National Association of State Boards of Accountancy
150 Fourth Avenue North, Suite 700, Nashville, TN 37219-2417
Tel 615/880-4200 Fax 615/880-4290 Web www.nasba.org
January 13, 2003
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: File No. S7-49-02
As the national organization of state accountancy regulators, the National Association of State Boards of Accountancy (NASBA) applauds the Commission's efforts to implement the Sarbanes-Oxley Act of 2002. NASBA's member boards, composed of both licensees and public members, are obliged by state law and oaths of office to place the public interest above advocacy for special concerns. As rulemakers themselves, NASBA's constituent boards appreciate the challenges of a politically-charged legislative mandate to shape a transparent, efficient and vigorous regulatory approach to restoring investor confidence in the financial reporting for SEC issuers. As enforcers who remain the only authorities empowered to revoke CPA licenses, NASBA's member boards understand the delicate balance between the need for swift discipline and the necessity of procedural fairness. Finally, as independent government agencies that must operate exclusively on licensing fees, NASBA's member boards are sensitive to budgetary realities that inevitably limit program prerogatives.
NASBA's ongoing primary focus will be upon rules implementing enforcement, with special attention regarding federal/state cooperation. We note certain areas of particular interest regarding the proposed auditor independence rules because of their potential to enhance and compliment state regulation.
In developing these comments regarding the proposed rules, NASBA asked its committees, staff and Board of Directors to offer feedback. A sampling of comments are summarized in section III below and may provide additional insight for your consideration of these complex issues.
I. General Comments
In general, NASBA continues to urge that the new regulations promote vertical clarity so that state accountancy boards can easily translate Commission/Public Company Accounting Oversight Board case results into swift, equitable and defensible disciplinary actions against audit firms and individual licensees implicated in violations of the new rules. In so doing, the Commission will be able to place greater practical reliance upon an effectively administered state board licensing function that puts the offending CPAs at risk of losing not just their SEC clients but their certificates and their livelihoods as CPAs. NASBA respectfully notes that state accountancy regulation is not self-regulation, but licensing based on state law that when applied and exercised can result in discipline in a number of forms including the revocation of the right to practice and call oneself a CPA.
Our past interaction with the Commission strongly suggests that a closer cooperation and working partnership with the State Boards would result in a more potent regulatory effort.
II. Discussion Of Selected Questions Concerning Some Of The Proposed Rules
B. Services Outside the Scope of the Practice of Auditors
NASBA urges caution and suggests that such direct restraints on trade in financial services should not yet exceed the specific mandates of Sarbanes-Oxley.
In consultation with the professional associations, various regulators, industry leader, and lawmakers, NASBA spent several years assisting in the development and implementation of the Uniform Accountancy Act (UAA) which has been adopted in some form in a majority of states. That Act codified a somewhat different statutory approach to limitations that state accountancy boards could place upon the types of products and services auditors could offer to audit clients. The perspective of the UAA restraint was to focus upon the form and business context of method of compensation. Although that approach is different in form from the line-of-commerce approach provided in Sarbanes-Oxley, the practical effect might be comparable. Ironically, the UAA was in large part an effort to align state accountancy laws with the preferences of the Federal Trade Commission and the U.S. Supreme Court particularly with regard to restraint of trade.
C. Partner Rotation.
For now, NASBA believes it would be prudent to limit certain aspects of the rule on audit partner rotation to the requirements prescribed by Sarbanes-Oxley. (For purposes of these comments, the term "partner" includes also principals or shareholders as contemplated by the scope of the proposed rule.) NASBA believes that the initially adopted rule should apply only to the lead audit partner and the concurring review partner (as provided by Sarbanes-Oxley) rather than each audit engagement team partner. NASBA also believes that the initially adopted rule should require rotation off of the audit engagement team for one year, (including possible exceptions or alternate standards for smaller firms) as contemplated by Sarbanes-Oxley rather than five years. Stricter standards on these two requirements may well be appropriate and the
Commission should consider proposing stricter rules and inviting extensive comment on these points when there is time for more thoughtful consideration both by interested parties and by the Commission.
As a technical drafting matter (in the event the adopted rule applies to audit engagement team partners rather than just the lead partner and the review partner), the current (previously existing) definition of "audit engagement team" in 17 CFR 210.2-01(f)(7) appears to be broader than intended for this purpose (based on the discussion in the Proposing Release). The current definition of "audit engagement team" includes "all partners, principals, shareholders, and professional employees participating in an audit, review, or attestation engagement of an audit client, including . . . all persons who consult with others on the audit engagement team during the audit, review, or attestation engagement regarding technical or industry-specific issues, transactions, or events." However, the discussion in the Proposing Release regarding the proposed rule on partner rotation notes that "partners assigned to 'national office' duties . . . who may be consulted on specific accounting issues related to a client are NOT considered members of the audit engagement team even though they may consult on client matters regularly" (emphasis added). Still, the expansion of the rule beyond Sarbanes-Oxley to include "audit, review or attest services" rather than just "audit services" does appear appropriate since the policies that would warrant protection of independence for audit engagements would also apply to review and attest engagements.
Also, the expansion of the rule beyond Sarbanes-Oxley to include services for an "issuer or any significant subsidiaries as defined in 17 CFR 210.1-02(w)" rather than just an "issuer" likewise appears appropriate -- especially if the rule is limited to the lead audit partner and the review audit partner and/or requires rotation off of the audit engagement team for just one year (or other short period of time). The restriction on audit, review or attest engagements for significant subsidiaries likely is needed to protect against abusive evasion of the rule. However, the test of significance uses operating income as a measure. Because operating income can fluctuate greatly from year to year, there would be the potential for inadvertent violations.
