Hein + Associates LLP
January 10, 2003
Mr. Jonathan G. Katz, Secretary
RE: File Number S7-49-02
Dear Mr. Katz:
I am responding on behalf of my partners and associates at Hein + Associates llp. Our firm was established in 1977 and has offices in Denver, Houston, Dallas, Phoenix and Southern California. We have approximately 20 partners (of which nine are qualified SEC audit partners) and 150 staff members. We rank approximately 60th based on revenues among CPA firms in the United States and have a major SEC practice with over 70 SEC clients, which constitutes a large part of our practice. As a result of our extensive SEC practice, we have served on the SECPS Executive Committee for over 18 years and for four years on the SEC Regulations Committee of the AICPA. Based on our firm's qualifications, I would like to respectfully submit our firm's comments on the proposed rules on auditor's independence.
I would also like to express the sincere disappointment my partners and I share as a result of the actions of a relative few within our profession, which have brought so much harm to so many, including creditors, investors and employees of both public companies and public accounting firms. These few betrayed the trust and integrity that our profession has worked hard to earn over many years of service in the public interest. We, as CPAs, will need to work even harder now to restore this trust. I believe we will accept that commitment and challenge, however, I also ask that we be given the opportunity to carry out our important responsibilities in a reasonable environment. I fear that if certain of the current proposals are adopted, greater harm will result and the public interest will not be served.
Small auditing firms and registrants will be adversely affected unless some changes are made to the proposed rules. Two areas in particular should be revised or accommodated through exceptions to the overall rules. These important considerations are as follows:
Many small firms are dropping out of the SEC audit arena and I understand as many as 200-400 more may do so. Even the large regional firms with a number of SEC clients have less than 5% of their revenues from SEC audits and, therefore, are reassessing their interest in serving SEC companies. The limitations imposed by partner rotation, the probable loss of tax services to public company clients and related compensation issues have the potential of severely limiting competition and the availability of alternative auditing firms for small public companies. The $6,000,000 small business exemption for audit firms will not resolve this problem and revisions to the proposed rules are required. Otherwise, the consequences of the proposed rules would appear to be contrary to the public interest.
The following is a more detailed discussion of the above as well as other significant areas of concern:
A. Partner Rotation: There is little doubt, in my opinion, that the experience gained by a partner working on the same engagement leads to better understanding of a company, its operations and the risk areas of the engagement. This knowledge enhances the performance of an audit. However, partner rotation does provide for fresh perspective, which is also important. As members of the SECPS, we rotate the primary audit engagement partner on SEC engagements in accordance with the membership standards of seven years on and two years off. I believe this is a reasonable standard. We must now reluctantly accept the five year rotation policy as written in the rules. However, when combined with the proposed five year cooling-off period, the shorter time requirements for future filings, and the limited number of SEC qualified partners in each office of multi-office firms and smaller firms, the proposed rule will result in financial reporting problems. Valuable insights about a company and its operations, which are necessary in the conduct of an audit, will be lost and there may also be time pressures that result in an important financial reporting issue being missed by new partners in re-learning prior information. Mid-size firms, as well as smaller CPA firms, do not have adequate partner coverage to implement the rotation and cooling-off period as proposed. At the very least, public companies will need to accept partners from other cities serving on an engagement, which will provide for less opportunity for critical interaction between the audit partner and company executives or possibly the resignation from the engagement by the accounting firm. I can not imagine a firm smaller than ours having enough qualified partners to even begin to deal with this problem. Therefore, I strongly recommend that this requirement be limited to five years on and one year off.
I believe this rule should also be limited to only the audit engagement and audit review partners. To include tax partners would be a critical error. Generally, the greatest single expense on a financial statement is income taxes. When a company has multi-jurisdictional tax issues (including possibly foreign), it is critical that the same tax partner be allowed to continue with the engagement. The re-learning of a company's complex tax situation, along with the changes in other partners, could inadvertently result in an error in financial reporting for income taxes and create an opportunity for potential corporate abuse. The same logic holds true for other specialist partners. Besides being extremely difficult to define the specialist partner, there needs to be continuity by professionals with adequate expertise and professional skepticism (which comes at the partner level) and knowledge (which comes from experience with the company) in order to conduct a thorough audit and provide assurance that the disclosures are complete. It will be difficult enough to rotate two audit partners, it would be incomprehensible for a firm our size to also rotate other partners as well, especially since several partners will consult among themselves on critical accounting and/or financial reporting issues related to the same engagement.
