Independent Community Bankers of America
January 17, 2003
Jonathan G. Katz
Re: Proposed Rule Strengthening the Commission's Requirements Regarding Auditor Independence
Dear Mr. Katz:
The Independent Community Bankers of America1 (ICBA) welcomes the opportunity to comment on the proposal by the Securities and Exchange Commission (SEC) to amend its requirements regarding auditor independence to enhance the independence of accountants that audit and review financial statements and prepare attestation reports filed with the Commission. The SEC proposed the changes to implement the Sarbanes-Oxley Act.
The SEC plans to revise its regulations, regarding non-audit services that, if provided to an audit client, would impair an accounting firm's independence; define the circumstances whereby an issuer's audit committee can and should pre-approve all audit and allowable non-audit services provided to the issuer by the auditor of its financial statements; prohibit partners on the audit engagement team from providing audit services to the issuer for more than five consecutive years; prohibit an accounting firm from auditing an issuer's financial statements if certain members of management of that issuer had been members of the accounting firm's audit engagement team within the one-year period preceding the commencement of audit procedures; and require that the auditor of a issuer's financial statements report certain matters to the issuer's audit committee, including "critical" accounting policies used by the issuer.
The SEC has used principles as a guide for its proposal that state a public company auditor should not: audit its own work, function as part of management or as an employee of the audit client, act as an advocate of its audit client, or be a promoter of the company's stock or other financial interests.
The typical SEC-reporting community bank is locally owned and operated. Many are located in smaller communities or rural areas. Some have securities listed on a national securities exchange. Many, however, do not have listed securities but have more than 500 shareholders making them subject to SEC reporting. Yet, these small, thinly traded institutions would be subject to the same requirements that the SEC proposes for the largest corporations in America, public traded companies whose stock may be held throughout the world. The SEC points out that the vast majority of registrants are audited by one of the four largest accounting firms that are clearly not small entities. But many community banks that fall under the SEC's requirements do not use one of the four largest accounting firms but rather use a small local or regional firm.
We urge the SEC to make accommodations in its proposal to recognize the differences in the institutions that must comply with a final rule.
Internal Auditing Outsourcing
In late 2000, when the SEC proposed a rule to modernize its requirements regarding auditor independence, ICBA filed a comment to the agency (attached) raising concerns that the proposal would unnecessarily constrain the ability of community banks and other smaller institutions to use their independent auditors for internal audits, consulting and other services. We also raised concerns about how the proposal could cause smaller CPA firms to go out of business. When the SEC issued its final rule the agency recognized the problems faced by small institutions when it provided an exception for small businesses identified as those with assets totaling less than $200 million. The SEC has not included a similar exemption in the current proposal because it interprets the Sarbanes-Oxley Act as viewing the auditor as being in a position of auditing his or her own work regardless of the entity's size.
ICBA recognizes that the Sarbanes-Oxley Act did not provide a size exemption but we strongly urge the SEC to seek ways to provide some relief for small entities for the reasons contained in our November 2, 2000 letter, reasons that are still very valid. Many community banks chose to obtain outside audits but also want to use other consulting services that their audit firm provides. For a number of community banks, their geographic location limits the number of audit firm alternatives. As a result, smaller institutions may be forced to forgo important services that outside audit firms can provide to improve their financial reporting, or to pay significantly higher costs that may not be affordable. The SEC notes in the preamble of the proposed rule that it is concerned about the effect of the proposal on small businesses that have no internal audit department or staff. Many community banks that would need to comply with this rule are not large enough to justify their own internal audit function. We ask that the SEC in its final rule permit institutions under $200 million in assets a safe-harbor if their audit committee (or board of directors if it is too small to have an audit committee) approves use of the audit firm for multiple functions.