F. Definitions - "Accountant"
NASBA asks, as a drafting matter, whether there is any need for the proposed addition of an express reference to "registered public accounting firm" since the definition has already provided that references to an accountant "include any accounting firm with which the certified public accountant or public accountant is affiliated."
NASBA notes that care should be taken in drafting these and other regulations so as not to dilute the existing requirement for SEC recognition that a CPA be "duly registered and in good standing as such under the laws of the place of his residence or principal office" and that a public accountant be "in good standing and entitled to practice as such under the laws of the place of his residence or principal office."
NASBA suggests that you add to the requirements of Regulation S-X regarding "Qualifications of Accountants" [and/or suggest that the PCAOB require] that an accountant be duly licensed, registered or permitted or otherwise hold valid practice privileges and be in good standing under the laws of each State (to be defined to include the District of Columbia, Guam, Virgin Islands and Puerto Rico) where or with respect to which his activities require the accountant to be licensed, registered or permitted or otherwise hold valid practice privileges under the laws of the State or the rules, regulations or policies of the applicable State Board.
These definitional nuances are all the more significant in light of the recent indication of willingness to exempt foreign issuers (and thus foreign audit firms) from some of the Sarbanes-Oxley requirements.
III. Sample Comments from State Board Members:
General Observations: "While ethics cannot be legislated, it is (or should be) understood that there are legal ramifications for behavior and actions that put the public in an adverse position. Particularly, there should be strict and direct corrective actions taken against professionals who take advantage of the public trust."
Bifurcation of internal audit outsourcing, and bifurcating rules to accommodate smaller firms: "While independence should be situationally determined, smaller registrants should make provisions to meet SEC objectives. Specifically, where a Company does not have the resources available to establish an internal audit function, it may instead have the accounting firm perform an independent assessment of the Internal Control Structure, as part of its interim preparation."
Another observed: "This seems to be a major issue where internal audit services are performed for audit clients due to a lack of sufficient employed personnel. It would appear that a size and percentage limitation would be sufficient as long as the audit committee approved each engagement and the engagement was limited in scope to supplementing internal personnel -- as long as registrant personnel performed the selection of the procedure to be performed and evaluated the results and were competent to perform these duties."
The boards were specifically asked to comment on the number of accounting firms with revenue under $6-million and the response quickly came back that the boards do not collect these statistics.
Audit Partner Rotation: There was support for the requirement in general: "Reference is made to a suggestion of performing forensic audits on accounting firm work in lieu of partner rotation. A forensic audit is an additional expense incurred (most likely by the client ultimately), which will have an after-the-fact effect, if in fact independence is impaired due to the partner relationship with the firm. A proactive, preventative action is to rotate the partners. Preventing long-term, cozy relationships is the impetus. Additionally, the ability of the accounting firm to provide accurate results, and thus high quality professional services, should be evaluated before the firm is chosen."
Audit Committee Structure/Responsibility: "Given the heightened emphasis on the role of the audit committee in the financial reporting process, perhaps the best way to prevent audit committees from delegating their authority would be to make it legislatively prohibited. Additionally, the SEC could determine a framework for corrective actions that could be taken against audit committees that do not fulfill the intended role."
Another stated: "SEC registrants should be required to have audit committees since we are relying on them to maintain the independence of both management and the auditor. ..."
Cooling-Off Period Provisions: "One year should be adequate time, and it should apply to all [audit clients] ... not just those defined in Section 205, but there should be a mechanism for granting of a waiver in certain circumstances."
"Calling for a five-year time out period would especially affect smaller accounting firms."
Coverage of Appropriate Officers Including National Office Personnel: Some believed that the rules should include "anyone who has oversight responsibility for the financial statements."
Non-Audit Services Restriction: The general consensus was that "There may be other services. However, this is such a complex area, development of rules should be delayed until sufficient time and input can be provided. This time frame is too short to address this issue."
In the area of information systems, one stated: "Assistance in selecting or testing accounting information systems is one of the primary ways that those with audit knowledge might serve audit clients. One way that would not seem to violate independence rules would be assistance in determining whether the changes in accounting information systems overcome weaknesses identified by the auditor or testing to find out whether the proposed changes did overcome these weaknesses."
On the specific issue of providing software, some felt that the "key might be whether the software is 'off the shelf' or not. As long as the auditor is not involved in developing the software, independence is maintained."
Regarding valuation services for tax purposes, comments included: "The question here seems to be whether valuation for tax services will be incorporated into the financial statements in ways which affect the `auditor auditing his or her own work.' This determination should be left to the auditor and the audit committee."
Another comment: "While overall services listed could impair an auditor's independence, there probably are some cases (perhaps actuarial services to a client's pension fund) that might not. The SEC's ability to approve these outside services is a good solution."
Use of Forensic Auditors: Comments included: "The use of forensic auditors should be left to the judgment of the company. It is an unnecessary expense and the benefits are difficult to define."
Another was: "In principle, a forensic exam during the engagement period could be quite disruptive, compromising the trust the client has that the firm will perform adequately. An accounting firm's technical capabilities should be addressed during an inspection process, not an engagement."
Composition of the audit engagement team: Some commented that: "Clearly, this definition is important since it concerns who might be subject to state disciplinary action in the event of non-compliance. The current discussion is imprecise about how an accounting firm should document individuals who meet this definition."
NASBA appreciates the opportunity to provide our comments and concerns. If you have questions concerning our comments on these independence proposals, please contact us. We look forward to responding to other proposals as appropriate. The state boards encourage enhanced cooperation and communication with the Commission.
|K. Michael Conaway
|| David A. Costello|
President & CEO, NASBA