Stephen E. Fiamma, Esq.
John C. Taylor, Esq.
One New Change
London EC4M 9QQ
Telephone: (020) 7330 3000
Direct Line: (020) 7330 3657
Fax (Group 3): (020) 7330 9999

13th January, 2003


Mr Jonathan G. Katz
Securities & Exchange Commission
450 Fifth Street, N.W.
Washington DC 20549-0609
United States of America

Re: File No. S7-49-02

Dear Mr Katz:

This letter is being submitted in response to the request by the Securities & Exchange Commission (the "Commission") for specific comments regarding the application of the auditor independence rules imposed by the Public Company Accounting Reform and Investor Protection Act of 2002 (the "Act"). We are pleased to have this opportunity to comment on the proposed rules: Strengthening the Commission's Requirements Regarding Auditor Independence (the "Proposed Rules"). The Proposed Rules are contained in Release Number 30-8154; 334-46934; 35-27610; IC-25838; IA-2088; FR-64 (the "Release"). Our comments focus specifically upon the auditor independence issues raised by accounting firms providing tax services to an issuer subject to the Act (an "Issuer").

These comments are made solely on our own behalf and do not necessarily represent the views or opinions of Allen & Overy, the law firm with whom we are associated, or its clients.

Prohibited Services

Section 201 of the Act amends the Securities Exchange Act of 1934 (the "34 Act") by adding new Sections 10A(g) and 10A(h). These provisions generally prohibit a registered public accounting firm (an "Audit Firm") from performing certain services which create a fundamental conflict of interest for the Audit Firm. The Act explicitly prohibits eight specific categories of non-audit services. The proscribed activities are: 1) bookkeeping or other services related to the accounting records or financial statements of the audit client; 2) financial information systems design and implementation; 3) appraisal or valuation services, fairness opinions, or contribution-in-kind reports; 4) actuarial services; 5) internal audit outsourcing services; 6) management functions or human resources; 7) broker or dealer, investment adviser, or investment banking services; and 8) legal services and expert services unrelated to the audit. Additionally, the Public Company Accounting Oversight Board (the "Board") also may issue regulations prohibiting other activities.

"Tax Services"

Our comment focuses on new Section 10A(h) of the 34 Act, which requires an Issuer's audit committee to pre-approve non-audit related services not prohibited by Section 10A(g) if they are to be provided by its auditor. This section specifically identifies "tax services" as a non-audit service subject to audit committee pre-approval. Tax services, however, are neither defined in the Act nor in the Proposed Rules. We agree with the conclusion in the Release that, "tax services are unique." The importance of tax accounting is, for example, identified in Section 1001 of the Act, which expresses the sense of the Senate that a corporation's chief executive officer should sign any Federal income tax return. Consequently, we believe that a comment focusing on this single issue is necessary.

Need for Guidance to Audit Committees

The issue of Audit Firm-provided tax services is unique because of its importance to both the Audit Firm and its audit clients, and because of the ambiguous nature of the Proposed Rules' treatment of tax services. Tax services generally form the second largest relationship between an Issuer and its auditor. The Release's discussion of permissible tax services clearly indicates that some tax services currently offered by Audit Firms to their audit clients will no longer be permissible. Thus, many audit committees will need to reduce the amount of tax services provided by their auditor to comply with the Act. This creates an inevitable conflict with the economic interests of Audit Firms. An audit committee should not be required to rely on the assertion of its auditor that independence will not be compromised by continuing any particular level of tax services. Our comment in particular requests additional guidance for audit committees making this difficult decision.

Paramount Importance of the Proposed Rules' Core Principles

We agree with the general approach of the Proposed Rules to the independence issues raised by auditor provided tax services. According to the Release, the intent of the Proposed Rules is to remove categorical exemptions and replace them with a list of prohibitions designed to "prohibit any service or scenario that reasonably could create one or more of the conflicts identified in the principles." The three core principles are: (1) the auditor cannot audit its own work, (2) the auditor cannot function as a part of management, and (3) the auditor cannot serve in an advocacy role for the client. We do not believe that the Act can or should be construed as providing a blanket exemption for tax services failing one or more of these criteria merely because an Audit Firm obtains audit committee approval. This is especially true where the approval given by the audit committee for auditor provided tax services is general in nature.

