to pool expertise. Indeed, this definition is so broadly worded that a CPA firm would have to remove the AICPA designation from its letterhead or risk compromising its independence. It also seems inconsistent that joint ventures that do not offer professional services would have to meet the definition of independence under Rule 2-01(f)(4)(C). Therefore, if a CPA firm joined with other business tenants to own an office building, all the partners in the real estate venture would have to be "independent" no matter what business they were in. The leased personnel definition, 2-01(f)(4)(F), is also over inclusive. As written, it suggests that when a mid sized firm turns to an employment agency for assistance in staffing the majority of a large audit assignment, the employment agency must be independent from the audit client.
In part because this definition is stacked into the definition first of "accounting firm" and then of "accountant," the rule becomes almost incomprehensibly complex. For example, smaller firms may cooperate, under either lease or de facto joint venture arrangements, in the audit of a single company. Does this arrangement mean that each firm takes on the independence obligations of the other firm with respect to all of the other firm's clients-even those audit clients for whom there was no sharing of work, profits or reputation?
It certainly is true that some of the traditional structures of business relationships in the profession have changed and that these changes pose complicated problems. The solutions to those problems should not stifle creative resource allocation for practitioners struggling to compete in an increasingly concentrated market. Nor should those solutions limit constructive networking opportunities for all accountants. If the Commission is concerned with subsidiary consulting services that are partially publicly held, it should draft a rule to address that specific issue.
Rule 2-01(c)(4): Ban on Non-Audit Services
First, in response to the Commission's request for comments on this alternative, the Texas Board found no reason to support a complete ban on all non-audit services. The expertise developed in consulting services adds value and insight to the auditing function. The symbiotic relationship between the knowledge the consultant offers and the precision of the auditor results in better audits and stronger financial statements.
Second, the Texas Board believes the services banned in the proposed rule may be described in unnecessarily broad terms. Specifically, as explained in our discussion of the four principles, Rule 2-01(c)(4)(i)(A) prohibits much of the constructive corrective work that an independent auditor can bring to the client's financial statements. This limitation should be redrafted to permit this exchange where the client competently accepts responsibility for the corrected statements. The ban on designing compensation packages in Rule 2-01(c)(4)(G) seems unrelated to any independence issue. This kind of work is also not proscribed by current rules. See SECPS Section 1000.35(Prohibits acting as a negotiator for compensation packages). Subsection J's proscription of expert services impinges on traditional tax representation that may not threaten independence.
In general, except as we have specifically stated, the Texas Board believes that the Commission's current rules in this area may be adequate. The claimed expansion of the Commission's rules in the areas of information systems services and internal audit services do not seem necessary to protect independence. While a codification of the rules may be helpful, the Commission should state plainly that it intends only to codify and not to change or expand.
The Texas Board offers these additional comments:
The Texas Board believes that a more rigorous system of peer review would do more to increase auditor independence than any SEC rule. SECPS Peer Review should be expanded to include more effective testing of independence and specific findings on failures should be accompanied by suggestions for improvement.
Amendment of Rule 240.14a-101: Disclosure of fees and services
In general, the Texas Board supports an obligation to disclose the audit fee and the aggregate fees paid to the accounting firm for non-audit services. The remaining details in the proposal seem to contribute to information overload without providing significantly useful data. Further, in this area the Commission can rely on the strength of audit committee requirements and responsibilities to protect the public.
The Commission's proposed rule is complex and sweeping. The Texas Board believes that many members of the profession and of its regulatory bodies may even now be struggling to grasp the implications of the proposal. The Commission will achieve more compliance if the regulated population has a meaningful opportunity to understand and participate in the development of the rule. The Commission should consider that its comment period is inadequate and should provide a second round of draft proposals and comments to achieve its goal.
This letter is the Texas Board's comments on the Commission's interpretation of requirements under the Securities and Exchange Act of 1934. The Texas Board presents these comments for the sole purpose of providing input to a federal agency on an issue of importance to the public and the accounting profession. The Texas Board maintains its own rules concerning independence requirements for audits performed by its licensees. These comments do not constitute an interpretation of, guidance concerning, or proposed changes to the Texas Board's rules. These comments are not rulemaking within the meaning of the Texas Administrative Procedure Act, Chapter 2001, Subchapter B, Govt. Code (Vernon's 2000). These comments are not binding on the Texas Board. These comments shall not have any affect on any issue presented to the Board within its jurisdiction, including but not limited to, rulemaking, Board opinions, enforcement actions or contested cases arising under the Texas Public Accountancy Act.
Very truly yours;
K. Michael Conaway CPA
Texas State Board of Public Accountancy
cc. Texas Board Members:
Billy M. Atkinson CPA
Jerry A. Davis CPA
April L. Eyeington CPA
Edwardo B. Franco
Gwen B. Gilbert CPA
Rebecca B. Junker CPA
Robert C. Mann CPA
Jimmie L. Mason CPA
Reagan S. McCoy
Janet F. Parnell
Edward L. Summers PhD., CPA
Barbara J. Thomas CPA
dd. Texas Board Rules Committee Members:
Robert R. Arms CPA
Wanda R. Lorenz CPA
Gary D. McIntosh CPA