If the rules are implemented as proposed, the only CPA firms left to audit smaller public companies, which have always been important in the growth and job creation in our free market economy, may well be the very large CPA firms. Even if a small business exemption is permitted, mid-size audit firms will be excluded and smaller firms will be limited in their growth potential. This will result in lack of competition leading to dramatic increases in cost, which cannot be absorbed by many smaller public companies.
Consideration should also be given to the transition for this new rule. We would recommend a reduction from the current seven year requirement of SECPS firms to the five year requirement occur over a three year period. Otherwise it could be tremendously disruptive to both public companies and CPA firms.
B. Partner Compensation: The proposed rule, if implemented, would result in greater independence issues as opposed to increased independence, as intended under the ACT. Our firm, as with most CPA firms, operates as a partnership and partner compensation is distributed based on firm-wide revenues and earnings, among many other factors including chargeable time, staff development, etc., and are not based on specific engagement revenues or earnings. If SEC audit partners are compensated solely on their related SEC audit engagements, as would be the inadvertent effect if the proposed rules are implemented, this may result in (or at least there would be the appearance of) the audit partners "protecting" such engagement revenues. This is exactly what the new rules are intended to prevent. By spreading compensation among all partners, total firm performance and using a number of factors, partners' earnings will not be based on any one engagement. The proposed rules, while appearing relatively simple, would be almost impossible to interpret and implement. I recommend deleting this section from the proposed rules.
C. Employment by Clients: The law, as enacted, already creates incredible problems for mid-size to smaller CPA firms. We generally serve smaller clients, therefore if our staff becomes employed by a client, it generally will be in a critical financial role, just by nature of the company's size. To expand it any further to include those who consult with members of the audit team regarding technical or industry specific issues, transactions, or events would result in significant adverse consequences for most public accounting firms and limit their public company clients from possibly hiring the best talent available. As it would be extremely difficult to define and monitor, it most likely would be interpreted to be any professional staff within our relatively small offices that goes to work for a public company client. I recommend deleting this section of the proposed rules.
D. Audit Committee Administration of an Engagement: The proposed rule provides for pre-approval of non-attest engagement services. Many public companies pay total fees of less than $50,000. The de-minimus exception provides for pre-approval of non-attest services in instances where the "aggregate amount" does not exceed 5% of the total amount paid to the auditor in the prior year, among other conditions. Often the auditor is consulted regarding the accounting treatment of a proposed transaction, which may not be specifically related to or contemplated in the current audit engagement letter. The related cost can easily exceed 5% of prior year's fees, especially if any research is involved and when aggregated with other minor consultations. To further burden audit committees' members with additional approval for relatively small amounts does not appear to be warranted. I would recommend eliminating the de-minimus percentage (while retaining the other provisions), or at least increasing the de-minimus amount to the greater of 5% of prior year's fees for the engagement or $25,000. This would also provide guidance on first year engagements.
E. Acting as an Advocate: Audit firms often represent their clients in connection with audits by Federal, state and other taxing authorities. They support their clients' tax positions, which were also previously considered in the performance of the audit and the related income tax accrual. It appears under the proposed rules that audit firms would be prohibited from providing this service. This limitation will cause significant additional expense to public companies: in not just engaging another specialist to represent the Company before taxing authorities, but most likely also engaging different firms to perform the tax compliance and audit. There are significant efficiencies incurred in the preparation of the tax return, which result from having an audit base. These efficiencies translate into reduced cost to the public company. In addition, as previously indicated, income taxes are a major consideration in the audit. To have separate firms performing the audit and preparing or reviewing the tax return could result in an inadvertent miscommunication between firms, resulting in different positions being taken at the time of the audit and preparation of the tax return. This situation would ultimately result in unnecessary differences. I recommend clarifying that representing an audit client before a taxing authority is not acting as an advocate, which would impair of auditor independence.
Once again, on behalf of my partners and associates, I appreciate your thoughtful consideration of our comments.