Our comments are designed to provide the Commission with a better understanding of the sensitivities facing Issuers using their auditor for tax services, and of how certain categories of tax services can impair an auditor's independence, as well as to recommend changes to the Proposed Rules we believe are necessary to ensure the purposes of the Act are met. Our approach attempts to strike a necessary balance between the Act's allowance of Audit Firm-provided tax services, on the one hand, and the Act's stated goal of identifying "non-audit services which by their very nature pose a conflict or interest and should be prohibited" on the other. We believe that the key issue under the Act is not whether a particular tax service is "useful" to either the Issuer or the auditor, but rather whether the provision of that service causes the auditor to cease to serve as an impartial representative of users of the Issuer's financial statements. To this end, our recommendations all relate to improving the impartiality of the auditor by precluding it from auditing its own work and serving as an advocate for the Issuer.

Categories of "Tax Services" and their Relevance to the Core Principles

We believe that the Proposed Rules should divide tax services into five broad categories: tax compliance, tax consulting, tax products, tax evaluation and tax controversy. Of these, we feel that tax compliance should be the only tax service that an auditor could supply to an Issuer without impairing its independence. Our comment will provide an analytical framework for distinguishing tax compliance from other tax services and discuss the rationale for excluding the other four categories from the scope of tax services permissible under the Act.

In the interest of clarity, we follow the approach taken in the Release and do not consider tax provisions or other similar services clearly supporting the financial reporting (as opposed to tax reporting) obligations of an Issuer as being within the scope of the term "tax services."

Tax Compliance

We believe that tax compliance services should be the only form of auditor provided tax services permissible under the Act. The Act specifically identifies "tax services" as a permissible non-audit service an auditor may provide to an Issuer. The Release refers to "traditional tax preparation services" as a service Congress felt would not impair an auditor's independence. We feel that the term "traditional tax preparation services" has the right focus. Consequently, we believe that tax compliance services do not raise the same auditor independence issues as other tax related services and therefore should be permissible under the Act.

The dividing line between tax compliance and what is typically called "tax consulting" by Audit Firms has become increasingly blurred over the past decade. It is possible, however, to provide a simple and clear test to differentiate tax compliance from consulting. Tax compliance refers to the collection of data needed to fulfill the Issuer's reporting obligations under various fiscal laws as well as the preparation of the paperwork necessary to fulfill those reporting obligations. In contrast, tax consulting refers to researching issues and rendering of advice relating to matters of taxation law.

A simple example illustrates the difference between tax compliance and tax consulting. An Audit Firm would be providing tax compliance services by calculating the amount of interest expense accrued for any given taxable period. In contrast, determining whether a transaction gives rise to deductible interest for US federal income tax purposes would be tax consulting.

In tax law parlance, resolution of any tax issue that cannot be resolved with an unqualified "will" level opinion based on the client's facts should be considered tax consulting. It follows that any decision by an Audit Firm to "take a position" on a tax return based on an interpretation of the law with respect to an item should be considered tax consulting rather than tax compliance.

Suggested Standard for Final Rules: Evidentiary Privilege under Common Law

We propose using an existing and independent benchmark for distinguishing tax compliance from tax consulting. The final version of the Proposed Rules should prohibit any tax service for which the availability of the attorney-client communications and work-product evidentiary privileges could be available. This approach is already grounded in the Act's focus on auditor independence.

