Wolf & Company, P.C.
January 13, 2003
Mr. Jonathan G. Katz, Secretary
Re: File No. S7-49-02
Dear Mr. Katz:
Wolf & Company, P.C. is a regional CPA firm located in Boston and Springfield, Massachusetts, with approximately 100 professionals serving a diverse client base in industries such as financial services, manufacturing, printing, professional services, software, and wholesale distribution. Our financial institutions practice is one of the largest in New England, and we currently provide audit services to eighteen publicly traded companies that file periodic reports with either the SEC or the federal banking regulators. We have been a member of the AICPA SEC Practice Section ("SECPS") since its inception. Several of the firm's shareholders currently hold or have held positions on AICPA committees related to peer review, ethics and financial services, and have served on the Board of Directors (including Presidency positions) of the Massachusetts Society of Certified Public Accountants. We are dedicated to providing the quality professional services that have been, and continue to be, the hallmark of the profession. Our firm has never been sanctioned by the Commission, the SECPS or any federal banking regulators. Historically and to date, the firm's revenues are generated principally by the provision of audit services (72%) and tax services (26%), with minimal revenues (2%) derived from consulting services (principally consumer compliance consulting in the financial services practice).
We appreciate the opportunity to provide commentary on certain components of the proposal regarding auditor independence. As a firm dedicated to providing audit and attest services, we are acutely aware of, and dedicated to preserving the concept of independence, whether real or perceived. Our commentary is as follows:
The concept of audit partner rotation is not new. The SECPS requires the engagement partner to rotate off the engagement after seven years and to remain off the engagement for two years. The Sarbanes-Oxley Act provides for rotation of the engagement and concurring partners after five years, with a cooling-off period of one year. We strongly believe, however, that the concerns the Sarbanes-Oxley Act is intended to address are not mitigated by the concept of partner rotation. To the contrary, we believe, and it has been our experience, that audit quality is in fact enhanced by increased knowledge and experience of the key members of the audit team. Concerns over audit quality and the unfortunate accounting restatements in the recent past appear to be unrelated to the issue of partner rotation. Any engagement partner in a position of authority who loses integrity can do so in one year. What is critical is the control structure within a firm that mitigates all audit risks. Historically, the concurring partner review function and the peer review process have provided the principal safeguards in this regard, and should continue to do so. The SEC proposal to require rotation of all partners who are members of the audit engagement team, including the concurring partner, after five years, and the extension of the cooling-off period to five years, is extreme and unwarranted.
Many small and medium-sized public accounting firms have historically provided quality audit services to SEC registrants. If these firms are comparable in profile to Wolf & Company, P.C., they are generally audit-based, without the extensive offering of non-audit services that the larger firms have provided. They are committed to providing audit services to small and middle-market companies that are integral to the domestic and global markets. The adoption of overly stringent partner rotation requirements will make it impossible for many quality firms to serve SEC registrants, and will significantly restrict the number of audit firms that small and middle-market companies will be able to engage. Most SEC registrants will be forced to engage large firms that are precisely the firms that congress and the SEC have been highly critical of. It is unfair to deprive these businesses of the quality services that a firm in their market is willing and able to provide. It is similarly unfair to deprive the firms of practices that they have spent years developing, simply due to partner rotation. It is difficult to believe that this was the intent of the Sarbanes-Oxley Act. Punitive actions or deprivation of practice opportunities should take place only when it has been determined through due process that a firm has provided substandard services or violated professional standards.
The role of the concurring partner is to monitor and concur with the significant audit decisions being made. While rotation of the lead engagement partner(s) allows for a fresh look, it seems far less productive to require rotation of the concurring partner, whose role should be one of independent oversight and to provide a continuity of knowledge of the critical audit areas. Also, to extend the rotation requirement to other partners, such as tax partners who assist in reviewing income tax provisions, unnecessarily limits the number of qualified firms serving SEC registrants, yet does little, if anything, to enhance independence. Accordingly, we urge the Commission to focus more intently on a firm's overall quality control structure and the oversight provisions determined by the Public Company Accounting Oversight Board. Rotation at the level proposed can have devastating effects on an audit firm's depth of knowledge and understanding of a client's business and the number of quality firms who qualify to serve public companies, with little enhancement of independence or audit quality.
SERVICES OUTSIDE THE SCOPE OF THE PRACTICE OF AUDITORS
Bookkeeping or Other Services Related to the Accounting Records or Financial Statements of the Audit Client
The proposal to eliminate the limited situations where bookkeeping services may be provided under the current rules presents a practical problem. Although we do not disagree with the basic prohibition of bookkeeping services, isolated emergency situations with small companies are a practical reality. For example, where the financial person in the organization is unable to complete certain aspects of a filing due to illness, it may be impossible to engage a knowledgeable person in a timely manner that could facilitate and assist with a timely filing. Accordingly, we believe there should continue to be limited situations that would allow for auditor assistance.
Internal Audit Outsourcing
With regard to internal audit outsourcing, we have chosen to respond specifically to the questions that have been asked in the proposal, as follows:
Is the definition of the "internal audit function" sufficiently clear? No. For example, at one extreme is the issuer that does not maintain an internal audit function. In this situation, the external auditor designs a comprehensive audit approach that does not rely on the work of an internal auditor. At the other extreme is the issuer that maintains an internal audit function, however, the internal auditors do not have sufficient technical expertise to perform an audit of the information technology controls. As a result, the external auditor performs a review of the information technology controls each year to effectively assess internal control for purposes of designing the financial statement audit in accordance with SAS No. 94. Does this constitute outsourcing of an internal audit function, simply because the internal audit scope did not include an information technology review that should otherwise have been included? Does the mere existence of an internal audit group imply that extended audit procedures performed by the external auditor are in fact some level of internal audit outsourcing?
