Before the

SEPTEMBER 13, 2000


Thank you to Chairman Levitt and the Commissioners for this opportunity to participate in today's hearings on the Securities and Exchange Commission's proposal to revise the rules of auditor independence.

I support your efforts toward strengthening our profession.

I speak to you today, as a CPA who has spent nearly six busy seasons auditing while employed by a Big 5 audit firm in New York. In my statement today, I feel that I represent the auditor in the field.

I have a family background in auditing as well. My grandfather passed the first CPA exam given in the United States in 1916 and later began his own auditing firm here in New York City. My father, after fighting for our country in WWII, joined my grandfathers' firm and worked as an auditor for five years before eventually starting a brokerage firm owning seats on the NY and American Stock Exchanges.

Both of them taught me never to invest in an entity's stocks without a careful reading of its audited financial statements. As a CPA, I believe, like my father and grandfather, in the independent and impartial audit. As an investor, I rely on auditor independence.

Defining Independence in Appearance

The AICPA Codification of Statements on Auditing Standards, in its section on Independence, cements a cornerstone of our profession when it states:

"It is of utmost importance to the profession that the general public maintain confidence in the independence of independent auditors. Public confidence would be impaired by evidence that independence was actually lacking, and it might also be impaired by the existence of circumstances which reasonable people might believe likely to influence independence."

It goes on to say that the public would be unlikely to accept the independence of an auditor who would in effect be auditing areas, which she or he had a part in making, even though the auditor might be intellectually honest.

It states:

"Independent auditors should not only be independent in fact; they should avoid situations that may lead outsiders to doubt their independence."

Why Would Someone Think the Auditor is Not Independent in Appearance?

Opponents of this proposal that requires audit independent say there is no empirical evidence pointing to a conflict. In fact, from the inside of the audit, I have never seen empirical evidence pointing to a conflict. But here, as far as empirical evidence is concerned, none is really needed for a problem to exist. The problem is the potential of a conflict. The problem is over independence in appearance.

When an audit partner allows staff to prepare and then audit financials, it may lead outsiders to doubt independence. That conflict in appearance is all that is necessary to hurt the integrity of the profession.

Let's say that a national rule is set that all high school juniors can now grade their own board scores for college admission. The students with the highest scores go to our nation's best schools. Would you trust this system? If most children wound up with high board scores, would you question the scores, even a little? Well this is analogous to what is now happening with the audits of our public firms.

If an auditor participates in putting together the financial statements, or helps with the computer system that puts the financials together, and then gives herself or himself a perfect grade on doing it, would you always trust that grade? Investors trust the grade, because investors don't fully understand that this is happening. But the Commission understands it and would like it stopped. And I applaud their integrity.

Having audit firms also be consulting firms is a problem. If I'm hired to make profits go up, will I then report that profits go down? Should I be trusted to? Whether I'm honest of not, here is the appearance problem again.

Do investors really want their financial statements audited by their company's consultants? I think this work hurts the appearance of auditor independence.

Who Would Oppose Auditor Independence in Appearance?

As this proposal states, there have been significant developments since the 1983 independence amendments, the most important being the large amount of revenues derived at audit firms from consulting practices. Consulting fees in 1983 were 10% of revenue. They are now 50% of revenue.

I have studied the writings critical of the proposed revision. It comes as no surprise that most of this protest comes from those who have sought the largest monetary rewards in the expansion of the auditing industry's consulting practices. They say that they won't invest in their clients' stocks, but ask the Commission to not take away their large fees for doing extra loan staff and consulting business with the client.

They claim that this extra work educates the auditor and improves her or his skills.

The critics feel that current audits are strengthened due to business information their audit teams pick up while conducting non-audit financial work for the same client. My questions are, (1) do the audits need to be strengthened, and if so (2) isn't there a better way to accomplish this without raising a conflict?

Monetarily, the Big 5 benefits from the expansion of their practice into lucrative consulting areas. Incoming auditors are steered toward offering so-called "value added" work to their clients. Should auditors be positioning themselves to help their clients in this way? Isn't this in conflict with their true task?

An Auditors' Motivation

The primary motivation of an auditor should be to insure that the financial statements that the client prepared are materially correct. Their motivation should not be to offer extra services to their client no matter how lucrative.

Auditors must approach each audit with professional skepticism. Unfortunately, an over involvement in the client business contributes to the auditor's professional skepticism of the entire audit process.

I can't tell you how many times I have privately sat down with Big 5 auditors who complained to me. They would tell me that their audits added no value to their client. I have often heard the audit labeled a necessary evil, and audit firms labeled sticker shops. I have often heard auditors wishing they could sell "value added" loan staff and consulting services to their clients.

The fact is that during my nearly six years of audit experience, I never came across an auditor who told me that her or his motivation was to protect investors. I kept hearing that we were a sticker shop, the client hated us, and again that we added no value.

I feel that the Securities and Exchange Commission's proposal to revise the rules of auditor independence will bring a renewed focus on our audit work, helping remind auditors of their true role in the financial community.

Who is the Real Audit Client?

Auditors wish to serve their clients.

But who is the real client of the auditor?

Is the client the entity being audited or the investing public?

