EPSTEIN, WEBER & CONOVER, PLC
December 13, 2002
Mr. Jonathan G. Katz
Re.: File No. S7-49-02
Auditor independence has become one of the public's most vocal issues in light of financial reporting fraud and failed audits. Congress has passed the Sarbanes-Oxley Act ("Act") with certain provisions dealing with auditor independence. Independence in-fact and in appearance is the cornerstone of our profession's integrity. Personally, in my 20 years in this profession, I have never known an auditor to risk his or her career, livelihood, reputation and integrity by purposely compromising that independence by accepting inappropriate management positions because of a cozy relationship with that client or because of a concern over losing that client and suffering a financial set back. However, there is certainly a perception that these situations do occur and the profession must respond.
Auditors are typically caught in a paradox where they have been trained to provide client service. However, they are frequently put into a position that is adversarial to that of their clients. The Act has provided for regulations regarding improperly influencing the auditor. We believe that these regulations will help in the context of this paradox. Those regulations should be strongly worded.
The profession and regulators have begun to place new requirements on auditors and preparers of financial information that appear to be steps in the right direction. However, we believe that independence issues do play an important part in dealing with these problems, it should not be the primary focus and nor should rules be implemented that so drastically may affect the way we conduct our business.
Our comments outlined below will address our opinions on the partner rotation rules.
The Act appears to have been designed with the large firms in mind. There does not appear to have been significant analysis on the effect on smaller firms. One of the concerns that had been voiced relates to the potential of a significant consolidation in our profession providing greater clout to a smaller group of participants. It would appear that the partner rotation rules would only exacerbate that possibility. As proposed, the partner rotation rules would eliminate a significant number of firms from the list of firms performing audits for public companies. This would force small public companies to go to larger firms and significantly increase their costs and likely reduce their level of attention provided by the auditors. Precluding smaller firms would deplete the talent pool of professionals assisting thousands of public companies. Our firm has four principals, all with substantial "Big 4" experience. One of our audit partners was employed by the SEC. We believe our firm has a very talented group of professionals and that we are capable to provide a comparable level of service to that provided by the larger firms. We are certain that there are numerous other talented small firms as well.
We believe that our relationships with our clients are different than those at the larger firms. Many of our clients rely upon us as business advisors. In many cases we know our clients' business nearly as well as management. Our business is dependent upon those relationships. Forcing us to turn over those relationships for five years may cause our clients to seek another firm altogether.
Many small firms such as ours have limited personnel to staff engagements. We carefully staff our audits with personnel experienced in SEC reporting matters as well as certain industry specializations. Under the proposed partner rotation rules, it would appear that firms would be required to have a minimum of four qualified audit partners and perhaps more when industry specializations are considered. We believe that this requirement would preclude a large number of firms from performing audits for public companies.
There are likely to some unintended results from these regulations. Firms will, at least initially, attempt to save their business by devising and implementing plans to comply that almost certainly will increase the risk of audit failure, especially in the short term. There is certainly a significant benefit to the audit process in familiarity and continuity. Lack of continuity will certainly raise the cost of performing the audits, especially in the smaller firms.
The profession has historically had an exemption to the partner rotation rules for smaller firms. It appears that the public's perception, as well as that of Congress, is focused on the large firms. That is not to say that the independence issue is, or should be, isolated to the large firms. However, there may be some alternatives to the partner rotation rules that would allow smaller firms to continue to serve as auditors of public companies without incurring significant hardship. Some possible alternatives may include:
Rotation of the concurring partner
Concurring partners are required to have a significant profile now. Consider requiring greater involvement and greater stake for the concurring partner. If the concurring partner has a greater stake, he or she would likely have a greater influence on the decision process. There would still be a new set of eyes upon rotation of the concurring partner without such a significant disruption. The current rules now allow for outside review. Maintaining that option would allow small firms to seek filling concurring review responsibility outside of the firm. Also, consider providing an extensive list of responsibilities for the concurring partner.
Require all public companies to have independent audit committees
The auditor will report directly to the audit committee and therefore eliminate some of the influence that management may attempt to exert upon the auditor. Currently, not all public companies are required to have independent audit committees.
Other new independence enhancement rules
It would appear that other proposed rules will substantially enhance auditor independence, notwithstanding the partner rotation requirement. Provide strong regulations for unduly influencing auditors. Perhaps requiring a review of smaller firms more focused on technical accounting and reporting matters rather than the QC approach that appears to be the focus of peer reviews.
When considering how to define a "small firm", perhaps a benchmark can be determined based on the number of audit partners in a firm where it would cease to be a hardship. That number would have to be determined after conclusion on other matters raised in these proposed rules such as the rotation of other engagement partners and personnel. Perhaps that definition can be formulating using an engagement approach such as that used for accelerated filers.
In conclusion, we request that the Commission consider the financial hardship to small public companies and their auditors should the partner rotation rules be implemented for small firms as well. Consider the effect on the quality of the audits, especially in the short term.