Testimony of Robert L. Ryan
Chief Financial Officer of Medtronic, Inc
Concerning Auditor Independence Requirements

Securities and Exchange Commission
Comment File No. S7-13-00

Public Hearing
Washington, D.C.
September 20, 2000


I am Robert L. Ryan, Chief Financial Officer of Medtronic, Inc., the world's leading medical technology company headquartered in Minneapolis, Minnesota. I appreciate the opportunity to participate in today's hearing on the revision of the Commission's auditor independence requirements. I have six points I would like to discuss related to the proposed rule changes. As you will see, we agree with the Commission's objectives but would realize them in a different manner than has been proposed.

1. Employment Relationships with Audit Clients

Our first point relates to the proposed rule change related to employment relationships with audit clients. The Commission is modernizing the independence rules, a very appropriate term, to recognize the changes in the business world and our society without sacrificing independence. The Commission uses the term "Covered Persons" to identify those that can influence the outcome of an audit, and imposes the greatest restrictions on those people and their family members. The proposed changes to the employment restrictions effectively address the dynamics in the marketplace resulting from the increase in dual income families and in our opinion, provide a reasonable and practical solution to the issue at hand. We fully support these proposed changes.

2. Financial Relationships with Audit Clients

The second point relates to financial relationships with audit clients. Determining appropriate criteria to identify financial relationships, which impair independence, is judgmental. The rules need to be reasonable and practical and yet assure independence is not impaired. The old rules were too complex and restrictive, and nearly impossible to monitor and enforce. By using the "Covered Persons" approach, the proposed rules should minimize bureaucracy, and should be easier to monitor and enforce. We commend the Commission for providing a practical solution to a complex issue.

3. Four Guiding Principles to Measure Auditor Independence

Our third point relates to the four principles by which to measure an auditor's independence outlined in the Commission's rule changes. We concur that an auditor is not independent if he or she has a mutual or conflicting interest with the client, or audits his or her own work, or functions as management or an employee of the client, or acts as advocate of the audit client. We are in complete agreement with these four guiding principles.

4. Application of Four Guiding Principles

The application of these four principles is our fourth discussion point. The Commission has specifically added financial information system design and implementation and internal audit outsourcing to the list of services considered to impair independence. As each situation is unique, we contend that the Commission should avoid defining specific activities that can or cannot be performed by the auditors, and instead focus on the four guiding principles mentioned. For example, we agree that if an accounting firm designs and implements an audit client's financial information system or any related system, independence would be impaired. This would create a significant mutual interest between the client and the auditor, and would result in the auditors' reviewing their own work.

On the other hand, if an internal audit function reports directly to the audit committee and does not perform any bookkeeping functions, we do not feel independence, real or perceived, is impaired. The Commission states that "the auditor would be relying on a system he or she helped establish and maintain" or "that management and the external auditor may become partners in creating an internal control system and share the risk of loss if that system proves to be deficient". We contend that external auditors already have a stake in the maintenance and establishment of internal controls, through the testing they perform and improvements they recommend, and as a result they already share in the risk of loss should the system fail. In addition, external auditors must satisfy themselves as to the soundness of their client's internal control systems, which they will do regardless of who performs the internal audit work. The bottom line in this scenario is that the outsourcing of internal audit could be viewed as an extension of the external auditor's existing role, and should not be treated differently when evaluating independence. However, if the internal auditors regularly performed monthly account reconciliations or similar tasks, we would agree that independence would be impaired since the auditors would review their own work; a violation of one of the four guiding principles. Each situation and the circumstances surrounding it is unique, thus we do not believe specific activities should be excluded from the activities performed by a company's auditors. Each situation should be evaluated based on the four guiding principles proposed by the Commission.

5. Role of the Audit Committee

Our fifth point relates to the role of the audit committee. Ensuring auditor independence has long been an objective of corporate audit committees. At Medtronic, our audit committee is actively involved in assessing our auditors independence. I can tell you that they take this responsibility very seriously. In the past year, requirements and responsibilities of audit committees have been enhanced, creating more engaged and active committee members. We believe that we should continue to require our audit committees, who are in the best position to evaluate independence, to play an active role in this assessment process, as the proposed rule changes outline.

6. Disclosure Requirements for Non-Audit Services

Our last point relates to the proposed rule changes on disclosure requirements for non-audit services. An important consideration in evaluating independence is the magnitude of the fee of the non-audit service provided, both in absolute dollars and compared to the audit fee. It is fair to say that the larger the fee for consulting services, the more likely independence, actual or perceived, will be impaired. However, determining the appropriate threshold is a matter of judgment and each situation and service is likely to be viewed differently. In our opinion, non-audit service fees would be considered significant if they exceed the greater of 25% of the audit fee or $50,000. These parameters are slightly different than the Commission's proposed guidelines of 10% or $50,000. Full disclosure of the non-audit services exceeding these thresholds in the proxy statement is appropriate. The disclosure should include the nature and amount of the non-audit service.

I discussed earlier the importance of the role of the audit committee in assessing independence. We feel it is equally important to disclose in the proxy statement that the audit committee has considered the impact of non-audit services on independence, both actual and perceived, and has concluded that independence is not impaired by the auditors providing these services.

The disclosures proposed would require companies to perform their own independence sensitivity analysis, which may serve as a "wake up" call, and should assure independence is achieved. Thus, we are in agreement with the proposed changes related to disclosures with the exception of the magnitude of the non-audit service requiring disclosure.


In closing, I would like to summarize the six points I discussed today.

1. We are in agreement with the proposed rule changes related to employment relationships with audit clients.

2. We are in agreement with the proposed rule changes related to financial relationships with audit clients.

3. We fully agree with the four guiding principles used to measure auditor independence.

4. It is not practical to have rules that cover every non-audit service which can or cannot be provided by a company's auditors. Instead, we propose that the Commission should rely on the four guiding principles to act as the governing authority by which all non-audit services are evaluated. This philosophy acknowledges that each situation and its surrounding circumstances is unique.

5. The role of the audit committee is critical in evaluating and monitoring independence. Given the significance of this responsibility the audit committee should be held accountable.

6. Disclosure is a powerful tool in assuring that independence, both real and perceived, is achieved.

Thank you for the opportunity to speak to the Commission and I welcome your questions.