January 13, 2003
Jonathan G. Katz
Dear Mr. Katz:
Ref: File S7-49-02
Thank you for giving us the opportunity to respond to your proposed rule on "Strengthening the Commission's Requirements Regarding Auditor Independence". The Canadian Institute of Chartered Accountants ("CICA") together with the provincial and territorial institutes of chartered accountants represents a membership of approximately 68,000 CAs and 8,000 students in Canada and Bermuda. The CICA through its members provides funding for the setting of accounting standards and assurance standards for business, not-for-profit organizations and government. The provincial and territorial institutes establish and enforce rules of professional conduct, including auditor independence requirements.
Background and Implications
Canada has a history of maintaining a strong system of financial reporting and auditing based on accounting principles and auditing standards that are very similar to those in the U.S. and that include effective regulation through monitoring, discipline and enforcement. This was no doubt a significant consideration in the establishment of the Multijurisdictional Disclosure System (MJDS) between the SEC and the Canadian Securities Administrators. Under this unique relationship Canadian registrants under MJDS are permitted to file Canadian GAAS audit reports. The SEC has not granted such an accommodation to any other country.
Auditor independence is one component of an integrated solution we are implementing in Canada to improve investor confidence in the quality of financial reporting. In Appendix 1 to this letter we have summarized the initiatives taking place in Canada in addition to proposed new auditor independence rules. These other initiatives include increased oversight of the profession, new practice inspection procedures, new disciplinary processes and enabling legislation for securities regulators. Together with the proposed new Canadian auditor independence standards, these initiatives are designed as an integrated set of reforms to achieve the same overall objectives as the Sarbanes-Oxley Act in the U.S. We trust that the SEC will recognize that Canada's initiatives achieve the same objectives as the requirements that are being implemented in the U.S. Consequently, we hope that you will consider providing an accommodation to exempt Canadian filers and their audit firms from matters such as practice inspection, disciplinary processes and independence requirements.
The proposed SEC independence rules will have a greater effect in Canada than any other country outside of the United States because of the large number of Canadian SEC registrants. These companies represent a significant percentage of the market capitalization of Canadian markets. The implementation of these proposals will have a pervasive effect on Canadian issuers, regulators and accounting firms.
Auditor Independence Standards
While we are not commenting on the detailed requirements of the proposals, in Appendix 2 to this letter we have provided an overview of the proposed Canadian independence standards which have been developed from the principles-based framework issued by the International Federation of Accountants and which incorporate the more rigourous SEC requirements for listed entities. The appendix demonstrates that since the standards are founded on the same principles as the U.S. proposals they achieve a similar outcome.
Notwithstanding the similarities in approach, there is a significant structural difference between the Canadian and U.S. capital markets which we would like to raise. Other than the Greater Toronto area, Canada does not have a concentrated urban center that would compare to any such centers in the U.S. The offices of firms serving SEC clients are spread 4,500 miles across Canada. The SEC proposals to extend the requirements for partner rotation to cover all partners who provide audit services would therefore be challenging in the Canadian market. This is compounded by the fact that most Canadian auditors are not expert in U.S. accounting standards and SEC regulations. Also, Canada is a bilingual country but many partners serving SEC clients do not have French language capabilities, which limits geographical moves by partners.
Nevertheless, Canadian independence standards would require rotation of the lead engagement partner every five years, similar to the SEC proposals. For other senior members of the engagement team the threat to independence is addressed through the application of safeguards.
It is critical that Canadian foreign private issuers and their auditors have a lengthier transition period than U.S. issuers and their auditors. This is necessary because the SEC proposals are a greater change from existing requirements for Canada than for the United States. As noted above, Canada is currently revising its independence requirements for Canadian public companies to achieve the same objectives as existing and proposed SEC rules. This will have significant implications for Canadian audit firms as they implement, for example, partner rotation requirements for Canadian public companies.
A longer transition period would permit Canada's own new independence standards, which are important to the confidence of Canadian capital markets, to be implemented in a reasonable manner during 2003 without undue pressure that could arise from competing SEC requirements. It is important that the SEC's initiatives do not have the unintended consequence of negatively impacting Canadian efforts to achieve similar goals. At a minimum the transition arrangements for Canadian issuers and their auditors should be two years longer than the transition arrangements in the U.S.
Canada is implementing an integrated solution to improve investor confidence in the quality of financial reporting. We trust that the SEC will recognize Canada's initiatives as achieving the same objectives as the Sarbanes-Oxley Act. We hope that you will consider providing an accommodation to exempt Canadian filers and their audit firms from matters such as practice inspection, disciplinary processes and independence requirements.
Notwithstanding the similarities in approach there are structural differences between Canada and the U.S related to market size which must be carefully considered.
As a minimum it is critical that extended transition arrangements be granted because the proposals are a greater change from existing requirements for Canada than for the United States.
We welcome the opportunity to respond to your proposed new rules and look forward to a continued cooperative relationship between Canada and the U.S. in these matters of joint interest. We would be pleased to meet with you to discuss these matters further.
David W. Smith, FCA
OTHER CANADIAN INITIATIVES TO PROTECT THE PUBLIC INTEREST
The proposed Canadian independence standards are part of an integrated solution to improve audit quality and financial reporting. Other components of this integrated solution include:
Public Oversight of the Profession
The Canadian Public Accountability Board ("CPAB"), was announced in July 2002 by the Canadian Securities Administrators, the Office of the Superintendent of Financial Institutions and Canada's chartered accountants, It is a new independent organization that will oversee auditors of public companies. The mission of CPAB is to contribute to public confidence in the integrity of financial reporting of Canadian public companies by promoting high quality, independent auditing. The members of the board of CPAB will oversee the design, implementation and enforcement of a system of independent inspection of auditors of Canadian public companies. To ensure appropriate transparency, CPAB will report annually to the public on the conduct of its activities and the results achieved. Gordon Thiessen, a former governor of the Bank of Canada, has been appointed as the founding chair of CPAB.