It is well established that traditional tax compliance services are not entitled to the common law attorney-client privilege in the United States even when the return is prepared solely by an attorney. As formulated by one court, "[a]lthough communications made solely for tax return preparation are not privileged, communications made to acquire legal advice about what to claim on tax returns may be privileged."1 Thus, anything which may be eligible for privilege should be excluded from the scope of tax services permissible under the Act.2

The Supreme Court's decision in United States v. Arthur Young & Co.3 best illustrates the point that activities undertaken by an Audit Firm which are eligible for evidentiary privilege are not activities performed by an independent accountant. In Arthur Young, the Internal Revenue Service (the "IRS") issued an administrative summons for Arthur Young's tax accrual work papers prepared to verify its audit client's statement of contingent tax liabilities. Arthur Young refused, claiming that the work papers were privileged. The Supreme Court rejected the claim of privilege, even overturning a lower court's invention of an accountant-client privilege. According to the Court, the "work-product doctrine was founded upon the private attorney's role as the client's confidential advisor and advocate, a loyal representative whose duty it is to present the client's case in the most favorable light. An independent certified public accountant performs a different role."4

The central element of the attorney-client privilege, and the tax advisor corollary in the Internal Revenue Code, is that the provider of advice does so as an advocate for the client. The Release cites a key statement from the Arthur Young decision in its discussion of reasons for prohibiting legal services performed by Audit Firms that is apt here: "If investors were to view the auditor as an advocate for the corporate client, the value of the audit function itself might well be lost."5

The pre-existing common law test for privilege is useful in the present context because it is grounded in policy considerations consistent with those of the Act. According to the Supreme Court, an evidentiary privilege between audit client and auditor cannot exist if the auditor is independent. Existing case law in this area and in the area of legal services generally (see discussion of tax consulting services infra) should provide audit committees with sufficient guidance to draft policies for approving tax compliance services provided by their auditors and to receive opinions from counsel as to the general sufficiency of those guidelines.

The privilege eligibility issue should be based on US law. If this standard is adopted, it will allow ease of application to proposed Audit Firm services provided outside the United States. Issuers are already subject to US securities laws and competent US counsel already provide advice on similar subjects. Here, the test is sufficiently "bright line" (i.e., is the service "tax compliance" or not) as to be simpler to apply in a non-US context as some judgements which need to be made under current US law.

There may be jurisdictions where tax compliance is impossible without being performed by the same party providing otherwise prohibited tax services. We are not aware of any such jurisdictions, but the Board could provide for specific exemptions in unusual cases.

Tax Consulting

We believe an auditor cannot provide tax consulting services to an Issuer and remain independent. As discussed above, tax consulting can be defined simply as the provision of legal advice relating to tax matters. Thus, it can be distinguished from tax compliance by using evidentiary case law discussed infra. Additionally, audit committees, and their advisors, can look to unauthorised practice of law cases occurring before the Supreme Court's decision in Sperry v. Florida ex rel. Florida Bar6 for guidance in determining whether a tax accountant's activities constitute the rendering of legal advice. This combined body of law should provide adequate guidance for audit committees and Audit Firms in meeting their obligations under the Act.

The Release states that the audit committee should be mindful of the three basic principles of auditor independence in considering the use of its auditor for tax services. Two of those principles are directly implicated when an auditor provides substantive tax advice to an Issuer.

When an Audit Firm provides tax consulting services, it ascertains the relevant facts, researches the law and applies that law to the Issuer's facts. An Issuer relies, in whole or in part, upon an Audit Firm's advice in taking a position as to its tax liabilities. However, as auditor, the Audit Firm will have to "independently" evaluate whether or not the position it suggested is adequate when reviewing the Issuer's tax reserves. Thus, by providing specific legal advice to an Issuer, the Audit Firm is placed in the position of reviewing its own work. Similarly, by providing analysis of the law and applying it to the Issuer's facts the Audit Firm becomes an advocate for the Issuer's position.7

The provision of tax consulting by an auditor to an Issuer is particularly troubling because it creates a potentially wide loophole in the Act. The Act generally prohibits an auditor from providing legal services to an Issuer. However, substantial room for exploitation exists if legal services can be cloaked in the guise of tax consulting. For example, would drafting of legal documents by an auditor be permissible if it claimed that the documentation was for an Issuer's tax-motivated transaction? Specific guidance is needed to ensure that both audit committees and Audit Firms can adequately comply with the Act and ensure that the purposes of the Act are met.

