From: AURORA GROUP,INC. [AURORAGROUPINC@compuserve.com] Sent: Monday, January 13, 2003 10:29 AM To: Jonathan G. Katz Subject: File Np. S7-49-02 Response to Proposed Rules on Appraisal/Valuation Services File No. S7-49-02 Jonathan G.Katz, Secretary, U.S. Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC, 20549-0609. In response to the proposed rules on Appraisal or Valuation Services, Fairness Opinions, or Contribution-in Kind Reports, I wish to address the issue of "Cost Segregation Studies" as being a listed exception to the scope of the Sarbanes-Oxley Act of 2002. Cost Segregation Studies have historically been recognized as being and integral part of the valuation profession. In 1979 the Internal Revenue Service issued a National Office Technical Advice Memorandum reviewing the proper valuation procedures for cost segregation studies. (LTR7941002, June 25, 1979). These valuation procedures have been recognized and accepted by the Tax courts and other reviewing/examining agencies as key to the acceptance or rejection of cost segregation studies in disputed issues. The preparation of cost segregation studies requires the preparer to be competent in design, construction, and construction estimating procedures relating to building construction. In addition, the preparer must have extensive experience in valuation procedures, valuation concepts, and accounting treatments of assets and asset components. Professional valuation and appraisal companies have traditionally performed such cost segregation studies using the guidelines set forth by the National Office of the Internal Revenue Service, and by standards set forth in numerous professional appraisal organizations. Independence in preparing these cost segregation studies is crucial in order to provide the recipient with a fair and reasonable opinion as to not only the classification of the assets contained in a project, but the items which make up the fully allocated value of the assets. Over the years, the professional accounting firms have recognized the market for cost segregation studies and have established groups within the Tax and accounting practices in select offices in the country. Some accounting firms have added staff members with the necessary credentials to perform cost segregation studies. Marketing these services has been through auditing partners and tax partners of the accounting firms. However, the independence issues in preparing cost segregation studies and then reviewing and/or auditing the studies by the same accounting firm has been an issue yet to be resolved. Most of the accounting firms which provide audit services to publicly traded companies have eliminated their valuation staffs performing such services for financial accounting purposes. The accounting firms have either spun-off the respective staff members through a sale of the valuation practice or through the establishment of a separate, but related entity. The tax valuation staff members have not been part of this reduction, and are still actively engaged in performing tax-related valuation services for both audit and non-audit clients. The Sarbanes-Oxley Act of 2002 recognizes the independence issues of an accounting firm performing valuation and appraisal services to the clients for which they are the auditor. The bill does not carve out or exempt certain valuation or appraisal services. The exemption for cost segregation studies set forth in the proposed rules jeopardizes the independence of the auditor. As set forth in the rule: 3. Appraisal or Valuation Services, Fairness Opinions, or Contribution-in-Kind Reports Under the Commission's current independence rules, an accountant is deemed to lack independence when providing appraisal or valuations services, fairness opinions or contribution-in-kind reports for audit clients. However, the current rules contain certain exemptions that we propose to eliminate. These proposals would provide that the auditor is not independent if the auditor provides appraisal or valuation services, or contribution-in-kind reports where there is a reasonable likelihood that the results of the service will be subject to audit procedures by the auditor because the auditor is in a position of auditing his or her own work. Additionally, an auditor is not independent under the proposal if he or she provides a fairness opinion because to do so requires the auditor to function as a part of management and may require the auditor to audit the results of his or her own work. Appraisal and valuation services include any process of valuing assets, both tangible and intangible, or liabilities. …. Providing these services to audit clients raises several auditor independence concerns. When it is time to audit the financial statements, the accountant could likely end up reviewing his or her own work, including key assumptions or variables that underlie an entry in the financial statements. Also, where the appraisal methodology involves projection of future results of operations and cash flows, some believe that the accountant that prepares the projection could have a mutuality of interest with the client in attaining forecast results.37 The auditor may feel constrained by the valuation and appraisal issued by the firm, and as a result, the auditor may be unable to evaluate skeptically and without bias the accuracy of that valuation or appraisal. (emphasis added) Finally, the following statement is added to the proposed rules: Our proposals do not prohibit an accounting firm from providing such services for non-financial reporting (e.g., transfer pricing studies, cost segregation studies) purposes. The proposed rule does not limit an accounting firm from utilizing its own valuation specialist to review the work done by the audit client itself or an independent, third-party specialist employed by the audit client, provided the audit client or the client's specialist (and not the specialist used by the accounting firm) provides the technical expertise that the client uses in determining the required amounts recorded in the client financial statements. In those instances, because a third party or the audit client is the source of the financial information subject to the review or audit, the accountant will not be reviewing or auditing his or her own work. Additionally, the quality of the audit may be improved where specialists are utilized in such situations. It is our belief that Congress did not intend to provide exceptions, which provide accounting firms with the ability to do valuation or appraisal work for their audit clients. The exception for cost segregation studies (as well as the exception for transfer pricing) has been added to the Bill via the Proposed Rules in order to provide opportunities not authorized in the Bill. The definition of Prohibited Activities includes non-audit