January 9, 2003
Jonathan G. Katz, Secretary
Comments on the Commission's Proposed Auditor Independence Rule
Dear Mr. Katz:
I am writing to provide the Commission with comments on certain aspects of its recently proposed audit independence rule to implement the Sarbanes-Oxley Act.
I retired in 2001 as the chairman of Ernst & Young LLP, having served in public accounting for 40 years. I currently serve on the audit committees of four corporations, ranging from a quite small company to the General Motors Corporation. In 1998-1999, I served on the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. I thought that, because I have seen the issue of auditor independence from several different perspectives, I might be able to provide the Commission with some helpful insights.
I should note that auditor independence has been an issue in which I have had a great deal of involvement and interest. While I was chairman of Ernst & Young, I concluded that the provision of large-scale, big-fee information technology consulting services to audit clients was increasingly incompatible with the practice of public accounting. Accordingly, in 1999 I began discussions with various potential purchasers of Ernst & Young's consulting practice, and we sold our practice to Cap Gemini S.A. in May 2000. During that same period of time, the Commission, under Chairman Levitt, began consideration of major revisions of its auditor independence rules. I had numerous discussions with Chairman Levitt and members of the SEC staff about accounting firm consulting services, and I believe my firm had a significant and constructive role in the crafting of a final auditor independence rule. Unfortunately, the final rule did not actually prohibit information technology consulting work - had it done so, and had the accounting profession as a whole worked more cooperatively with the Commission towards a phasing-out of such consulting, I believe that much of the recent pressure in Congress to address this issue might have been avoided.
It is, then, a positive development from my vantage point that information technology consulting services will now be banned. But that should not mean that it would be appropriate, or that it would promote audit quality, if the Commission were to try to go farther than Congress provided in its very far-reaching recent legislation.
Thus, as a general matter, I urge that the Commission take a "go-slower" approach to rulemaking under the Act, not merely as to the independence rule but as to rulemaking projects generally. In its proposals on internal control reports, on attorney "whistle-blowing," and on the definition of "financial expert," the Commission has proposed to "one-up" Congress by proposing rules that go beyond what the Act requires. The Act by itself is the most significant legislation to affect U.S. corporations since the 1930s; it is not clear why it should be necessary for the SEC to go farther than Congress did in imposing broad new requirements and obligations. What will result from the SEC's approach will be additional costs; greater uncertainty about legal obligations; expanded liability risks; and more reluctance of talented and experienced persons to serve on boards and audit committees.
As for the independence rule specifically, I support most of its provisions. I believe, for instance, that the proposed changes to the proxy statement disclosures of audit and non-audit fees will provide investors with more accurate information on the nature of the auditor's services. In addition, I believe that barring firms from directly rewarding audit partners for the sale of non-audit services is a good idea. But there are certain other areas of the proposal that should be reconsidered.
First, I urge absolute clarity as to which non-audit services are prohibited and which services are permitted subject to audit committee pre-approval. As an audit committee member, I must now pre-approve all permitted non-audit services. This is a beneficial requirement. However, there shouldn't be any ambiguity as to whether certain non-audit services, in particular tax services, are permitted or prohibited by the rule.
It would appear that the SEC intends to allow accounting firms to provide tax services to their audit clients, but I have been shown a discussion in the rule commentary that casts some doubt on this conclusion. As a general matter, I do not believe that the provision of tax services detracts from the quality of our financial statement audits. In fact, I actually think it generally improves such quality. Having our auditors involved in tax planning and other tax services facilitates their understanding of our business. Moreover, because of the Act's pre-approval requirement, it actually seems more desirable to have our auditors provide tax services than to have another accounting firm or law firm. As an audit committee member, I want to know if the company is embarking upon questionable or "exotic" tax strategies (which, as a general matter, I would discourage the company from doing, although I would do so for reasons of corporate integrity rather than for reasons of auditor independence). The statutory scheme established by the Act ensures that audit committee members will know about such activities when they are provided by the independent auditor, but we may never know what a law firm or another accounting firm is recommending to the company. There is another point as well, which reflects my long career at Ernst & Young: allowing accounting firms to provide tax services to their audit clients ensures that accounting firms will be able to retain knowledgeable and experienced tax experts, whose expertise is relied upon for the tax provision in financial statement audits. Thus, the Commission should remove any doubt as to whether tax services are permissible.
Second, I am concerned about the proposed audit partner rotation requirements, which would require the rotation of all partners who provide audit, review or attest services for a five-year period to the issuer or to any "significant subsidiary". I am very concerned about the disruption and costs that would be associated with such a far-reaching proposal, particularly for multi-national companies for whom audits are performed in countries throughout the world. I believe quite strongly that such disruption would have a negative effect. In many countries in the world, it will simply be impossible to find qualified partners to assume needed audit responsibilities.
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I hope my views will be of some assistance to the Commission as it considers this important matter. Please do not hesitate to contact me if you have any questions or comments.