Suggested Standard for Final Rules: Expand Definition of "Legal Service"

To ensure auditor independence in relation to tax consulting, we suggest clarifying the definition of a prohibited legal service. This approach would expand the scope of prohibited services beyond the Release's current focus on services that "could be provided only by someone licensed, admitted or otherwise qualified to practice law in the jurisdiction in which the service is provided." It can be argued that many countries, including the United States, provide non-lawyers a limited license to practice tax law. Acting in this capacity, non-attorney legal practitioners function as attorneys performing legal work. The limited nature of the activity should not preclude such advice from being recognised as legal advice impairing an auditor's independence with respect to such advice. In light of the Act's purposes, we feel there is little policy justification for excluding from the prohibition legal services that could also be characterised as tax services. The Release's discussion of tax services explicitly warns that classifying a service as a "tax service" does not mean that it may also not be a prohibited service or otherwise result in an impairment of audit independence. Further, the Release cites the Senate Report for the proposition that, "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."8 Further, according to the Release, the Proposed Rules are designed to minimise instances "where legal services are provided by the auditor to the audit client."

If rendering legal advice is generally a prohibited service under the Act, then it should remain so even if the subject matter of that advice is taxation and the provider of the legal service is not otherwise licensed to practice other areas of law. Why should a legal opinion as to the potential for product liability be something an auditor cannot provide under the Act, but an opinion regarding a tax liability be permissible?

We also do not believe that an Audit Firm's independence is strengthened when tax consulting services are provided by an affiliated law firm. The status of affiliated law firms in general is a complex issue as methods of affiliation between the firms may differ from jurisdiction to jurisdiction. For example, in some jurisdictions true multi-disciplinary partnerships allow an Audit Firm directly to provide legal services; in others only economic ties are permissible. However, we contend that wherever a law firm is affiliated with an Audit Firm, their economic relationship impairs the auditor's independence when both render services to the same Issuer. Under such circumstances, we believe that auditor independence suffers from the same actual impairment as it would if the legal arm were organised within the same partnership as the audit arm. Further, we believe that the public perception of auditor independence is completely missing in such instances. As the Supreme Court has noted, "It is therefore not enough that financial statements be accurate; the public must also perceive them as being accurate."9 An auditor's independence is a key component in the public perception of the accuracy of financial statements.

We also believe that an auditor should not provide a tax opinion (which is in substance a legal opinion) to a third party as an inducement to engage in a transaction with the Issuer. It has been our experience that "marketing opinions", when drafted by a company's auditor, have been vital to that client's efforts to induce a third party to enter into a transaction. We think it is important for the Commission to question whether the auditor is acting as an advocate for the audit client by actively promoting the client's interests. In our experience this serves the same function as an auditor representing an audit client in judicial proceedings.

In the event the final rules do not explicitly prohibit an auditor from performing any tax service other than tax compliance services, we suggest that the final rules provide more detailed guidance concerning the issues raised by tax consulting performed by an auditor. In particular, we suggest that the rules address any overlap with the definition of prohibited legal services and an Audit Firm acting in an advocacy role for an audit client.

Tax Planning and Products

Our comments differentiate tax consulting from tax planning and products (jointly "Tax Products"). We feel this distinction is appropriate because differing independence issues attach to these types of services. Tax consulting can be viewed as a bespoke service provided upon a client's request. In contrast, Tax Products provided by Audit Firms typically involve selling pre-packaged ideas for transactions designed to reduce the client's tax liabilities. These Tax Products may be subject to significant customisation for a particular client, but are generally based on pre-developed core ideas ready for sale by an Audit Firm to its customers.

One key difference between tax consulting and Tax Products lies in the fee arrangements. Typically tax consulting is billed to clients based on the Audit Firm's hourly rates. In contrast, Tax Products are typically sold by the Audit Firm on a premium fee basis, often determined by reference to the amount of taxes saved or the size of the transaction. Some Tax Product transactions can generate significant fees for an Audit Firm, far in excess of what it would have charged merely based on the hours spent on the transaction.

The Release mentions "the formulation of tax strategies (e.g. tax shelters) designed to minimise a company's tax obligations" as an example of tax services that could impair an auditor's independence. We agree that Tax Products present a serious auditor independence issue for a number of reasons discussed below.