services such as "appraisal or valuation services…." On the surface, the exception in the Rules appears to be for non-financial reporting purposes only (e.g. Federal Taxation). But one must carefully review the use of cost segregation studies in the corporate world. The Senate Report on the bill that was the primary foundation for the Act, 24 states, in part: The intention of this provision is to draw a clear line around a limited list of non-audit services that accounting firms may not provide to public company audit clients because their doing so creates a fundamental conflict of interest for the accounting firms. The list is based on simple principles. An accounting firm, in order to be independent of its audit client, should not audit its own work, which would be involved in providing bookkeeping services, financial information systems design, appraisal or valuation services, actuarial services, and internal audit outsourcing services to an audit client. (emphasis added) Cost segregation studies, are by their content, valuations of assets for the purposes of establishing a reasonable basis for each asset. The content of the cost segregation studies (done in accordance with the established standards of performing cost segregation studies) is used for capitalizing assets in a fixed asset tracking system. Depreciation/Recovery is calculated using the values set forth in the cost segregation study. While an auditor may present the case that the purpose of the cost segregation study is to provide a basis for Federal or State Tax recovery (and therefore fall into the exception category), it is highly likely that the same study will be used to establish the asset basis in the financial accounting system for recognizing depreciation. In fact, most Property tax and other State related agencies rely on the financial accounting records to determine the applicable tax basis. The assumption that the valuation or appraisal services (i.e. cost segregation studies) are unrelated to the financial statement and would not result in a potential conflict of interest or independence issue is flawed. Independence is crucial to a comprehensive and accurate audit. We agree that a client may elect to perform a cost segregation study internally, or may elect to have an independent third party such as: · Professional valuation/appraisal firms · Accounting firms which do not provide auditing services to the client which would result in auditing a cost segregation study performed by the same accounting firm However, we do not agree that the accounting firm engaged to perform the audit can perform cost segregation studies for their clients in an independent manner. Providing an exception for cost segregation studies under the proposed rules may raise serious questions about the true independence of the auditor. If, for example, a firm elects to use their audit firm to provide a cost segregation study for a non-financial purpose, and then the results of that study are used to establish the financial accounting basis for calculating depreciation, how would the auditor maintain independence in reviewing the financial fixed asset records? In addition, if a firm elects to have their auditor review previous tax/fiscal years in order to correct classifications of assets the auditor may have to perform detailed cost segregation studies on assets which were erroneously booked as a mass asset. The cost segregation study then provides the "corrected assets" to replace the "incorrect" mass asset. Obviously, the client would ensure that the correction was made in the entire fixed asset system, which would include both tax and financial accounting. Again, the door to independence is left ajar with the potential review of the cost segregation studies in the content of the audit. Finally, one must look at what cost segregation studies are used for in order to fully appreciate the potential for a breach of independence by the auditor. The following examples are what cost segregation studies are normally used for by corporate America: · Allocation of purchase price · Retirement studies · Like kind replacement studies · Property taxation · State taxation · Federal Taxation · Transfer pricing · Disposition studies · Donation valuations · Insurable value studies · State and Federal Tax Credit studies · Fixed asset system implementation · Fixed asset consulting · Chart of Accounts development · Financial Accounting capitalization · Research Tax Credit studies One does not have to look hard at this list of uses of cost segregation studies to recognize the impact and interrelationship with financial accounting. In each instance, there is a definite and identifiable correlation to the financial accounting records of a company. And, these are the records, which are an integral part of an audit in which the auditor is obligated to present an independent review and opinion. In conclusion, it is our considered opinion that the exception for accounting firms to perform cost segregation for which they are the auditors is not warranted. The intent of the Sarbanes-Oxley Act of 2002 was to remove the auditor from the position of performing any service, which questions the independence of the audit. By providing exceptions to the Act, the door is left ajar for future questions as to the independence of the auditor. In order for the Act to create a comfort level in investors, there should be no defined exceptions (such as cost segregation studies) to the nine prohibitive services delineated in the Act. Respectfully submitted, George T. Hamilton Senior Vice President Aurora Group, Inc. NOTE: The following information is considered relevant to the credentials of Mr. Hamilton in preparing this response: Mr. Hamilton has been in the valuation/appraisal industry since 1973. He holds undergraduate degrees in construction and civil engineering from Purdue University as well an MBA from DePaul University. Mr. Hamilton's expertise is cost segregation and fixed asset system implementation. He has authored 6 books on cost segregation services for both Investment Tax Credit and Depreciation issues. Mr. Hamilton is a retired Lt. Commander in the U.S. Naval Reserve's Civil Engineer Corp. Mr. Hamilton is a recognized expert in the complex area of cost segregation and is a certified expert witness in the Tax Courts. Mr. Hamilton has given numerous speeches on the topic of cost segregation to local and national meetings of corporate tax and accounting organizations. In addition, Mr. Hamilton provided testimony to the Committee on Ways and Means on the tax treatment of assets, as well as State legislative bodies on appraisal certifications. In 1986, Mr. Hamilton was a candidate for the U.S. House of Representatives. Aurora Group, Inc. is a full service valuation and appraisal firm headquartered in Burr Ridge, IL.