California Board of Accountancy
STATE OF CALIFORNIA - STATE AND GRAY DAVIS,
January 13, 2003
Jonathan G. Katz, Secretary
Re: Proposed Amendments to Existing Requirements Regarding Auditor Independence, File No. S7-49-02
Dear Mr. Katz:
The California Board of Accountancy (CBA) commends the Commission for its exceptional efforts to integrate existing auditor independence requirements with the changes mandated by Section 208(a) of the Sarbanes-Oxley Act of 2002. In general, the CBA supports the proposed rules and we are pleased to submit our comments as outlined below.
Regarding the proposed rules as a whole, the CBA believes it is important for rules to be readily accessible. Compliance with the increasingly complex independence standards could be enhanced if the auditor has a single source to consult for reliable and easily accessible information. To facilitate this, the CBA urges the Commission to explore creative approaches to placing all substantive independence requirements in a single location, be it in Regulation S-X, in a guide similar to the General Accounting Office's "Yellow Book" for governmental audits, or a system similar to the American Institute of Certified Public Accountants' codification of Statements on Auditing Standards (SAS) into United States Auditing Standards (AUs).
Also, the CBA supports the uniform application of rules and encourages applying the same independence standards, whenever possible, to auditors of all companies that must file with the Commission. Consistent with this approach, CBA has concerns regarding any exemption from independence requirements for audits of small businesses. Independence is no less necessary for financial statement users and public confidence when the audit client is a small business than when the audit client is a large multi-national company.
With regard to conflicts of interest resulting from employment relationships, the CBA concurs with the Commission regarding the need to restrict employment with audit clients by former employees of the accounting firm. Section 206 of the Sarbanes-Oxley Act bars a firm from auditing a company when the company's chief executive officer, controller, chief financial officer, chief accounting officer, or any person serving in an equivalent position was employed by the audit firm and participated in any capacity in the audit in the past year. The term "any capacity" is vague and may raise questions regarding managers or engagement partners who have removed themselves from the audit, but who are consulted in the course of the audit. In addition, the proposed rules would further restrict the former employees from accepting any position in "in a financial reporting oversight role at an audit client." CBA encourages the Commission to provide a more precise definition of the prohibited positions in order to avoid ambiguity and general concerns that will exist if the positions are open to too much interpretation. As an alternative to the approach outlined in the Commission's proposal, the CBA suggests that the rule more specifically define participation in the audit to include only licensees who exercise "significant judgment in the audit process" including, but not limited to positions, however titled, where the licensee was a person in charge of the audit fieldwork, up through positions where the licensee was a partner on the engagement. This is the approach recently adopted by California for all audits of publicly traded companies (Attachment A, California Business and Professions Code Section 5062.2, AB 2970).
With regard to services outside the scope of the practice of auditors, the CBA endorses the Commission's effort to identify prohibited non-audit services based on a set of general principles. The CBA suggests, however, that the Commission consider adding an additional principle: "To be independent, the auditor should not have any business arrangement with an audit client that creates a mutuality of interest." This would prohibit arrangements where the audit client or the auditor, either directly or indirectly, advertises or otherwise promotes the other's products or services.
With regard to the exemption authority granted to the Public Company Accounting Oversight Board (PCAOB) under Section 201(b), the CBA submits that rarely, if ever, would circumstances justify compromising the independence standards. Consistent with this approach, the CBA encourages restricting exemptions from the independence rules under Section 201(b), using the test articulated by Senator Sarbanes on the floor of the Senate on July 25, 2002. Senator Sarbanes stated that the exemption authority granted to the PCAOB by the Sarbanes-Oxley Act is "intentionally narrow to apply to individual cases where the application of the statutory requirements would impose some extraordinary hardship or circumstance that would merit an exemption consistent with the protection of the public interest and the protection of investors" (emphasis added).
Section 201(a) of the Sarbanes-Oxley Act prohibits offering internal audit outsourcing services to an audit client. The CBA considered this issue in early 2002 and also concluded that it is in the best interest of consumers for auditors to be prohibited from providing internal audit outsourcing services to audit clients. The Commission asks whether independence would be impaired if the auditor performed individual internal audit projects for the client. The CBA believes that whether an individual internal audit project impairs independence should be judged on the basis of whether it violates any of the Commission's fundamental principles which form the basis for independence, for example, whether performing the project might result in the auditor auditing his or her own work or performing a management function. Further, such projects should be pre-approved by the audit committee on a case-by-case basis and not pursuant to any general or standing policy approved by the audit committee but implemented by management.
Tax services are another category of non-audit services discussed in the Commission's proposal. The CBA believes that tax preparation is properly a part of the audit function. However, all other tax services should be assessed based on whether the service violates the Commission's fundamental independence principles. Also, before these services are permitted, they should be pre-approved by the audit committee.
The CBA has not sufficiently studied the issue of audit partner rotation. However, on the face of it, it does not appear that a forensic auditing requirement would be an appropriate substitute for the proposed rules that identify a more expansive group of audit partners subject to rotation. The Commission also asks if there should be different rotation requirements for small firms. The CBA does not generally support establishing different standards based on the size of the public accounting firm. Further, such a size-based standard may adversely impact competition and create audit risk if an audit client instead decides to just hire an audit firm that is exempt from audit partner rotation in order to retain the same engagement partner for a longer period of time. In addition, to the extent that the proposed rules on audit partner rotation are enacted, the CBA strongly encourages consideration of a sufficient transition period to reduce the audit risk associated with the lack of continuity as a result of partners rotating off of the audit engagement.
With regard to communication with audit committees, the CBA supports the proposed amendment of Regulation S-X to require audit firms to report to the client's audit committee all critical accounting policies and alternative accounting treatment of financial information prior to the filing of the financial statements with the Commission. We suggest revising the third item to be reported so that it includes both material written communications and material oral communications between the accounting firm and management of the issuer or registered investment company.
Further, the CBA believes that CEOs, CFOs, as well as the audit committees need to be informed regarding critical accounting policies and practices and alternative accounting treatments. The CEO and CFO cannot be expected to certify information on the company's filings and the audit committee cannot be expected to perform its review and oversight role without access to all relevant information.
With regard to expanded disclosures, the CBA supports the Commission's proposal to expand the categories of fees for audit and non-audit services that must be disclosed. In addition, we suggest that the time period for additional fee disclosures be extended to three years, which coincides with the Commission's financial reporting requirements.
Thank you for this opportunity to express our views. Should you have questions or need additional information, please contact Carol Sigmann, Executive Officer, at (916) 263-3980.
c: Members, PCAOB
Attachment A: http://www.leginfo.ca.gov/pub/01-02/bill/asm/ab_2951-3000/ab_2970_bill_20020826_chaptered.pdf
Senator Liz Figueroa