Statement of William D. Travis
Concerning Auditor Independence Requirements
Securities and Exchange Commission Proposed Rule Amendments
Comment File No. S7-13-00
September 20, 2000
My name is Bill Travis. I am the Managing Partner of McGladrey & Pullen, LLP, one of the eight largest CPA firms in the U.S. In August 1999, McGladrey became a part of an alternative practice structure when it sold its non attest assets and business to a new entity called RSM McGladrey, Inc., an indirect wholly-owned subsidiary of H&R Block, Inc. This transaction was completed to provide access to the capital necessary for us to significantly increase our rate of growth and profitability in a very competitive marketplace. Since that transaction, we have worked hard to design and implement a structure and the related policies to preserve our professional standing as a CPA firm, our reputation for quality and integrity, and our independence with respect to our audit clients. The SEC staff has been very helpful to us in accomplishing that objective.
I appreciate the opportunity to provide testimony regarding the Commission's proposal to modernize the auditor independence rules. We appreciate the efforts of the SEC staff to take on this important project. There are many positive elements in the initial proposal and we are supportive of this undertaking. In particular, we applaud the proposal to alleviate overly burdensome restrictions on investments and employment relationships involving audit clients and the families of certain audit firm personnel.
Today I will provide comments on certain aspects of the proposal that we believe requires further analysis and attention.
Let me begin my comments by stating that I am proud to be a CPA and an audit partner in a CPA firm. Our profession has a long history of insisting that our members achieve a high level of technical competence and personal integrity. The profession has consistently demonstrated a commitment to continuous improvement by investing in enhancements to the profession and by providing experienced advice to help our clients grow and prosper. The audit profession has carefully maintained its good standing through the delivery of independent and objective audit, tax and business consulting services.
I have been very impressed with the talent and commitment to excellence of the CPA audit professionals and the SEC staff that I have had the good fortune of working with over the last few years. I believe that we both want what is best for the public interest and the audit profession.
On a personal level, I am very concerned that the negative publicity surrounding the independence debate will adversely affect the audit profession and the public interest. I strongly recommend that the profession and the SEC work together to resolve our differences on a timely basis. I fear that continuing to debate the issues in the press will cause irreparable harm to the audit profession. From our perspective, the negativity is already creating problems for the profession in attracting and retaining the best and brightest talent.
Independence Standards Board
We suggest that the Independence Standards Board (ISB) be included in the process to assess the input received from this public debate and to help identify and develop enhancements and modifications to the proposal. The ISB Board is comprised of an equal number of representatives from the profession and the public sector and would provide an unbiased view of the public comments. The ISB Board members and management are extremely experienced, competent and committed to the public interest. They would be valuable resources in the assessment and enhancement of the independence rules for the auditors of public companies.
We believe it is appropriate to build the foundation for specific applications around a general standard and supporting principles. This approach will help persons inside and outside the audit profession understand the basic concepts of independence. We offer the following additional comments-
- We are fully supportive of the proposal to incorporate the joint efforts of the SEC and the audit profession to implement independence quality control systems and training to ensure that independence is maintained by the audit firm and relevant professionals within the audit firm.
- We believe that rulemaking needs to further clarify the definition of "appearance". Consider the following-
- The rules should better define who is capable of making a fair and objective assessment of the appearance of independence.
- A fair assessment requires full knowledge of the relevant facts as well as the independence rules and related interpretations. We seriously doubt that most reasonable investors are capable of, or want to, make these determinations in situations involving complex fact patterns. For example, most of us don't want or need to know how the airplane works, but do want to know that the regulations, systems and training are in place to ensure that we get to our destination safely and on time.
- An objective assessment would require an experienced person that has an unbiased perspective. We believe this is a logical role for the ISB.
- We disagree with the fourth principle, which states that the auditor is not independent if they act as an advocate for their client. We believe that the definition of advocacy is too subjective to be useful and that a reasonable level of advocacy is acceptable. We further believe that most audit clients expect the auditor to act as an advocate for them, within the reasonable bounds of professional integrity and objectivity. The best audit professionals are those who are able to perform effective and efficient audit engagements and, at the same time, identify opportunities for clients to better safeguard assets, save tax dollars, improve operations and increase shareholder value. We believe it is entirely logical for competent audit professionals to be able to effectively perform both roles while maintaining their objectivity.
Investments by the Audit Client in the Auditor
Proposed rule 2-01(c)(1)(iv)(A) provides that an auditor's independence is impaired when the audit client or an affiliate of an audit client has, or has agreed to acquire, any direct investment in the audit firm or its affiliate. The discussion regarding this proposal cites two reasons: (i) the auditor may have to audit the value of the securities of the audit firm or its affiliates, and (ii) the auditor would have a mutuality of financial interest with the audit client-shareholder. We provide the following comments regarding this proposed rule-
- We suggest that the rule include provisions to cure unintentional violations on a timely basis when and if they arise, since the client and its affiliates are outside of the control of the audit firm. Additionally, we are concerned that non-CPA client management will not fully understand or appreciate the potentially adverse impact of inappropriate investments on the audit client and the audit firm.
