Testimony of Philip A. Laskawy, Chairman
Ernst & Young LLP
Before the U.S. Securities and Exchange Commission
on the SEC's Proposed Auditor Independence Rule
September 20, 2000
Mr. Chairman, Commissioners, and Staff of the Securities and Exchange Commission:
My name is Philip A. Laskawy. I am the Chairman of Ernst & Young LLP. I want to thank you for inviting me to appear before you today on this vitally important rule proposal.
As you know, Ernst & Young is one of the "Big Five" accounting firms in the United States. We have more than 23,000 partners and employees in the United States. And, increasingly, we are a globally integrated firm, with members of Ernst & Young International having offices in 689 cities around the world.
Integrity and independence are, of course, the cornerstones of the accounting profession. The SEC's independence rule release discusses this fact at some length, and also discusses the unique and important role that the accounting profession plays in the nation's securities markets. Ernst & Young understands that role. We acknowledge that we have a unique relationship to public investors, who rely on us as vital "gatekeepers" to the public securities markets and count on us to perform our audits well and effectively.
There is another relationship - another unique relationship - that was not discussed in the SEC's Release, and it also warrants a few words. It is the relationship between the accounting profession and the Commission. Unlike broker-dealers, investment advisers, investment companies, stock exchanges, or other central players in the capital markets, accounting firms are not entities over which the Commission has direct regulatory powers. But, in my view, we work more closely with the Commission and the SEC Staff in the development and application of rules and principles that are essential to the integrity of our nation's financial markets than does any other sector of the economy. We do so through the FASB and other self-regulatory activities; through meetings with the Staff to discuss difficult or unusual accounting issues; through countless interchanges during the SEC Staff's review of our clients' SEC filings; and through many other channels, both formal and informal.
This public-private sector relationship has had occasional rocky moments, but I believe it has worked very well for more than half a century. And it has worked well for one specific reason: our primary goal, and the Commission's primary goal, is exactly the same. Like the Commission, we want to make sure that our client's financial statements are as accurate as possible in accordance with generally accepted accounting principles. And we want public investors to be completely certain of the integrity and independence of the accountants who audit those financial statements. Thus, the appearance of independence is perhaps as important as is actual independence.
In this regard, we have supported the SEC proposal on enhancing the Public Oversight Board. I believe that it is in the public's and the profession's best interest to have independent oversight of the profession. For the same reason, I also support having a majority of public members on the Independence Standards Board.
Both of these relationships - the one we have with the investing public, and the one that we traditionally have had with the Commission - were the principal reasons for my firm's decision last May to express support for the concept of an SEC independence rule. I have grown increasingly concerned during the past several years that the heightened scrutiny of auditor independence has had a negative impact in the marketplace. Increasingly audit clients are troubled by the uncertainty surrounding the independence rules, and questioning and denying our ability to offer a range of services that the SEC would agree do not present independence concerns. I have, in other words, been concerned that the appearance that auditors lacked independence could undermine our relationship with the investing public. And I was also hopeful that a rule could help us restore some civility to the relationship between the profession and the SEC.
It is unfortunate that the Commission's attempt to promulgate an independence rule has actually led to less civility and has increased the tension between the profession and the Commission. I do not agree with the approach taken by others in the profession, including the American Institute of Certified Public Accountants, in making harsh attacks against the Commission and in trying to stonewall the Commission's efforts. In fact, I am quite troubled that the AICPA, which has an obligation to represent all of its members, would "take sides" in a fashion that can only weaken public confidence in the accounting profession. I have always believed that the profession can and should work to reach a reasonable resolution with the Commission, one that would best serve the public interest.
Thus, although I too have concerns about certain aspects of the Commission's rule proposal, and I have stated those concerns publicly, we decided several weeks ago to meet with the Commission Staff to discuss these matters. Together with representatives from PricewaterhouseCoopers, we have conveyed to the Staff our conception of a rule that best furthers the public interest. The issues in this rulemaking will affect millions of investors, tens of thousands of professional careers, and thousands of public companies. And they are very complicated issues. Accordingly, we wanted to make sure that the Staff had a chance to listen carefully to our concerns. My colleagues and I at Ernst & Young have been greatly impressed by the dedication and time commitment the Staff has displayed throughout the comment period and have been particularly impressed at how seriously the Staff has taken its commitment to the protection of public investors. And the Staff's receptiveness to our concerns is an example of precisely what I just discussed - the positive and productive relationship that has traditionally existed between members of the accounting profession and the Commission.