Auditors define "audit client" as the entity whose financial statements or other information is being audited, reviewed, or attested.

Contrary to this definition, Webster's dictionary defines client as "a person or company in its relationship to a lawyer or accountant engaged to act in its behalf."

Let me repeat that, because it is important to remember. Let me repeat that because it needs to be heard by our profession.

The client is a person in her or his relationship to an accountant engaged to act in its behalf.

Here, is not the auditor hired to act in behalf of the investor?

Clearly, here, wouldn't the audit client actually be the investing public? Isn't the public the real audit client?

Shouldn't auditors serve their true client, the public?

And doesn't the public want audit independence?

I think they do.

The S.E.C.'s position is that the auditor "owes ultimate allegiance to the corporation's creditors and stockholders, as well as to the investing public."

I feel that if you disagree with this position, you simply should not be auditing.

The investing public is the real audit client. The investing public, as the real audit client wishes the auditor to act in their behalf, in rendering an opinion on the accuracy of an entity's financial statements. The investing public places their trust in this relationship. This trust requires auditor independence in fact and appearance. If the auditor acts in behalf of the investor and then takes a loan staff or consulting job acting in behalf of the company, the auditor is hurting its relationship with the investing public. This would be akin to a lawyer defending both the plaintiff and defendant. If an auditor takes loan staff or consulting work with an audit client, the auditor is sacrificing independence.

Who Hires the Auditor?

Let's say you disagree with the concept of acting in behalf of the investor. Let's say that, as an auditor, you feel that you owe your allegiance to the people who hired you. When money is received by an audit firm, the auditors may not be clear who has hired them. I'm not sure auditors know that investors in public firms hire the audit firm. The choice is typically the second item on the investor's annual proxy card.

Auditors should be more responsible to their investors by purely seeking to judge the reliability of the financials. This is what they have been hired to do. This is what the Securities and Exchange Commission's proposal to revise the rules of auditor independence seeks to do.

I believe that the passing of this proposal will provide steps for investor reliance. I praise Chairman Levitt and the Commissioners for their proposal. This proposal will greatly benefit the true audit client, the public.

Conclusion: Motivating Auditors

I recall fondly, sitting in the basement of a very large audit client at 1 o' clock in the morning on a Sunday. The bleary eyes of my staff were looking up at me, hoping for some sort of motivation through the remaining weeks of our audit.

Things got bad when, earlier, on Friday, the client had come downstairs to visit us, before he left for the weekend. He knew we were working the weekend as usual and had to say a few words to us before he went home. He began by asking us why in the world anyone would want to become an auditor. He said it was a useless profession. He reminded us of how we had no lives. He called us nerds. He reminded us of how little money we made. He told us that we did nothing to improve the world of business. He told us to go home. But we could not. If we went home, we would be fired.

Thirty-one hours later, my staff looked up at me, like actors asking "O.K., Tom, what's our motivation." My staff asked me to give a motivational speech. They wanted to hear my speech.

For years, everyone knew me at my auditing firm as the guy who gave the speech. In the middle of a class when I was teaching a new audit computer program, half of my class made me stop teaching and asked me for the speech.

I think this would be a good time for all of you to hear the speech. Here it is:

You know, you can take a walk outside, during lunch, and look at all of the beautiful buildings around, or grab a newspaper and read about the goings-on at huge corporations. But do you know who has paid for all of these buildings and all of these companies? Do you think the King and Queen of America own them? Guess what? We are in a free economy. The money that goes into America comes from investors; many who are just like you, and your moms and dads. Even if there's a big shot who has his name on the company, you'll find 9 times out of 10 that most of his money came from a lending institution with your money in it. Or it came from the issuance of stock, stock that you or your parents may be invested in. And what are these large institutions doing with your money?

Are people taking your money and buying themselves cars and jewelry with it? Are the people taking your money and pretending to make money with it?

Who is looking over what these entities are doing with the life savings of Americans? America works so hard, day and night, just to put away savings for a rainy day. Who is tracking that money?

The auditor is. You are.

You have gone through hell in business school.

While everyone else was partying, you were studying. You had to get straight As in the driest, most difficult business courses. Then you had to pass one of the most difficult exams given in the U.S. to get your CPA.

You did it. You are here for a reason. You are some of the brightest minds in America.

You're now a CPA.

Do you know for whom you are working so hard? Is it simply for the person who comes to visit you on his way home to tell you that you are adding no value? I don't think so. He is the person we call the client.

The people you are working for is the parent who squirrels away a meager savings into a bank account that is lent out. The person you are working for is the person who buys a few shares of stock after reading the financials. It's the investor and creditor.

You are giving your all to protect the American public. You are the numbers cops. You do not work for the client. The client may not even want you here, as you've noticed. You are also not here to help the client. You are here to help the public.

That was my typical speech.

I have always told this to auditors. I now tell it to the public for whom I have worked so many years. Fundamentally, as the AICPA states, we must prove ourselves independent from our clients. This, more than anything else, will preserve the integrity of the profession.

There is no better way to do this, and there is no better way to strengthen the audit profession, than to support this proposal.

I urge all of my fellow CPAs to fight for its passing. It is honorable to stand up for what is right, however unpopular it seems.