Parson Consulting

January 13, 2003

Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609

Re: File No. S7-49-02 Strengthening the Commission's Requirements Regarding Auditor Independence

Dear Mr. Katz,


Parson Consulting is a leading no conflict financial management consultancy headquartered in Chicago, serving clients in the United States and United Kingdom. Our client base includes over a third of the Fortune 1,000 (who are impacted by the reforms mandated by Sarbanes Oxley), as well as privately held enterprises. Our business is concentrated in helping accounting and finance organizations improve the speed, reliability and efficiency of their finance and business support functions, including those activities that may relate to transaction processing and financial reporting. We accomplish this through three principal service lines: Business Process Engineering, Business Technology and Operational Support Services. Our Services are delivered by experienced consultants who, in prior phases of their careers, served in a variety of industries in roles such as CFO, Director of Finance and Controller.

Recognition of current initiatives, suggestion of additional actions

We applaud the recent actions of the Congress, the Commission, and the securities exchanges to enhance safeguards and improve the integrity of the capital markets. We believe that the recent codification of standards and guidance regarding corporate governance and auditor independence are good starting points. We have concerns, however, that the proposed rules regarding auditor independence may not be sufficient to address the systemic weaknesses which have contributed to near catastrophic losses investors. Our concerns are based upon the following factors contributing to independence challenges:

  • Continued pressure to provide value in addition to assurance services

  • Keen and continuing interest by many public accounting firms to protect their diverse revenue streams

  • Consolidation within the accounting industry which has concentrated resources in a small number of firms (limiting available choices of global scale enterprises for assurance services) and constricted opportunity for other providers of professional services

  • Ineffectiveness of accounting industry self policing mechanisms

  • Apparent preference for rules based frameworks, which encourages "pushing the envelope" and engineering exceptions

  • Potential conflicts of executive officers who hold audit committee positions on other registrants' Boards of Directors, and thus may be in a position of determining service provider for those other registrants, including those that perform attest services to their own enterprises (a condition we refer to as the "Non-Executive Director Web")

Our concerns are heightened by a review of the questions to which the Commission is seeking commentary. It appears to us from the questions that the Commission may be inclined to be more permissive as it relates to auditor independence. Additionally, we believe that the introduction of exceptions, exemptions and clarifications would introduce more complexity to the already difficult task of enforcement and preservation of auditor independence. We fear that such complexity would further undermine investor confidence in the capital markets, service providers, legislators and regulators. Therefore, we urge the Commission to adopt the strictest interpretation of both the letter and spirit of the law, reject any liberalization of the requirements of the Sarbanes-Oxley Act and implement regulations that would:

  • Prohibit any non-audit service (excluding tax return preparation,) by an auditor to a registrant

For the purposes of our discussion, we define audit service to mean the application of analytical and investigative procedures applied to financial statements for the purpose of expressing an opinion as to the fairness of the financial statements in conformity with Generally Accepted Accounting Procedures. This would include limited opinion engagements (review services) as well.

Our suggestion is grounded in a fundamental belief that auditors should do audits and nothing else as it relates to registrants.

We believe the rationale for this suggestion was best expressed in the former Public Oversight Board Panel on Audit Effectiveness Report and Recommendations August 31, 2000 (O'Malley Report), Chapter 5, Statement Supporting an Exclusionary Ban on Non-Audit Services, excerpted as follows:

"Some members of the Panel believe that, with very limited exceptions, audit firms and their affiliates should be excluded by rule from marketing and furnishing management services to their audit clients that do not directly advance the interests of investors in objective and reliable financial reports on the stewardship of management. This position rests on the belief of these Panel members in (a) the central importance of independence to the profession of auditing in general, and to the effectiveness of the audit process in particular, and (b) the severe and growing challenges to independence that the audit profession faces in the current environment"

The report further positioned:

"Of fundamental importance in understanding the conflict of interest that arises from the provision of non-audit services to audit clients is the fact that in so doing the audit firm is really serving two different sets of clients: management in the case of management consulting services ("MCS"), and the audit committee, the shareholders and all those who rely on the audited financials and the firm's opinion in deciding whether to invest, in the case of the audit. The firm is a fiduciary in respect to each of these client groups, duty-bound to serve with undivided loyalty. It is obvious that in serving these different clients the firm is subject to conflicts of interest that tear at the fragile fabric of loyalty owed to one client or the other. And it is equally obvious that the existence of dual loyalties creates a serious appearance problem, regardless of whether, in particular cases, the fabric actually tears apart or not"

With respect to the suggestion that a review and approval by the audit committee of non-audit services by the auditor, members supporting an exclusionary approach stated:

"No one has suggested that the audit committee can be a substitute for clear rules where the problem of conflicts is most serious. Thus, for example there is no suggestion that the audit committee be charged with discretion to assess independence despite the existence of financial interests by the audit firm in its audit client. Stock or other financial interests in one's audit client have long been viewed as creating too clear a conflict of interest to become the subject of discretion. The need for an exclusionary rule on non-audit services is rooted in the same ground: prospective revenues from the provision of non-audit services, extending into the future, create precisely the kind of financial stake that produces a conflict of interest capable of impairing independence."

In offering these excerpts, we acknowledge that the panel members did not all agree with the suggestions excerpted above. We believe however, that the events occurring since the publication of the O'Malley Report confirm what some panelists feared and the continuation of conditions existent at the time of the publication of the report supports the adoption of an exclusionary rule.

In addition to the arguments described in the O'Malley report, we submit that:

  • The franchises possessed by the largest public accounting firms are due in large measure to the requirements of the Securities Acts of 1933 and 1934

  • The largest public accounting firms have financed their tremendous growth with the profits generated from the defacto franchises arising from the '33 and '34 Acts

  • The scale and resources possessed by the largest public accounting firms, financed by the considerable profits arising from the provision of both audit and non-audit services to SEC registrants, now represents a significant barrier to entry for other firms who might otherwise be capable of providing either assurance or management advisory services

  • To allow the largest of the public accounting firms to continue to provide non-audit services to any registrant will not only discourage additional entrants into the assurance business but will also aggravate the independence issues for global scale registrants. Those who may desire to change audit service providers will be limited due to prior engagement of large public accounting firms as management consultants

  • Recent history has shown that the bias against change by the large accounting firms is significant with dire adverse consequences leading to the systemic failure to protect the interests of sophisticated and unsophisticated investors

We recognize that the suggestion we are making clearly goes beyond the rules currently being proposed by the Commission. We also acknowledge that such a proposal is bound to be met with considerable opposition. Nonetheless, we believe that the suggestion merits discussion, perhaps in combination with the prescription by the Sarbanes Oxley Act for the General Accounting Office (GAO) to conduct a study and report regarding consolidation of public accounting firms.

Public Policy benefits of adopting stringent rules

We believe that the adoption of a stringent view of auditor independence as suggested in this letter would result in many benefits to registrants, investors, oversight authorities and auditing firms. Benefits that are available include:

  • Simplicity of standards and ease of enforcement

      A narrow definition of permitted services (i.e. those directly related to the conduct of an audit engagement) eliminates the need for extensive deliberation by registrant audit committees, and reduces the potential for conflict between audit committees and auditors. As stated by the O'Malley Report:

      "Nor is it feasible to expect independence to be assured by approval of the audit committee, because it is impossible to identify when the problem exists, and to challenge the auditor's judgment on the matter is to challenge its integrity, something audit committees are highly unlikely to do. Independence is a state of mind, necessary to maintain the skepticism and objectivity that are hallmarks of the accounting profession. Being subjective and invisible, it is not something an audit committee can apply any known litmus test to determine. Moreover, the credibility problem would remain whenever there are substantial levels of non-audit services being provided. This problem has long been seen as of profound importance to the public maintenance of confidence in the audit function."

