Johnson & Johnson

Johnson & Johnson
One Johnson & Johnson Plaza
New Brunswick, NJ 08933
(732) 524-2076

Clarence E. Lockett
Vice President
Corporate Controller

September 13, 2000

Mr. Chairman and Commissioners, I am Clarence Lockett, Vice-President, Corporate Controller of Johnson & Johnson and I am pleased and honored to be here to express the views of Johnson & Johnson on the subject of `Auditor Independence Requirements'.

By way of background, as the Corporate Controller of a Registrant (which is also a component of the Dow Jones index) I have numerous interactions with our public accountants and with the accounting and auditing profession in general. I have also been the General Auditor for Johnson & Johnson and have served on the executive committee of the Institute of Internal Auditors.

We believe that the auditor independence requirements need to be amended and modernized. There have been significant developments in the marketplace and in the way that accounting firms are organized, as well as in the services they provide, that warrant such change:

We do believe, however, that the accounting profession should set the rules for independence. Congress has entrusted the accounting profession with the responsibility of auditing the financial statements of companies registered with the SEC. You have indicated that you look to the Independence Standards Board (ISB) to provide leadership in improving auditor independence and in establishing and maintaining a body of independence standards applicable to auditors of public companies. We agree with that position and believe the ISB should set such rules.

Investor confidence in financial statements of public corporations is key. Management of public corporations is responsible for the accuracy and the quality of the financial statements. The independent auditors provide the public with the assurance that these financial statements can be relied upon. It is therefore imperative that the auditors are truly independent from those that issue financial statements, and that the public perceives them as such.

We do not believe the concept of independence needs to be redefined. That concept is rooted in the notion of objectivity. That still holds true. However, the criteria and rules that need to be in place in order to ensure that objectivity remains the cornerstone and that independence is indeed effective, need to be modernized to keep pace with the developments that we have previously described.

The general standard for auditor independence sets forth the basic test of an auditor's independence. Under that test..."we will not recognize as independent an accountant who, with respect to an audit client, 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 auditor's engagement. An auditor must be independent in fact and appearance".

We agree with the proposed general standard for auditor independence and the four governing principles for determining when an auditor is not independent. However, we do believe the four governing principles are guiding principles rather than rules. They should be part of the framework. For example: we believe we would all agree that high quality and transparent financial information is in the interest of corporations as well as their auditors. This could be described as a `mutual interest'. If the first principle (`no mutual or conflicting interest') is to be read as a rule, one could argue that the example is an undesirable or prohibited situation. We believe it is not. Therefore, we believe the four principles should be part of the framework, rather than of the rules.

Please also consider the following observations:

1. Financial and employee relationships

The proposed rule states that an accountant is not independent if the accountant has a direct or (certain) indirect financial interest in or an employment relationship with the audit client. These interests and relationships also extend to certain relatives of the accountant.

We believe the financial interest rule should apply to any member of the accounting firm who is part of the `chain of engagement', which would include the whole engagement team, as well as those in national offices or those rendering specific ad hoc advice to the client, whether related or unrelated to the specific audit engagement. As far as employee relationships are concerned, we suggest you consider the concept of `key positions' as the determining factor. Functions such as Vice President of Human Resources or Vice President of Quality Assurance can make key decisions that can have a significant business and financial impact.

2. Non audit services

The proposed rule lists services that would raise independence concerns if provided by the accounting firm to the audit client. We believe that, given the complexity of financial and business systems, knowledgeable individuals are required to consult on them. Accountants and auditors certainly have such knowledge, and, coupled with the knowledge they have on the specifics of their client, they are a powerful source of business advice.

We do not believe that auditors should be prohibited from rendering other services to their clients. We believe it is in the economic interest of the investors that services be rendered by those who are most qualified to do so. Accountants and auditors are in a unique position to give sound business advice to their clients. However, the nature of those activities should not be such that it could lead to impairment of objectivity. For example, auditors should certainly not audit their own work.

We believe that a sound system of internal control, oversight by the audit committee and proper disclosure are a key in monitoring independence. For example, at Johnson & Johnson, purchasing of services is independent of audit relationships. Competitive bidding is used and has lead to the selection of service providers other than our independent accountants. All fees and services are reviewed with the Audit Committee. We believe this represents an adequate framework of ensuring we obtain the best services for the best price, while monitoring auditor independence.

Please note that one of the proposed excluded activities deals with `financial information systems'. We would like to point out that corporations are more and more using integrated business systems, of which the financial systems represent a module. Also, there is a need to ensure that proper controls are built into all systems. The prohibition of auditors to consult on `financial information systems' may therefore imply that consulting on any part of such integrated business systems will no longer be allowed or that consulting on controls over these systems would be prohibited. We suggest you consider this situation and ensure that any proposed restriction is not so broad as to preclude corporations from taking advantage of the expertise of their audit firm.

On the topic of outsourcing of internal auditing, we believe that, at times, there is a need to use outside services for highly specialized areas, or unique international situations. The logical choice for this type of activity is often our independent auditors, since they understand our business, policies and concerns. The ability to draw in their resources enhances the control environment. We also believe that broader outsourcing activities in the internal auditing area should not be prohibited since, in many cases, they can improve the total audit process. We do not believe such outsourcing should be prohibited when conducted under the supervision of the corporation's management.

3. Proxy disclosure requirement

The proposed rule will reinstate a proxy disclosure requirement, which would require companies to (a) describe specifically each professional service provided by its auditor, and (b) indicate whether the company's audit committee approved the service and considered the effect that the provision of each disclosed service could have on the auditor's independence. This would apply to fees of less than $ 50,000 or 10% of the audit fee, whichever is lower.

Disclosure requirements on auditor independence have already been adopted based in large measure on recommendations made by the Blue Ribbon Committee. We believe these requirements are adequate and sufficient, but would support an additional reasonable proxy disclosure requirement. We believe the proposed new rule is too specific and will not add to transparency of information. Multinational corporations, like Johnson & Johnson, manage numerous affiliates around the world. It would not be beneficial to describe specifically all activities in the proxy statement. A limited overview should suffice. Similarly, our audit committee monitors audit independence on an ongoing basis, but should not be required to approve each non-audit service rendered by our auditors. Summary information for monitoring purposes should suffice.

Thank you again for inviting me. I will be pleased to answer any questions you may have.

Clarence Lockett

Clarence Lockett
Vice President, Corporate Controller