Financial Information Systems Design and Implementation
Under the proposed rule an accountant would not be independent if the accountant directly or indirectly operates or supervises the operations of the audit client's information system or manages the audit client's local area network or information system, or designs or implements a hardware or software system that aggregates source data underlying the financial statements or generates information that is significant to the audit client's financial statements as a whole. The SEC's view is that performing such functions may place the auditor in a management role or result in the accountant auditing his or her own work or attesting to the effectiveness of internal control systems designed or implemented by that accountant.
ICBA agrees that it is important for the auditor not to be involved with these functions in order to remain independent. However we believe that if an institution is considering the purchase or redesign of a system that it be able to have a general discussion of it with their auditor, without jeopardizing the auditor's independence, to gain the auditor's perspective on whether it is appropriate for their needs. This is particularly important if the system is being purchased or changed in response to criticisms raised during an audit by an independent auditor. We believe that this can be done without negating the independence of the auditor and will facilitate the process of improving financial data that a company generates and reports.
The proposed rules states that an accountant's independence is impaired as to an audit client if the accountant provides expert opinions for an audit client in connection with legal, administrative, or regulatory proceedings or acts as an advocate for an audit client in such proceedings. The SEC states that the appearance of advocacy (and the corresponding appearance of mutual interest) created by providing expert services is sufficient to deem the accountant's independence impaired. The proposal would not prohibit an auditor from assisting the audit committee in fulfilling its responsibilities in connection with the financial reporting process since the Sarbanes-Oxley Act states that an audit committee may engage advisors as it determines necessary to carry out its duties.
We recognize that it was Congress' intent to prohibit outside accountants from advocating on behalf of a client in the capacity of an "expert." However, there are legitimate instances where an outside accountant should be permitted to provide factual information to other outside groups such as banking regulators, or in a legal, administrative or regulatory proceeding, without jeopardizing their independence. Banking regulators have long worked in various degrees with the outside auditors of banking institutions as part of the examinations process. Both examiners and auditors benefit from this process. We are very concerned that the proposed rule could close the door to such communication, communication that can occur simply to gain factual information from the most knowledgeable individuals, for fear that it render an outside auditor no longer independent. We urge the SEC to clarify in its final rule that auditors may provide factual information or testimony (not in an advocacy role) without loss of their independence.
The SEC states that the proposed rules are not intended to prohibit an accounting firm from providing tax services to its audit clients when those services have been pre-approved by the client's audit committee. However, the SEC points out that classifying a service as a "tax service" does not necessarily mean the service may not be within one of the categories of prohibited services or may not result in an impairment of independence.
Many community banks depend on the tax department of their accounting firms to help prepare tax forms and provide other tax services. Community banks also need their assistance when responding to inquiries by the Internal Revenue Service. We do not see that relying on tax department accountants employed by the same firm that provides auditing services jeopardizes the auditor's independence. We are concerned that community banks will find it difficult to determine what is a tax "strategy" as compared to tax "planning." The SEC indicates that the formulation of tax strategies designed to minimize tax obligations would fail the independence test while tax planning would not. We believe that in both situations, the accountant is providing valuable services that do not violate the independence standard and we do not see that Congress intended to prohibit such relationships. We ask that the SEC provide clarification of permissible and impermissible tax services.
We strongly support the SEC's intention of continuing to permit auditors to assess the effectiveness of internal controls and to recommend improvements in the design and implementation of internal controls and risk management controls. We see this as an important function of the auditor. We agree with the SEC that as auditors gain an understanding of clients' internal accounting control systems during the auditing process, they may identify weaknesses and be able to make recommendations to properly address them. We see this as a very valuable benefit that should continue. Once a recommended change in the system is made, the auditor should be able, without jeopardizing their independence, to review the change to ensure that the problem was properly addressed. We do not see this as an outside accountant taking on a management function, but an outside resource providing accounting or auditing expertise.