- The proposal fails to address materiality by using a one share is significant approach and, therefore, ignores the ability to significantly influence provisions included elsewhere in the proposal. This rule is also impossible to cost effectively monitor, since many investors hold shares in street name accounts. We suggest the rule be revised to utilize a materiality approach similar to the one recommended in the ISB's draft Exposure Draft, Evolving Forms of Firm Structure, which provided that audit clients shall not own securities of the audit firm, its investee or a Corporate Employer (as defined in the Exposure Draft) unless such investments are immaterial (investments of less than 5% of the securities of the firm, affiliate or Corporate Employer and whose market value does not exceed 3% of the audit client's net worth are immaterial).
- We agree with the provisions of the proposed rule which excludes audit client management and Board of Directors members from the restrictions on direct investments in the audit firm or its affiliates. We recognize that this is a change in position from previous discussions we have had with the SEC regarding investments by the audit client in the audit firm and are pleased with this proposal. We do not believe that investments in the auditor or its affiliates by audit client management or Board members have an adverse impact on auditor independence. In particular, we do not believe such investments generally allow the individual to influence the auditor's judgment, do not create a mutuality of interest between the auditor and the individual nor result in the auditor having to audit its securities or the securities of its affiliate.
Scope of Services
We disagree with certain aspects of the proposal to broaden the service restriction placed on auditors of public companies. We believe this portion of the proposal may be, to some degree, a solution looking for a problem. We understand that neither the Commission nor the profession have identified a material number of financial reporting problems created as a result of the scope of services provided to the audit client. Additionally, we do not believe that the recent improvements in audit committees have been in place long enough to determine whether additional rulemaking in this area is necessary and cost beneficial. It seems to us that audit committees should be able to adequately assess what is best for the audit client. As a result, we recommend that adequate due process be performed before expanding the scope of services restrictions. Please consider the following-
- We believe that the overwhelming majority of CPA auditors would not sacrifice their personal integrity and professional responsibility in the face of external client pressure or internal management pressure. As a result, we do not believe that audit quality is adversely affected because of the breadth of services currently provided to public company audit clients.
- We agree with certain items included on the list of restricted services for public companies, which are currently recognized by the Commission and much of the audit profession as creating a conflict of interest, including bookkeeping, valuation services and actuarial services.
- The proposal should further clarify the definition of prohibited internal audit outsourcing services. We do not believe that the current proposal is clear enough as to what services are acceptable and what services would compromise the auditor's independence. Furthermore, we believe additional input may be necessary to understand the public views on this service.
- We generally disagree with the inclusion of financial information system design and implementation consulting services and certain human resources consulting services on the list of prohibited services. We believe that these services are significantly different than those services that result in the auditor specifically determining an actual number in the company's financial statements, such as the calculation or other determination of a financial statement asset or liability, the valuation of an asset or the actuarial determination of a liability. We believe that independence is not compromised when company management is actively involved in all significant decisions regarding systems design and implementation issues and management is subsequently actively involved in the utilization and management of such systems and related outcomes. Consider the following-
- The design and implementation of financial information systems provides the client with the tools to efficiently and effectively manage daily activities and to prepare periodic financial statements. Independence is not compromised if client personnel are actively involved in and responsible for those daily activities and the analysis of the propriety of and ultimate determination of all financial statement balances generated by the system.
- We believe further clarification is necessary regarding recruiting restrictions. Assistance in the recruiting of personnel, other than senior management and senior financial people, should not be restricted. Our experience is that personnel will demonstrate significant greater loyalty to their new employer than to the consulting firm involved in the hiring process.
- The design and implementation of organizational structure, evaluation systems and compensation systems provides the client with efficient and effective means to convey job responsibilities and to attract and retain personnel. Independence is not compromised when those systems and the related decision making is entirely the responsibility of company management.
- We believe that mid-sized companies rely on their audit firms to provide a full scope of services to assist them in gaining or maintaining a competitive edge in today's market. The mid-sized company has limited resources available to accomplish all of its needs and frequently looks to its audit firm for help. Also, the client respects the trust relationship that has been established with the audit firm and expects to get experienced and objective counsel to address its needs. As stated above, we believe the auditor can provide certain expanded services and retain its objectivity.
- We believe that restrictions on the scope of services that auditors can provide to publicly traded companies should be carefully debated before such restrictions are applied to auditors of non-public companies. We believe there is an inherent difference between the public interest in companies that are publicly traded and those that are privately held.
Affiliate of an Accounting Firm
We believe the definition of an "affiliate of an accounting firm" is too broad and, as a result, will sweep in other audit firms and other business relationships that are truly outside the sphere of control and significant influence of the audit firm. If our understanding is correct, this definition would include other U.S. and foreign firms affiliated with the audit firm through licensing, franchising or other cooperative marketing arrangements but for which the audit firm has no financial or operation control. This proposal is not workable and will cause a significant increase in the amount and cost of independence monitoring and compliance work with little or no real benefit to the public interest.
We believe additional clarification is needed to help distinguish between contingent fees and billing for value. We do not believe the SEC should be involved in determining what the value of services are.
Proxy Disclosure Requirement
We do not object to the proposal for proxy disclosure of fees paid to the audit firm. However, since facts and circumstances play a major role in the magnitude of professional fees, we do believe the materiality limits are unreasonably low and question the value to be derived from the disclosure.
I thank you for allowing me to present our views on this important proposal. We are supportive of this project and recommend that the SEC invest adequate time to gather and understand informed input, seek the involvement of the ISB and work together with the audit profession to resolve our differences.
William D. Travis