The sale of Tax Products by an Audit Firm to an audit client presents a clear conflict of interest for the auditors. The audit arm of an Audit Firm must be in a position to evaluate "independently" the tax side of the transaction, even though the Audit Firm's experts in a particular subject area exploited by the transaction may all be involved in the product's construction and/or distribution. It is inconceivable that auditors, on a regular basis, will provide the proper level of impartial scrutiny for Tax Products sold by their firm. Even if the proper level of scrutiny were imposed, the Audit Firm is placed in a position to audit its own work, a violation of one of the three general principles governing auditor independence. As with tax consulting, the issue is not the quality or propriety of the particular Tax Product being sold. The issue is whether the Audit Firm can genuinely be an impartial reviewer of something an audit client has done when it is the auditors who originate the action being reviewed and profit substantially from that activity.

The sale of Tax Products by an auditor to audit clients is more serious than providing tax consulting due, in part, to the fee structure. Typically, the sale of Tax Products is the most lucrative part of an Audit Firm's tax practice.10 Although the Act now specifically prohibits "cross-selling compensation" for audit professionals, this does not eliminate the independence issue. It appears to many that Audit Firms have under-priced audit services in order to facilitate the cross-selling of more lucrative services. According to the Release, a key component of the prohibition on cross-selling based compensation is to reinforce the "position that accountants at the partner level should be viewed as skilled professionals and not as conduits for the sale of non audit services." As long as lucrative services like Tax Products are being sold to audit clients and the auditor economically benefits from those sales, the auditor will be a conduit for the sale of non-audit services.

An additional issue is created by the sale of Tax Products that have a financial accounting element embedded within the transaction. This element may be part of the "business purpose" for the tax motivated transaction as a whole in order for the transaction to be respected as something other than a shuffling of papers solely for tax purposes. The auditor must "independently" determine whether the financial accounting benefits are allowable. It is very unlikely that a Tax Product promising financial accounting benefits would depend on financial accounting advice originating outside of the Audit Firm. Therefore, an individual auditor is placed in a position of questioning a position already taken by the Audit Firm. This would clearly require an Audit Firm to audit its own work.

Tax Products are different from mere tax consulting services in one other area that deserves serious consideration. As has been noted by Professor Bernard Wolfman, the major accounting firms all sell essentially the same tax planning ideas and tax products.11 Accordingly, the same auditor independence issues arise if an Issuer audited by Audit Firm A buys a tax shelter from Audit Firm B substantially similar to the one marketed by Audit Firm A. If the principle that an auditor may not audit its own work is to be enforced in this area, then it makes little difference which Audit Firm is the actual seller of the Tax Product.

We believe that the sale of Tax Products to an Issuer by its auditor creates a fundamental conflict of interest and should be explicitly prohibited under the Act. At a minimum, the sale of Tax Products, including general tax planning ideas, poses the same auditor independence issues raised by tax consulting. The auditor is placed both in a position to audit its own work and to act as an advocate for the Issuer on novel legal issues. However, Tax Products present a greater independence risk due to their pre-packaged nature and the premium fees they command.

Finally, we suggest that, due to the overall independence issues raised by such transactions, at an absolute minimum an auditor be specifically prohibited from selling "potentially abusive tax shelters" (as identified in 26 C.F.R. 301.6111-1T) to its audit clients.12 The IRS already has specific rules that identify potentially abusive tax shelters and requires extensive record keeping for material advisors in such transactions.13

A weaker solution would be to have the audit committee specifically review the Tax Product in question, discuss it with its auditors, and require the auditor to disclose to the audit committee any substantially similar Tax Products that it markets.14 The audit committee could then specifically vote on whether it believes that the use of the Tax Product impairs its auditor's independence. An opinion provided by an outside advisor, selected by the Issuer's audit committee and not recommended or supplied by either accounting firm, may also be used to provide a second opinion approving of a particular transaction's tax treatment.