We solicit comment on whether an exception should be provided for small businesses. If so, what criteria should we consider in providing such an exception? Small businesses typically cannot maintain an internal audit function due to excessive cost and the limited ability to attract someone with appropriate credentials or experience. In a small business situation where internal audit services are desired, for example as a result of regulatory recommendations, such services are generally limited to significant risk areas or specified activities. In these situations, it is reasonable to view such services as an extension of external audit services, even if they are not required to render an opinion on the financial statements or a separate report is issued. Accordingly, independence should not be deemed impaired.
However, if the external auditor is also attesting to, and reporting on, management's assertion pertaining to the company's internal control structure and procedures for financial reporting, as is required by Section 404 of the Sarbanes-Oxley Act, and management is relying on these internal audit services as the primary basis for its assertion, independence would be impaired in relation to this attestation engagement. See AICPA Ethics Ruling on Independence, Integrity and Objectivity No. 103, Member Providing Attest Report on Internal Controls, for further clarification. Accordingly, unless an exemption from the assertion pertaining to the company's internal control structure and procedures for financial reporting is provided for small businesses, an exemption should not be provided that allows small businesses to outsource the internal audit function to their external auditors. The Federal Deposit Insurance Corporation Improvement Act currently requires insured institutions with assets of $500 million or more to provide management's assertion relating to internal controls over financial reporting and an independent attestation report thereon.
Does it impair an auditor's independence if the auditor does not provide to the client outsourcing services related to the internal audit function of the audit client, but rather performs individual audit projects for the client? Neither situation should impair the auditor's independence, unless the situation noted above exists. The substance of the services does not change simply by breaking them into smaller pieces.
Are there safeguards that can be established by the auditor that would allow the audit client to outsource the internal audit function to the auditor without impairing its independence? Independent reporting to the audit committee should provide adequate safeguards for any audit function.
Would it impair the auditor's independence if the auditor performs only operational audits that are unrelated to the internal controls, financial systems, or financial statements? No.
Is additional guidance necessary to distinguish the services that would be prohibited under this proposed rule from those services that would be permitted as operational audits? Yes. Please provide examples of what would constitute an operational audit.
In the Sarbanes-Oxley Act, Congress made its view clear that providing tax services to audit clients does not impair the independence of the audit firm. Consistent with congressional intent, the proposed rules state: "Nothing in these proposed rules is 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. As discussed in our previously proposed rules on independence, tax services are unique, not only because there are detailed tax laws that must be consistently applied, but also because the Internal Revenue Service has discretion to audit any tax return" (67 FR 76790). Further, the proposed rules state that "tax services traditionally have been viewed as closely related to audit services and as not being in conflict with an auditor's independence." (67 FR 76798).
Despite these comments, the proposed rules regarding tax services, and specifically the following language, creates significant uncertainty as to what tax services are permissible:
"Classifying a service as a "tax service" however, does not mean that the service may not be within one of the categories of prohibited services or may not result in an impairment of independence under Rule 2-01(b). The accounting firm and the registrant's audit committee should consider, for example, whether the proposed non-audit service is an allowable tax service or constitutes a prohibited legal service or expert service. As part of this process, the accounting firm and the audit committee should be mindful of the three basic principles which cause an auditor to lack independence with respect to an audit client: (1) the auditor cannot audit his or her own work, (2) the auditor cannot function as a part of management, and (3) the auditor cannot serve in an advocacy role for the client. For example, where an accountant provides representation before a Tax Court, the accountant serves as an advocate for his or her client and the accountant's independence would be impaired. Another example would be the formulation of tax strategies (e.g. tax shelters) designed to minimize a company's tax obligations. The provision of these types of services may require the accountant to audit his or her own work, to become an advocate for the client's position on novel tax issues, or to assume a management function."
A bright line needs to be established to clarify the high level of uncertainty created by the foregoing language for both the audit committee and the auditor as to whether any tax services are permissible. Without clarification, the end result will be that the auditor will not be able to provide any tax services to the audit client. We believe this result would be inconsistent with the intent of Congress and the Commission.
More importantly, we do not believe that providing tax services impairs auditor independence. IRS publication Circular 230 outlines the rules governing practice before the IRS for Certified Public Accountants. The rules outlined there provide a level of responsibility by tax practitioners to be objective and independent advisors in their provision of tax services. Accordingly, we respectfully suggest the Commission clarify in the commentary accompanying the final proposal that the provision of all lawful tax services remains consistent with auditor independence.
The proposed regulations list "expert services unrelated to the audit" as prohibited services. As drafted, this rule would not allow tax professionals of an audit firm to represent its client in an audit by the IRS or other taxing authority. It is inconsistent to assert that the auditor can be independent while preparing and advising a client on tax returns, but cannot defend positions taken on the same return in legal, administrative or regulatory proceedings. If an audit fee is not dependent on results of such proceedings and different firm professionals perform the audit and tax services, then independence should not be considered impaired.
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We appreciate the opportunity to comment on the proposed regulation, and remain committed to enhancing public trust in the profession.