In October 2002, the Canadian Institute of Chartered Accountants ("CICA") announced the establishment of an independent public body to oversee the setting of auditing and assurance standards in Canada. The Auditing and Assurance Standards Oversight Council ("AASOC") will oversee the Assurance Standards Board, providing input, strategic direction and the perspective of users into the setting of auditing and assurance standards in Canada. James Baillie, a former chairman of the Ontario Securities Commission, has been appointed as the chair of AASOC. AASOC will report publicly on its activities.
In September 2000, the CICA established an independent body to oversee the setting of accounting standards in Canada. The Accounting Standards Oversight Council ("AcSOC") oversees the Accounting Standards Board. Reporting to the public and consisting of 21 prominent business and government leaders, it brings a broad perspective to complex issue facing standard-setters. Thomas Allen Q.C chairs AcSOC
One of the responsibilities of CPAB is to design and implement a rigorous program for the inspection of public company auditors. The practice inspection unit will be led by a full-time inspector and will have its own staff. The inspection process will commence in 2003.
One of the outcomes of the CPAB practice inspection could be to impose sanctions directly or in appropriate circumstances, through a provincial CA institute, to ensure identified deficiencies are rectified in a timely manner. CPAB may also refer matters to the appropriate securities regulator.
In addition an independent review of the disciplinary process of the Ontario Institute of Chartered Accountants was recently conducted and published. As a result of this review, reforms are being implemented that will substantially broaden the reach of the Institute's existing rules of professional conduct which includes the ability to discipline of firms. In particular, to underscore the Institute's position, in the course of exercising their professional duties, chartered accountants in industry are expected to avoid and discourage reliance on any "fringe interpretation" of generally accepted accounting principles.
Amendments to Ontario Securities Act
In December 2002, a bill was passed by the Ontario Government initiating a number of reforms, including several related to financial reporting and auditing. The changes empower the Ontario Securities Commission to prescribe practices similar to provisions of the Sarbanes-Oxley Act. For example, the Ontario Securities Commission is given power to make rules requiring the appointment of and prescribing requirements for audit committees, requiring systems of internal controls, requiring disclosure controls and procedures, requiring chief executive officers and chief financial officers to provide certifications relating to internal controls and disclosure controls and procedures and defining auditing standards for reporting on internal controls.
Participants in these Reforms
The participants developing these reforms in Canada have included the provincial securities regulators, the Office of the Superintendent of Financial Institutions, the Canadian Institute of Chartered Accountants and the provincial Institutes/Ordre of Chartered Accountants. Public comment has been sought and received and, as you can see from the above, a number of changes are being rapidly implemented.
CANADIAN INDEPENDENCE STANDARDS
Significant changes to the independence standards for auditors are being introduced in Canada. These proposed independence standards address the same goals that the SEC's independence proposals aim to achieve. The Canadian proposals represent a move towards a rigorous "principles-based approach" establishing the principles of independence and providing a conceptual framework, along with specific examples, for applying those principles. The proposals would require members of the profession and firms to identify any threat to independence created, for example by the provision of a non-audit service. Members and firms are required to evaluate the significance of any threat and apply safeguards to reduce the threat to an acceptable level. In certain circumstances no safeguards can reduce the threat to an acceptable level and accordingly the proposed standard prohibits such activities or relationships.
Context vis-à-vis SEC proposals
The Canadian proposed independence standards1 were issued by the Public Interest and Integrity Committee of the CICA ("the Committee"). The following comments from the foreword to the Exposure Draft puts the Canadian proposed standards in context vis-à-vis the SEC proposals:
The Committee recognizes that independence standards continue to be the subject of significant debate internationally and, particularly, in the U.S. where SEC requirements will change in response to the Sarbanes-Oxley Act of 2002. As the full nature and extent of the changes in the U.S. will not be known until the SEC establishes the regulations required by the Act, the proposed Canadian standard incorporates the current SEC rules for listed entities. The Committee is aware the SEC rules will be updated to address the current public concerns. Accordingly, the Committee will review the revised SEC regulations when they are issued and promptly modify the Canadian proposals, as necessary to protect the public interest in Canada. The Committee will also monitor and recommend, as appropriate, the implementation of any changes to the IFAC code, thereby ensuring convergence with current global standards."
The SEC proposals and the Canadian proposals are founded on the same premise. Under the SEC proposals the scope of prohibited services is judged against the three broad principles that: an auditor cannot
Under the Canadian proposals all activities and relationships are judged against five threats to independence
Although these principles are characterized in different ways, because they are founded on the same premise their application results in an essentially similar outcome. Consequently we hope that the SEC will recognize that Canada's proposed independence standards achieve the same objective as the SEC proposals and therefore will view adherence to Canadian independence standards as equivalent to complying with SEC rules.
To illustrate the application of the framework we provide an example of how the standards are equivalent. This example relates to partner rotation but the principles would apply to other items including, for example, taxation services. The SEC proposals to extend the requirements for partner rotation to cover all partners who provide audit services to the client may be problematic in the Canadian market place for reasons that include the following:
The proposed Canadian independence standards would require the rotation of the lead audit engagement partner every five years, similar to the SEC proposals. However, for other senior members of the engagement team, the proposed Canadian standards would take a threat and safeguards approach. Paragraph 80 of the proposed Canadian standards states:
The auditor must document the identified threats, the safeguards applied to eliminate the threat or reduce it to an acceptable level, and provide an explanation of how the safeguards eliminate or reduce the threats to an acceptable level.