KRAFT BROS., ESSTMAN PATTON AND HARRELL, PLLC
January 10, 2003
Mr. Jonathan G. Katz, Secretary
Dear Mr. Katz:
This is our response to the Commission's proposed rules implementing the auditor independence provisions of the Sarbanes-Oxley Act.
Kraft Bros., Esstman, Patton & Harrell, PLLC is a 14 partner, 100+ person CPA firm in Nashville, Tennessee. Our practice includes two community bank clients subject to SEC reporting requirements. These clients are subject to SEC reporting pursuant to statutory requirements with respect to the number of shareholders. Neither clients' stock is traded on an exchange, nor actively traded. We have served one bank for many years, the other for two years. Truthfully, the audit failure and market risks attributable to our SEC clients are nominal compared to Fortune 500 entities, but we take our responsibility to financial statement users seriously. If our firm is legislated from serving these clients, we will survive; they represented approximately 2% of our total billings. Our concern is for our clients. They are "A" clients to us, and we are quite certain if forced to move to an international firm, they would loose a tremendous amount of attention and personal service they are accustomed to by working with us. They will likely pay a premium fee for the marginalized services. Accordingly, we expend tremendous effort to insure we are serving these clients in accord with professional standards, insuring that the clients "toe the line". There is no significant error these clients could make that would not be a significant issue to our firm.
We have a general concern about responding at this time because the Commission has not disclosed many of the details that will be necessary to bring the proposed regulations into play. We believe you are requesting a response on matters critical to our firm that are unknown or undisclosed. For example, the transition rules are, to our knowledge, undisclosed. There is much speculation about numerous transition issues that are germane to a rational and reasonable response. We believe a response would be more appropriate when all the rules are disclosed.
Secondly, we understand the gravity of the errors and misjudgments that preceded the current legislative and regulatory activity and deplore the conduct of the auditing firms that contributed to this dilemma; however, we believe that the proposed rules reward the perpetrators at the expense of the innocent. The onerous partner rotation rules, as proposed, will impede the ability of small firms, like ours, to audit SEC clients. The rules, as currently designed, effectively apply a defacto rotation rule for small firms. Large and mid-tier firms will have a tremendous advantage in serving SEC clients due to their large pools of partners. Hundreds of small firms will be totally disenfranchised, others forced to take extreme steps, such as hiring concurring review partners to continue serving their SEC practice, which could impair audit quality. In addition, we believe that higher fees will result, caused by a significantly smaller pool of SEC eligible audit firms, which will adversely affect small SEC registrants and statutory SEC reporters, like our bank clients.
Our response to specific questions posed in the Commission's discussion memorandum follows:
A. Should the proposed rules apply equally to large firms as small firms? Would the proposed rules impose a cost on smaller issuers that is disproportionate to the benefits to be achieved?
As noted above, we believe a small firm or a small SEC client exception is in order. SEC reporting entities that are not traded on an exchange nor actively creating a market for their stock could be excluded from the proposed rule or subjected too less punitive rules. Community banks often meet the above criteria. They are subjected to SEC reporting because they exceed a statutory shareholder threshold but are often capitalized by market insensitive stock. Also, they are subject to heavy regulatory oversight. We believe that this category of SEC reporting entities could be deleted from the proposed rules, if they are not otherwise mitigated, without significant risk to users of financial information.
B. Should the definition of bookkeeping be further clarified? If so, how?
Small registrants sometimes have limited expertise in preparing year-end financial statements in accordance with generally accepted accounting principles (GAAP) --particularly statements of cash flows and certain footnote disclosures because they see them once a year. Auditors, on the other hand, are uniquely qualified to address reporting requirements because they see GAAP statements all the time. The U.S. General Accounting Office (GAO) has taken a position that auditors can prepare draft financial statements for governmental entities from information provided by management and reviewed and approved by management. We believe that the GAO position on this matter has merit. Question 46 in the GAO's Answers to Independence Standard Questions discussed this position in more detail. We suggest that the Commission consider the merits of a GAO type position.
C. Should issuers be given a choice between engaging forensic auditors periodically and having the audit partners on their engagement team be subject to the rotation requirements? Why or why not?
We cannot imagine why an issuer would elect this course of action considering the cost/benefit ramifications. Our question would be, "why do you want to retain the auditor at this cost?" If proposed rotation requirements are not modified, there is no reason not to offer this alternative.
Also, the idea of forensic auditing ignores the fact that all registered firms will be peer reviewed by the Public Company Accounting Oversight Board under the auspices of the SEC. Further, the SEC engagements served by these practices will be much more likely to be peer reviewed than if served by a big firm. Our individual offices will continue to be significantly reviewed, while big firms will have offices and clients that will comparatively receive a bye based on their size.
C. Should certain partners providing non-audit services for the client in connection with the audit engagement be excluded from the rotation requirements?
We believe that adopted independence rules are sufficiently restrictive to eliminate any damage from continuous service for non-attest functions, such as taxes. Familiarity has its virtues in insuring that companies comply with laws and regulations and adopt prudent strategies. In short, there is a point where our zealous efforts to separate the CPA firm from the company can actually damage the company. Accordingly, if a partner's activity complies with prescribed independence rules, we do not believe non-audit partner rotation is necessary.
C. Should the rotation requirements apply to all partners on the audit engagement team? If not, which partners should be subject to the requirements?
A reasonable rotation requirement for all audit partners is acceptable.
C. Should the rotation requirements be different for small firms? What changes would be appropriate and why? If so, how should small firms be defined?
As noted above, we believe rotation requirements should be different from those proposed. In fact, current rotation requirements, prior to the proposed requirement, are onerous enough for small firms, so we would recommend current requirements with a measurement modification from total partners to audit partners. Unlike the existing peer review program, the proposed peer review rules provide the Commission with punitive powers if a firm does not properly serve an SEC client.
D. What economic impact would the proposed rules have on the current system of partnership compensation in accounting firms?
The new and more stringent independence rules, which will further restrict non-audit activity, should be sufficient to minimize partner's economic dependence and the resulting potential bias to please. There is a line here that needs to be carefully drawn because it could restrict the ability of audit practices to attract the best and the brightest people. Reality is that this potential economic bias can never be totally removed from audits as long as companies pay CPAs to perform their audits. Accordingly, this rule appears to be overly redundant.
The Commission's pursuit of comments on these matters is commendable. The volume of considerations is immense. As a small firm practitioner, we wish we could respond in more depth, but we do not have personnel dedicated to this type of administrative efforts, as do the big firms. As a result, our response and the responses of many of our fellows will likely be modest in comparison. We also may not be aware of all the possibilities respecting these matters, but we hope that the Commission will listen loudly to our positions and consider the pervasive impact of their conclusions without the blinders that are often prevalent in these politically charged matters.