We believe that the issue of Tax Product sales by Audit Firms is very significant. Guidance in this area needs to be clear for the benefit of the audit committee. We believe that the experience the IRS has gained in dealing with Audit Firms selling tax shelters would be particularly helpful in understanding the need for clear and unambiguous rules. In particular, guidance should be provided for audit committees facing the potential impairment of their auditor's independence caused by Tax Products sold to the Issuer by another Audit Firm.

Tax Evaluation Services

We believe that an Audit Firm is not independent when it provides tax evaluation services to its audit clients. We believe that the term "tax evaluation services" should cover any service where the auditor reviews an Issuer's activities and renders a report or opinion used by the Issuer for any fiscal purpose other than tax compliance as defined supra.

As discussed above, new Section 10(g) of the Act includes a prohibition on "appraisal or valuation services, fairness opinions or contribution-in-kind reports." The Release specifies, however, that this provision does not prohibit "services for non-financial reporting" such as transfer pricing studies. Nevertheless, we believe that the prohibition should extend beyond the definition of "expert" or "appraisal" services discussed in the Proposed Rules and could apply to transfer pricing studies.

Suggested Standard for Final Rules: Adopt Same Rule as for Fairness Opinions

We hold that the same rationale for excluding fairness opinions applies to transfer pricing services, and therefore, we urge the Commission to reconsider its position on this matter. Many transfer pricing services serve the same function as tax consulting opinions or appraisals. This potential overlap with otherwise prohibited services needs clarification in order to allow audit committees to evaluate whether or not such activities should be performed by their auditor. Further, many transfer pricing services are performed to minimise tax risk. If performed by the auditor, their utility must also be evaluated by the same firm. This leaves the auditor in the position of reviewing its own work, which violates one of the three principles of auditor independence.

We suggest that the Commission identify more clearly which tax evaluation services should be governed by the "expert services" or "appraisal" prohibitions and which tax evaluation services should be precluded under other general principles of auditor independence. Further, we urge the Commission to consider providing more explicit guidelines on how to apply the general auditor independence principles to tax evaluation services in general.

Tax Controversy Services

We believe that an independent auditor cannot represent an Issuer in a tax controversy. The Release states that an auditor's independence is impaired where the accountant provides representation of an audit client before a tax court. We agree, but also believe that the prohibition should extend further than just direct representation before a tax court. Auditor independence is impaired whenever the auditor acts in an advocacy capacity constituting the practice of tax law. This is true even if the accountant has an actual or implied license to practice only tax law and is legally barred from representing clients in other legal matters. This issue is similar to the tax consulting services issues discussed supra.

We believe that an auditor should be prohibited from assisting an Issuer in any tax controversy forum if the Audit Firm acts as an advocate for the client's position. The Release states that an auditor cannot be both a zealous legal advocate for a client company and maintain the objectivity and impartiality that are necessary for an audit. We agree. As noted in our discussion of tax compliance supra, the Supreme Court recognised in Arthur Young that the value of the audit function may be lost if the auditor is seen to act as the client's advocate. We do not believe that the particulars of the forum should control whether acting as an advocate for an audit client impairs the auditor's independence.

Finally, an auditor acting as an advocate for an audit client in a tax controversy clearly violates two of the three core independence principles. Although not acting in a judicial proceeding, the auditor is acting as an advocate for the audit client and attempting to advance the client's interests. Equally, the auditor is effectively auditing its own work. The outcome of an audit can have the same material impact on an Issuer's financial statements as actual tax (or non-tax) litigation. The same Audit Firm representing the audit client in the tax controversy will determine the adequacy of the Issuer's tax reserves. The matter may be even further clouded if the Audit Firm is defending a position it provided to the audit client whether by way of tax consulting or through the sale of a Tax Product. Even more complicating issues arise if the Audit Firm, or a law firm affiliate, documented the item under review and the adequacy of the documentation is a subject matter of the controversy.

