Presentation Before the Securities and Exchange Commission
September 20, 2000
Thomas J. Sadler, CPA
Washington State Board of Accountancy
Support for the SEC's Rules Review Activities
The Washington State Board of Accountancy supports the SEC's rules review efforts. This is key given the changing landscape of professional services and changes in the business, professional, and social environment such as:
In Washington State the Board of Accountancy, along with all other state agencies, constantly reviews its rules, interpretations, policies, and practices to ensure the rules are sound, clear, easy to understand, equitable, fair and supportable. We call it "regulatory sanity." Why are we undertaking these efforts? For the same reasons I just mentioned - changes in the profession, changes in the business environment, and changes in the international environment. Plus, we are seeking to eliminate out-of-date and/or unnecessary rules and requirements and to reduce the amount of paperwork necessary to meet our requirements.
So, we personally understand the time, commitment and effort required to review rules and obtain stakeholder input. On behalf of the Washington State Board I applaud the SEC's efforts.
Your efforts both compliment and support our own regulatory review activities.
Respond to the SEC's Proposed Rule: Revision of the Commission's
Auditor Independence Requirements
To ensure I provide a complete and cohesive response, I have directed my comments to you in the same format as the Proposed Rule.
I. Executive Summary
We have nothing to add to this section, except to underscore our support for this activity.
II. The Need to Preserve Auditor Independence.
A. The Securities Laws give Independent Auditors a Vital Mission and Responsibility.
The need to preserve auditor independence extends beyond audits of SEC registrants. The State of Washington, and most all other states, requires that a CPA performing attest services must be independent and must comply with the standards of appropriate bodies. Under Washington State rules, the Securities and Exchange Commission is an "appropriate body." This means the SEC's rules are basically adopted by states. And, because of this, the SEC's rules have a much broader impact than just CPAs auditing SEC registrants. I want to highlight - the consequences of amending the SEC's rules extend beyond the audit of SEC registrants.
B. Independence in Fact and Appearance
Professional standards (SAS #1) require "independence in mental attitude."
However, representatives of the profession assert the audit function is necessary to gain the opportunity to sell other services. The AICPA maintains: the growth of audit fees is stagnant, auditing has become a commodity, and using the audit as leverage is necessary to obtain more profitable work. These factors play on the importance of independence and highlight the need to focus on independence in fact and appearance.
In this environment, how can auditors maintain independence?
We believe independence in fact and appearance and the requirement for professional skepticism should be extended to the audit firm. In other words, we believe your first statement under this paragraph should read: "To fulfill the important role assigned to the auditor, the auditor must approach each audit with professional skepticism and must have a willingness and freedom to decide issues in an unbiased and objective manner, even when the auditor's decisions may be against the interests of management of an audit client and the audit firm."
C. The New Business Environment calls for Modernized Rules
We agree. Conceptually the new business environment calls for a modernization of the rules governing relationships, scope of services, quality control and proxy disclosure. These issues are important and need to be revisited.
D. The Need for a More Accessible Auditor Independence Framework
We believe the suggested review activity supports Washington's own efforts towards `regulatory sanity.' We also believe that the review activity should be performed by an organization that is independent, includes representatives of each stakeholder organization or group, and includes a NASBA representative. We would nominate the Independence Standards Board (ISB) to provide this framework. However, we are concerned that the SEC lacks confidence in the current ISB. If this is the case, we strongly recommend the SEC revisit the structure, charter, and membership of the ISB and establish a board or committee that will uphold the SEC's trust while carrying out its mission. In any event, a NASBA representative on the board or committee is imperative.
III. Discussion of Proposed Rules
A. Qualifications of Accountants
We appreciate the SEC's acknowledgment that states are responsible for the licensing of CPAs. However, states are also charged with enforcement. Violations of professional standards, including violations of SEC requirements, have consequences. Because states mandate independence and mandate adherence to professional standards, they are also charged with enforcement of those rules to protect the public and ensure the integrity of financial information.
Practitioners must know the violation of profession standards has consequences. And, we strongly encourage a joint enforcement activity when these standards are violated.
B. The General Standard for Auditor Independence
We suggest the general standard include the concept that the professional has a duty to maintain their professional skepticism and the professional must not subordinate his or her judgement to others.
C. Specific Applications of the Independence Standard
Before we examine specific applications we believe the stakeholders should first come to an agreement on the general standard.
Then the appropriate review body should be identified. Will this be the ISB or the SEC? If not, what board or committee will be chartered to interpret the rules?
When the appropriate body is identified, we believe it should be this organization that:
(1) Identifies the specific circumstances or scenarios that need to be interpreted,
(2) Performs a careful and cautious review,
(3) Provides an opportunity for public input, and
(4) Utilizes a due process.
This hearing and the public comment period is not an adequate process to review these scenarios. Rules with such a broad impact as those contemplated in this proposed rule, require a careful and deliberate review process.
