From: John Lyon [jlyon@arthurconsulting.com] Sent: Thursday, December 12, 2002 2:39 PM To: rule-comments@sec.gov Subject: Comments on Proposed Rule Regarding Auditor Independence, File: S7-49-02 Dear SEC: The following comments relate to the proposed revision to section (c)(4) Non-audit services. (iii) Appraisal, or valuation services, fairness opinions, or contribution in kind reports. In the Discussion of Proposed Rules addressing this section, it is stated that "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." We have a number of concerns with this comment: 1. Does this comment mean that "non-financial reporting" is "for tax purposes"? If so, this seems completely inconsistent with Sarbanes-Oxley and the discussed elimination of the (4) prior exemptions from this section, including the elimination of "(B)(3) The valuation is performed in the context of the planning and implementation of tax-planning strategy or for tax compliance services." If valuation studies for tax purposes are to be allowed, what is the point of removing this exemption from the Rule? How can a major expense such as taxes not be regarded as being subject to "audit procedures"? 2. Alternatively, if valuations for tax purposes are intended to be prohibited under the revised Rule, why are transfer pricing studies and cost segregation studies excluded from this prohibition? These types of studies are specifically for "the planning and implementation of tax-planning strategy or for tax compliance services." Again, if these studies are to be allowed, what is the point of removing this exemption from the Rule? 3. If transfer pricing and cost segregation studies are to be allowed because they are not regarded as appraisal or valuation services, we believe that these services should be prohibited both due their nature and CPA firms' past behavior with respect to these services. a) As to their nature, prohibited valuation services involve the determination of fair market value through the cost, market and income approaches. Transfer pricing studies determine the income streams of related entities for tax and/or customs duty purposes. Determination of such income streams involves judgment, whether performed for "valuation" or transfer pricing purposes. Cost segregation studies do not merely involve "assisting management in determining the appropriate allocation of a management determined purchase price and/or interpreting income tax law and regulations," as has apparently been the position of the SEC staff in the past. As reflected on the Moss Adams LLP website (www.mossadams.com/services/appraisal_clientsvcs.htm), a cost segregation study includes "accurate estimation of the installed cost of personal property and land improvements using tax-oriented valuation techniques...". According to the Ernst Consulting Group website (www.bestcostseg.com), a cost segregation study is required because "Estimating costs by your contractor or your accountant are not acceptable unless they are part of an engineering study. (IRS Legal Memorandum 19991045)." In other words, these studies involve specialized skill and judgment and are not merely a mechanical allocation of costs provided to the accountant by management. If these tax-related studies are proposed to be allowed because they are subject to review by the IRS, note that the IRS has said, "Resource constraints may limit the ability of the IRS to monitor and judge the appropriateness of these section 1245 designations. The sheer volume of individual items is staggering and the IRS may not be able to review adequately each cost segregation study." Further, "The use of such studies may provide an advantage for aggressive taxpayers and may otherwise provide depreciation allowances that inappropriately vary among taxpayers." (2000ARD 147-1, Treasury Report: Report to Congress: Depreciation recovery periods and methods.) b) As to CPA firms' past behavior, clients have reported to us (when competing against CPA firms for cost segregation work) that they were told by their auditor that audit fees could be reduced if "their people" performed the cost segregation study. Their justification is that they have confidence in their own people and would have to give additional scrutiny to a study performed by another firm. Isn't that what we want? These statements acknowledge a lack of independence and it would be the height of irony for CPA firms to be allowed to continue in this service area after making claims of such "synergies" in the past. Further, please recall the U.S. v. Ernst & Whinney debacle from the early 1980s, where the IRS accused the firm of a broad pattern of deception and falsification with respect to investment tax credit (cost segregation) studies performed for clients. In promoting their services, the firm distributed advertising materials suggesting that they could help claim more investment tax credit than allowed under "traditional methods" of claiming property. The IRS alleged that the following items were claimed and disguised though the use of misleading terminology: concrete blocks were called "knock-out panels"; fixed walls were called "movable partitions-gypsum"; doors were called "movable partitions-wood." In summary, CPA firms do not have a track record of restraint when it comes to serving their clients. They already have a unique, "conflicted" role when providing tax services to an audit client (simultaneously an advocate of the taxpayer and serving the public). The AICPA's Statement on Standards for Tax Services (STTS) 4 states that "The CPA may advise on estimates used in preparation of a tax return, but responsibility for estimated data is that of the client." The CPA should not provide the estimated data. Both STTS-1 and IRS circular 230 require that a practitioner may not prepare, sign, or recommend that a position be taken on a tax return unless the position has a "realistic possibility" of being sustained. How can a CPA firm objectively rely on a tax-related valuation study when it has been prepared by the same firm? CPA firms should not be allowed to perform valuation services, including cost segregation and transfer pricing studies, for their audit clients for either financial or tax purposes. Thank you, John Lyon Senior Vice President Arthur Consulting Group, Inc. Westlake Village, CA