Suggested Standard for Final Rules: Evidentiary Privilege under Common Law

The evidentiary rules used to differentiate tax compliance from other tax services should also provide an administratable test for the permissible role an Audit Firm could play in a tax controversy situation. In United States v. Frederick,15 the Seventh Circuit addressed the privilege issue arising from representation in an IRS audit. The court drew a distinction between "accountant's work" not eligible for privilege and "lawyer's work" to which the attorney-client privilege may attach. According to the court, accountant's work entailed "merely verifying the accuracy of a return" before the IRS and "lawyer's work" entailed a lawyer dealing with "issues of statutory interpretation or case law that the revenue agent may have raised in connection with his examination of the taxpayer's return."16

This distinction is similar to that drawn in the Release regarding the provision of expert services by an Audit Firm for its audit clients. The Release indicates that an Audit Firm is not prohibited from testifying as a fact witness to its audit work for a particular client. Specifically, the Release states that the auditor is "merely providing a factual account of what he or she observed and the judgments he or she made." This matches the description of "accountant's work" by the court in Frederick, as opposed to "lawyer's work" which may be eligible for evidentiary privilege. Thus, the potential for evidentiary privilege again provides a useful and pre-existing distinction for the types of tax controversy related activities an auditor can undertake for an audit client without being seen to function as an advocate for that client.

We urge the Commission to provide explicit guidance for audit committees on this issue. In particular, specific guidance is needed for when tax controversy representation by an auditor becomes impermissible advocacy and when tax controversy involves an auditor auditing its own work.


We believe strongly that auditor independence is one of the critical issues facing our global financial system today. The current system relies upon Audit Firms to act on behalf of those who use a company's financial statements and not the company they audit. When an auditor provides tax services other than tax compliance to an audit client, it places itself in a role inconsistent with that of a third party reviewer of the Issuer's activities. Therefore we feel this is the proper dividing line for permissible tax services.

We think it is very important to keep in mind that Audit Firms have a government-granted and supervised oligopoly to perform audits of companies subject to the 34 Act. This franchise is premised on the Audit Firm's independence from the companies it audits. As stated by the Supreme Court, "This 'public watchdog' function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust."17 The fact that Congress felt the need for the Act presents clear evidence that complete fidelity to the public trust has been compromised. Therefore, it is important that, when the Proposed Rules are finalised, they rigorously enforce the concept of independence rather than leave substantial ambiguity that may be exploited.

The sole issue that rules introduced under Section 201 of the Act should address is auditor independence. There have been comments made that question the ability of an Audit Firm to perform a competent audit if it cannot also provide a "broad range of tax services" to its audit clients. Others maintain that suggestions to limit tax services are merely attacks on the professional ability of Audit Firms to provide non-audit services in general. We strongly disagree on both counts. Our comments have not questioned the competence of Audit Firms to perform non-audit functions, including tax services. Rather, we question the ability of an Audit Firm to competently perform audit services where it also provides legal services relating to tax law, reviews its own work, and performs an advocacy function on behalf of companies it is supposed to review impartially. The starting point for a proper independent audit of a company is independence of the auditor. It is a legal requirement under the 34 Act and that must be the primary focus of any auditor independence regulations.

There have also been comments made with regard to the Proposed Rules extolling the virtues of an Audit Firm using its extensive knowledge of its clients to provide valuable tax advice. However, the same argument can be made with respect to internal accounting, legal and other services specifically identified by Congress as impairing an auditor's independence. The issue before the Commission is auditor independence, and not what arrangement might provide beneficial tax advice for audit clients. Not all audit clients use their auditor as their primary tax advisor. Additionally, some of the concerns over loss of expertise if tax services are prohibited do not bear closer scrutiny. Under the approach we advocate, Audit Firms would remain in a position to provide a full range of tax services to non-audit clients and audit clients who are not Issuers (except in cases such as Tax Products where the independence of the Audit Firm is necessarily impaired, regardless of who its client is). Further, Audit Firms may provide any of the other prohibited non-audit services to any client other than an audit client. Thus, an Audit Firm's ability to retain tax experts should not be compromised.

Finally, we urge the Commission to consider more detailed guidance for audit committees in this area. Implementation of the Act requires many changes to the corporate governance of Issuers, particularly those not based within the United States. The issue of tax services is likely to be the most important auditor independence issue faced by audit committees this year. The Proposed Rules raise many serious and complicated issues for audit committees and their advisors. Therefore, we believe additional guidance is necessary and appropriate.