D. Non-Audit Services - The Proposals
Services that clearly constitute a conflict of interest should be prohibited. However, to be blunt, many of the other `non-audit services' are not a problem until something goes wrong. In other words, if I as a CPA have my staff assist a client with a new accounting system, and it is done correctly, and I issue an audit report, where is the damage? Isn't the work product better than if I search through someone else's work and identify errors that must be corrected before I issue a report? We agree these issues deal with the appearance of independence - but is there really a problem until an error or engagement failure occurs?
We would suggest that the rule not establish a prohibition against providing specific services, but rather create a burden to withdraw from the attest engagement if the services place the CPA or the CPA firm in a position of conflict. In other words, when a problem arises, where the other services provided have failed, then the CPA needs to resign from the audit.
D. Non-Audit Services - The Alternatives
Any rule or standard that encompasses or forces an artificial practice structure should be avoided.
E. Contingent Fees
F. Quality Controls
G. "All Relevant Circumstances"
H. Proxy Disclosure Requirement
We agree. However, we believe this should be expanded to include a per hour realization rate comparing audit fees to consulting or other fees. Any disclosure that omits realization rates is incomplete.
Enforcement is Key to Performance
We consider the profession's performance to be predicated on three factors of equal importance:
1. Professional competency
While your review activity is currently focusing on independence, and we do not want to take away from that effort, we would like to emphasize and suggest the SEC focus on the third leg: Enforcement.
It is our understanding that the SEC prosecutes only the most egregious cases and settles other cases.
And, while we understand resource issues may preclude the SEC from pursuing all cases (we face similar issues in Washington State) we would like to suggest that the SEC consider:
1. The impact of settling cases nolo contendere
2. Referring cases to the state boards for action
Washington State Investigates all Cases Referred by Other Governmental Agencies
As I mentioned at the meeting with the Public Oversight Board last July, Washington State actively investigates issues of substandard work or noncompliance with technical or ethical standards.
For example, in the past four years we investigated 22 cases dealing with standards deficiencies. Of these 22 cases, 4 were referred by the federal government, 2 were referred by other governmental organizations and 14 were identified through our own quality review program. Of these 22 cases, 2 resulted in license suspension, 11 resulted in practice restriction, and only 1 was closed without board sanction.
I would reiterate - Washington has investigated every case referred by the Federal Government.
A Partnership Effort for Establishing a Process for Referring Cases to States for Action
I would ask for consideration of a method of referral to state boards when the SEC opens a case.
Ideally this referral should be to the state(s) issuing the CPA firm license, the state(s) where the client(s) principally resides, and the state(s) issuing the individual CPA licenses.
Keep in mind, by way of referral the Washington State Board of Accountancy gains the means to establish a litigation monitoring procedure which ensures we are aware of any resulting action against the CPA or firm.
Again, we are ready to step up to the plate. We are fully committed to the protection of the public interest. We are committed to the perception of the public that there are consequences from failure to properly audit and behave ethically.
As I mentioned in July, the Washington Board can think of no better partner than the SEC when addressing the profession's ethical practices.
But, in the same regard, I would like the SEC to consider the value in partnering with a state board. The state board is the organization with the authority to issue and the authority to suspend or revoke the CPA license. We request the SEC consider advantages to be gained by partnering with the state boards.
Suggestions for Additional Review
The SEC, POB, state boards, and peer reviews should make questions of independence foremost when conducting investigations of audit failures.
Additionally, the SEC should perform the research and analysis necessary to prove or disprove the common-sense notion that (1) the practice of low-bidding or (2) the providing of other services to an attest client impacts independence.
Past audit failures should be re-examined for evidence of impaired independence.
A review of audit failures both past and present is needed to provide evidence to support the conclusions we need for establishing appropriate rules.
In 1996 Tom was appointed to the Washington State Board of Accountancy by then Governor Mike Lowry and reappoint to the Board in 2000 by Governor Gary Locke. In 1999 Tom served as Chair of the Board and he has been nominated to service on 2001 National Association of State Boards of Directors.
Tom is responsible for Brink & Sadler's litigation-related services, including business valuations. His professional experience includes accounting and consulting service to Brink & Sadler's accounting and auditing clients, and he provides personal financial, tax and estate planning. Tom's previous employment includes Johnson, Paulson & Stolz, now part of Ernst & Young. He is a Certified Fraud Examiner and a member of the Association of Certified Fraud Examiners
Tom is a member of the AICPA and Washington Society of CPAs where he has served as a member of the Board of Directors, Chair of the Litigation Services Committee, Director and President of the Tacoma Chapter, a member of the Private Companies Practice Section Committee, a member of the Accounting and Review Services Committee, and a member of the Auditing Standards Committee.
Tom is a former member of the Tacoma Estate Planning Council and has served as the Council's secretary/treasurer. He is a past president of the Lakewood Area Chamber of Commerce and the Rotary Club of Lakewood. Tom is a former member of the Tacoma/Pierce County Economic Development Board and a former member of the Business Advisory Committee for the Lakes and Clover Park high schools.