  • Level playing field improves choice, recognizes the true value of high quality audit services, and improves price for other non-audit services through increased competition

  • Reduced independence conflicts yield higher quality audits and internal and disclosure control reviews, thereby improving earnings reports and pricing in the capital markets

  • There have been numerous studies which correlate independence to improved earnings quality and share price premiums.

Response to objections to proposals

Previous debate regarding the effect of non-audit services on independence has typically resulted in arguments against significant change. Two objections often raised are:

  • The elimination of auditors as management consulting service providers reduces efficiencies

      While we recognize the benefits associated with the institutional knowledge gained in the course of serving as external auditors, we believe that the capture of the institutional knowledge by alternative consulting service providers is a short cycle event, especially when the alternative service provider develops a business advisory relationship with its clients over time. Furthermore, we believe that external auditors can assist their audit clients well by facilitating the collaborative transfer of such knowledge.

  • The elimination of auditors as management consulting service providers reduces choice

      The plain fact of the matter is that there are dozens of qualified providers of the types of non-audit services that audit firms seek to continue to provide. The choices among the alternatives to audit firms are more plentiful now than ever before. Given this, to include audit firms among the choices at the expense of both the appearance and perhaps fact of independence would be fundamentally unnecessary to provide choice. As stated by the O'Malley Report in response to this objection:

      "Audit firms also argue on behalf of their clients that they are simply giving corporate management greater choice. But independence is not about management choice. Corporate management is the client for management consulting services, but for the audit the clients are shareholders (and the audit committee as surrogate), creditors and the investing public, all of whom need an objective, reliable report on management's stewardship. If offering corporate management a choice of using its audit firm to supply a full range of other services threatens to impair this oversight function, on which the credibility of our markets depends, then the denial of that choice is simply a cost - a minor one at that - of preserving investor confidence in our financial system. Indeed, the proposed rule is the least intrusive method we could imagine for achieving this essential goal."


Thank you for the opportunity to contribute to the discussion of this important issue. We have provided responses to select questions of the Commission in the Appendix to this letter. Should the Commission be interested in accessing our management for clarification of the suggestions in this letter, we can be reached at 312-541-4690.


Kevin Parry
Chief Executive Officer
Parson Consulting


Should an auditor be permitted to provide bookkeeping services to an audit client if it is not reasonably likely that the results of those services will be subject to audit procedures during the audit of the client's financial statements? Why or why not?

Is the standard of reasonably likely sufficiently clear? If not, should we use some other standard? If so, what standard should we use?

Response: We do not believe that an auditor should be permitted to provide bookkeeping services, due to the difficulty in determining "reasonably likely", and the potential for violation of the first principle, i.e. an audit firm should not audit its own work.

Is an auditor's independence impaired when the auditor helps select or test computer software and hardware systems that generate financial data used in or underlying the financial statements? Why or why not?

Response: In our view, assisting in the selection of computer software and hardware systems would be an impairment of auditor independence, much in the same way that performing human resource services would; the auditor would develop a vested interest in the appropriateness of the selection of the software and hardware and may be put in a position to admit or defend a poor choice at the risk of losing the client.

Whether a system is used to generate information that is "significant" to the audit client's financial statements may depend on the size of the engagement. Does the magnitude as a percentage of either audit fees or total fees of the fees for such services make a difference on whether performance of the service impairs independence?

Response: The significance of information in relation to financial statements is not related to magnitude of fees, however measured. Again, for reasons described in our main letter, we believe to allow exceptions based on subjective or difficult to interpret standards defeats the intent of the recently enacted legislation.

Does it impair an auditor's independence if the auditor does not provide to the client outsourcing services related to the internal audit function of the audit client, but rather performs individual audit projects for the client?

Would it impair the auditor's independence if the auditor performs only operational audits that are unrelated to the internal controls, financial systems, or financial statements?