Alternative Accounting Treatments
The Sarbanes-Oxley Act states that the audit committee should be informed in a timely manner of disagreements about key assumptions underlying a company's financial statements between the auditor and management. Yet the SEC proposes to require communication, orally or in writing, by auditors to the audit committee of all alternative accounting treatments of financial information within generally accepted accounting principles (GAAP) that have been discussed with management, including the ramifications of the use of such alternative treatments and disclosures and the treatment preferred by the accounting firm. This would include recognition, measurement, and disclosure considerations related to the accounting for specific transactions and general accounting policies.
We believe that the requirement that all alternative treatments of financial information within GAAP that have been discussed with management be reported to the audit committee is overly burdensome and unnecessary. Information about alternative treatments discussed and rejected by both management and the auditors for legitimate reasons would need to be reported. In such a situation we believe it is overly burdensome to require the documentation of the discussion in a manner proposed by the SEC and unnecessarily require the audit committee to spend time reviewing the matter. We urge the SEC to use the language of the statute and require the reporting of situations when a disagreement between management and the accountants occurred on key assumptions.
The Sarbanes-Oxley Act establishes a requirement that audit partners be rotated every five years. The Act imposes this requirement only on the lead auditing partner and the auditing partner responsible for reviewing the audit. However, the proposed rule goes beyond this scope and would require the rotation of partners who perform audit services for the issuer, such as the client service partner, other "line" partners who are involved in the performance of the audit and tax partners who perform significant services related the auditing engagement. ICBA opposes the proposal to broaden the scope of partner rotation. Congress had the opportunity to specify additional partners that should be rotated, but chose not to. Many smaller accounting firms will face difficulty meeting the proposed requirements to rotate additional staff, because of the relatively small size of their staff and, in some geographic areas, may find it difficult to attract additional staff. The result will be fewer accounting options for many community banks that must comply with SEC regulations, and increased costs for outside accounting services.
We urge the SEC as it considers the appropriate timeframe for implementing the final rule to provide sufficient flexibility for smaller institutions that may have more difficulty finding alternative auditing firms or that work with smaller audit firms that may find it difficult to comply with partner rotation requirements. We ask that the implementation date be delayed for smaller institutions for one audit cycle (or current contracted engagement) after publication of the final rule with exceptions made on a case-by-case basis.
Although the Sarbanes-Oxley Act did not specifically exempt small institutions from its provisions, we urge the SEC in it final regulation to allow some flexibility in how small firms may use outside auditors with approval by their audit committees. The SEC has stated that it is concerned about the effects of its proposal on small businesses that have no internal audit department or staff. We ask the SEC to allow auditors of banking institutions to continue their long standing practice of sharing information with banking regulators or others without jeopardizing their independence. ICBA opposes the proposal to broaden the scope of partner rotation and asks the SEC to clarify what are permissible and impermissible tax services. Finally, we urge the SEC to only require the reporting to the audit committee of situations where management and accountants disagree on key assumptions underlying financial statements, not all alternative accounting treatment possibilities that they discussed.
We appreciate the opportunity to comment.
A. Pierce Stone
November 2, 2000
Jonathan G. Katz, Secretary
Dear Mr. Katz:
The Independent Community Bankers of America1 (ICBA) wishes to express concerns regarding how its members and smaller CPA firms they use may be hurt by the rule proposed by the Securities and Exchange Commission (SEC) to modernize its requirements regarding auditor independence. The ICBA is concerned that the proposed rule would unnecessarily constrain the ability of community banks and other smaller institutions to use their independent auditors for internal audits, consulting and other services. We are also concerned that the proposal will cause smaller CPA firms to go out of business.
The proposal amends the SEC's governing principles for determining whether an auditor is independent in light of investments by auditors or their family members in audit clients, employment relationships between auditors or their family members and audit clients, and the scope of services provided by audit firms to their audit clients. The proposal identifies certain nonaudit services that, if provided to an audit client, would impair an auditor's independence.