In conveying our comments, we have told the Staff that, in our view, an independence rule could accomplish three important objectives. First, a rule might address an issue that has long needed attention - the financial relationship and investment restrictions governing the profession and audit clients. In many respects, the current rules are both outdated and irrational. This is particularly true with respect to spousal employment and restrictions on the participation by spouses in employee stock compensation programs.
Second, a rule might clarify what is, and what is not, allowed with respect to non-audit services for SEC attest clients. In that regard, a rule might properly address the two activities that obviously have raised the most public concern, namely information systems consulting and internal audit outsourcing.
Third, a rule could clarify certain relationships and affiliations that an audit firm can have. Increasingly, partnerships, joint ventures, minority investments, cross-licensing, customer alliances, and other cooperative arrangements are key requirements for our clients' existence in the global marketplace. And it is important that we, too, be able to have such relationships, not, of course, with audit clients, but with entities that are not audit clients.
After discussing these matters with the Staff, we and PwC have developed our own proposed independence rule. We have given an initial copy to the Staff, which I understand has been placed in the public record, and we will attach a final version to our comment letter. We ask the Commission to consider our proposal carefully and ultimately to adopt our proposed modifications to the final rule. Our approach would address most of the issues that were raised in the Commission's rule proposal but, at the same time, it would protect our ability to serve the needs of our audit clients in a fast-changing and global market place.
I want to discuss two aspects of the proposal that have been at the heart of the independence controversy and have received the most attention during the Commission's recent public hearings, namely, information systems consulting and internal audit outsourcing. Our proposal would restrict the provision of both of these services to audit clients.
First, information systems, or management, consulting. We recently sold our practice in this area. We did so for a variety of reasons, but one reason certainly was that, although we did not believe independence was actually impaired by this service, we could understand that, particularly with the large fees that sometimes were involved, an appearance problem could be present. I might note that now that we have sold this practice, we have not discovered that we are somehow enfeebled, unable to perform effective audits or to maintain a top-notch audit and tax practice. In fact, we have found the opposite to be true: without a large consulting practice to manage, we are now more targeted and more focused on our core audit and tax business. And our audit and tax partners feel as though they, and not the management consultants, are in the driver's seat at the firm. Moreover, from our clients' perspective, there actually may be an advantage in not having such a practice. We have had a greater string of "wins" in obtaining new audit clients since we sold our management consulting practice than we have had at any time in recent history - four new Fortune 500 clients, including two Fortune 50 companies, just within the last six months.
Second, internal audit outsourcing. I personally believe that such work can actually improve the quality and efficiency of the audit, and that independence is not affected. In fact, not that long ago most companies did not have internal audit departments and the audit firm performed more extensive audit procedures. However, I accept the fact that, in the eyes of some, full-scope internal audit outsourcing raises an appearance problem. I think it would be a mistake, however, for the Commission to prohibit all outsourcing, including smaller-scale activities that have been performed for many years without raising an independence issue. Providing outsourcing services in specific areas or locations, such as computer auditing or work at a company's foreign operation, should not be prohibited. And these less far-reaching activities clearly can improve the quality of the client's financial statements.
I also believe that if the SEC promulgates any proxy disclosure rule, it should be essentially the same as the rule that has been in effect in the United Kingdom since 1991, that is, a rule that discloses the total fees for audit services and total fees for non-audit services. This would mean that companies would make a general disclosure about non-audit services, but the specific independence-related aspects of any such services would be examined through the communications that are now required between auditors and the audit committee. We should give these new audit committee rules a chance to work.
These issues, and many others, are addressed in our suggested modification to the SEC's proposal. I sincerely hope that, for the good of both the investing public and the profession, the Commission will adopt our proposal so that we can ensure public confidence in the accounting profession and also put these contentious issues behind us.
Thank you very much. I would be pleased to answer any questions you might have.