Is additional guidance necessary to distinguish the services that would be prohibited under this proposed rule from those services that would be permitted as operational audits?

Response: In accordance with the arguments presented in the body of our letter, and with respect to the four broad principles cited by Congress and the Commission, we believe any engagement, not directly related to the performance of the audit performed with respect to the financial statements filed with the Commission, or other permitted attest services (comfort letter, etc.) is an impairment of independence. Internal Audit is Internal Audit, period. A series of engagements, separately undertaken but linked to the same strategic objective is Internal Audit. External auditor involvement in operational assessments to determine effectiveness or efficiency puts the auditor in a position of serving as an extension of management. Today, there are simply too many qualified alternatives to allow the risk of impairing independence.

Do services related to designing or implementing internal accounting controls and risk management controls result in the auditor auditing his or her own work? Would such services impair an auditor's independence when the auditor is required to issue an opinion on the effectiveness of the control systems that he or she designed or implemented?

Response: Such services clearly impair the independence of the auditor and would result in the auditor auditing his or her own work, in the same way that providing bookkeeping services or designing, implementing or operating a client's information systems would. Auditors should work with the client and other service providers to determine effectiveness but should leave the implementation to others.

Do services related to assessing or recommending improvements to internal accounting controls and risk management controls result in the auditor auditing his or her own work? Would such services impair an auditor's independence when the auditor is required to issue an attestation report on the effectiveness of the control systems that he or she has assessed or evaluated for effectiveness?

Response: Auditors should be encouraged to make suggestions regarding improved controls, but should not participate in the implementation of the improvements. We do not believe there is independence impairment related to the effectiveness attestation, as long as management's effectiveness assessment is separate and not dependent upon the external auditors.

We request comment on whether there are circumstances under which an accounting firm can perform or assume management functions or responsibilities for an audit client without impairing independence?

Response: We do not believe there are any circumstances under which this is possible.

Should the Commission create other exceptions (beyond the de minimis exception) that would allow an audit committee to adopt a policy that contracts that are recurring (e.g., due diligence engagements in connection with a series of insignificant acquisitions) and less than a stated dollar amount (such as $25,000) or less than a stated percentage of annual revenues (such as 1% or 5%) could be entered into by management and would be reviewed by the audit committee at its next periodic meeting?

Is allowing the audit committee to engage an auditor to perform non-audit services by policies and procedures, rather than a separate vote for each service, appropriate? If so, how do we ensure that audit committees have rigorous, detailed procedures and do not, in essence, delegate that authority to management?

Response: We do not believe exceptions such as those described above would be consistent with the goals of enhanced governance and improved auditor independence. Furthermore, engagement by policies and procedures opens up too many opportunities for the purpose of audit committee participation to be subverted. 

Should more or fewer aspects be left to the discretion of the audit committee?

Response: We believe that the audit committee decision should be as simple and straightforward as possible. 

What, if any, audit committee policies and procedures should be mandated to enhance auditor independence, interaction between auditors and the audit committee, and communications between and among audit committee members, internal audit staff, senior management and the outside auditor?

Response: We believe that audit committee members that hold executive officer positions with other registrants be precluded from advising on or participating in the decision to engage an audit firm for any service, for any registrant, if the proposed service provider is engaged as auditor or provider of non-audit services for the registrant in which the committee member serves as an executive officer.

Would expansion of the proxy disclosure of professional fees paid to the independent auditor from three categories to four provide more useful information to investors?

Response: Yes.  

Are the new categories of disclosure appropriate? Are they well defined, or should they be more accurately defined? Should there be additional (or fewer) categories?

Response: Assuming the Commission is going to allow auditors to provide such services, the categories of disclosure are appropriate and accurately defined.  

Is disclosure of two years of fees appropriate? Should the proposed additional fee disclosures be expanded to three years or remain at one year?

Response: Yes, two years is appropriate.