The SEC has stated that it believes it is time to tighten its independence standards as audit firms move more and more into nonaudit services, and enter business and investment relationships with clients and as clients hire more audit firm partners and professional staff for high level management positions. Investor confidence in auditor independence turns on whether auditors are in fact independent and appear to be independent. The
The SEC's proposal focuses on who can influence a particular audit. It contains four principles governing the determination of whether an accountant is independent of its audit client. According to the proposal, an accountant is not independent whenever, during the audit and professional engagement period, the accountant (1) has a mutual or conflicting interest with the audit client, (2) audits the accountant's own work, (3) functions as management or an employee of the audit client or (4) acts as an advocate for the audit client.
According to the proposed rule, an auditor is not independent when the auditor performs certain internal audit services for an audit client or an affiliate. This does not include nonrecurring evaluations of discrete items or programs that are not in substance the outsourcing of internal audit functions. Also, it does not include operational internal audits unrelated to the internal accounting controls, financial systems, or financial statements.
ICBA agrees that the independence of auditors is a key factor in providing financial statement users, investors and in some cases, bank examiners, confidence that those statements are accurate. However a realistic balance must be maintained for small financial institutions and other organizations, particularly those located in rural or isolated areas, that have few options in audit firms.
In July, Comptroller of the Currency Jerry Hawke testified before the SEC that the proposal would modernize and strengthen the standards for determining independence. He stated that the growing number of national banks outsourcing some or all of their internal audit functions to auditing firms has raised concerns.
However, Comptroller Hawke stated that the SEC's proposal might be problematic for smaller banks when neither the banks nor the outside auditors they use have the staff or resources to institute proper independence safeguards. Also, banks in smaller communities may have a limited range of external auditors to choose from.
Comptroller Hawke noted that while banks with less than $500 million in assets are not required to have independent external opinion audits, a substantial number in fact do. "I would be concerned if a rigid application of a rule against outsourcing internal audit caused some smaller institutions to elect to forego such audits, in order to be able to continue outsourcing internal audit functions to the same firm they had been using for external opinion audits," he testified.
The ICBA agrees with the concerns that Comptroller Hawke expressed regarding the effects of the SEC's proposal on smaller banks. Many small community banks chose to obtain outside audits but also want to use other consulting services that their audit firm provides. Also, community banks have found it more efficient and economical to use a firm for audits and other work due to the knowledge the firm gains about operations during the audit process. Unfortunately, because of their geographic location, many community banks do not have many alternatives for audit firms. Often the choice is their local CPA firm or a branch of a nationwide audit firm located in a large city hundreds of miles away. Losing their local firm would require the bank to chose between forgoing valuable services or paying significantly higher costs that it may not find affordable. De novos located in rural areas that are required to have outside audits will find the cost of the audits particularly burdensome if they can not use smaller local CPA firms.
We are also concerned about the affects of the proposal on smaller CPA firms. In September, SEC Chairman Arthur Levitt told members of the National Association of State Boards of Accountancy that the proposal is aimed at large public accounting firms, not smaller ones. We truly hope that this is the case. Community banks located in small communities want to be able to use their local CPA firms or refer their small business customers to them. Generally the size of these communities limit their attractiveness as a place of business to larger CPA firms due to limited business opportunities. These smaller CPA firms play an important service role in their communities. Restricting the use of these firms in a manner proposed by the SEC would drive these firms out of business. The result would be less use of outside auditors and the consulting services they provide. In our view, this would be very detrimental to the financial health of small institutions and the safety and soundness of smaller financial institutions.
The ICBA is aware that there have been attempts by Congress to delay a final rule. Whether the SEC chooses to go forward with a final rule now or must delay its action, ICBA urges the SEC to make it clear that smaller community banks and other institutions are not subject
to the stringent constraints regarding the independence of their auditors with respect to certain internal auditing and consulting services as the proposed rule envisions for larger audit firms. Similarly, we ask the SEC to provide a safe harbor for smaller CPA firms so that any final rule does not drive them out of business or otherwise have a detrimental impact on their clients.
We appreciate the opportunity to comment.
Thomas J. Sheehan