We appreciate this opportunity to comment on the Commission's proposal, and we would be happy to discuss any questions the Commission or its staff may have with respect to this letter. Questions may be addressed to Stephen E. Fiamma of our London office.

Respectfully submitted,

Stephen E. Fiamma, Esq.

John C. Taylor, Esq.

1 United States v. Abrahams, 905 F.2d 1276, 1284 (9th Cir. 1990).
2 The focus is on eligibility for evidentiary privilege and not on whether a privilege has been waived under the particular circumstances.
3 465 U.S. 805 (1984).
4 Id. at 817.
5 Id. at 819-20 n.15.
6 373 U.S. 379 (1963) (federal law authorising non-lawyer practice in a federal matter supersedes state unauthorised practice of law rules). There are several cases involving the prosecution of tax accountants practising federal tax law prior to the Sperry decision. See, e.g., Gardner v. Conway, 48 N.W.2d 788, 797 (Minn. 1951) (practice of tax law means the resolution of "difficult or doubtful questions"); Lowell Bar Assoc. v. Loeb, 52 N.E.2d 27, 33 (Mass. 1943) ("Doubtless the examination of statutes, judicial decisions, and departmental rulings, for the purpose of advising upon a question of law relative to taxation, and the rendering to a client of an opinion thereon, are likewise part of the practice of law in which only members of the bar may engage.").
7 This is more than just a figurative statement. The Issuer may rely upon the Audit Firm's opinion to avoid tax penalties.
8 Report of the Senate Comm. on Banking, Housing and Urban Affairs to Accompany S. 2673, S. Report 107-205, 107th Cong., 2d Sess. (July 3, 2002).
9 Arthur Young, 465 U.S. at 819 n. 15.
10 The general topic of accounting firms selling tax shelters has been covered extensively by the press. See Janet Novack and Laura Saunders, The Hustling of X Rated Shelters, Forbes, Dec. 14, 1998 at 198, 203 ("Big Five accounting firms have grabbed the lead in this hugely profitable new business.") The infamous Forbes article was cited repeatedly by the US Treasury Department in its report on tax shelters. See Department of the Treasury, The Problem of Corporate Tax Shelters: Discussion, Analysis and Legislative Proposals (July 1999).
11 Bernard Wolfman, "Accountants-Audit Standards 'Sarbanes-Oxley' Needs Fixing," 71 U.S. Law Week 2083 (Aug. 13, 2002). We believe that Professor Wolfman has also submitted comments to the Commission concerning this issue.
12 Although the potentially abusive tax shelter definition contained in the regulations focuses on US federal income tax, it can be easily adapted to function in a non-US context. Essentially, the final rules could require an Audit Firm to identify whether a transaction would be a potentially abusive tax shelter based on the objective criteria independent of specific US tax considerations.
13 The material advisor investor list rules apply when fees from a particular transaction are at least $250,000. Therefore, if the Commission does not prohibit auditors from providing tax consulting services to audit clients, adoption of the tax shelter prohibition would not affect many tax consulting services or simple planning ideas.
14 The US tax shelter rules contain provisions for determining what constitutes a substantially similar transaction. The rules favour an expansive interpretation of a substantially similar transaction. See T.D. 9018, reprinted in 2002 Tax Notes Today 202-2 (Oct. 17, 2002) ("[A] substantially similar transaction includes any transaction that is expected to obtain the same or similar types of tax consequences and is either factually similar or based on the same or similar tax strategy. . . . [T]he term substantially similar must be broadly construed in favor of list maintenance."). We urge the Commission to adopt the same expansive approach for purposes of preserving auditor independence.
15 182 F.3d 496 (7th Cir. 1999).
16 Id., at 502; see also Long-Term Capital Holdings v. United States, 2002 U.S. Dist. Lexis 23,224 (D.C. Conn. Oct. 30, 2002) (The 26 U.S.C. § 7525 tax advisor privilege did not apply to accountants "when they are doing other than lawyers' work.").
17 Arthur Young, 465 U.S. at 818.