SEC Challenges ISB

SEC Chief Accountant Lynn Turner

In a January 7 letter from Lynn E. Turner, chief accountant of the Securities and Exchange Commission, to William T. Allen, chair of the Independence Standards Board, the SEC set forth its priorities and challenged the ISB to address a number of controversial issues.

According to the letter, the SEC's highest priority is the form of practice of CPA firms and its impact on auditor independence. The commission wants this issue resolved by the end of 1999.

"Some of these structures involve public entities that have acquired public accounting and auditing firms using various forms of consideration, consolidating the firm's employees into the buyer's organization, and then conducting audits through leasing of these employees back to the shell organization that remains from the target," Turner wrote.

He said the SEC is concerned about the independence issues that would arise if a firm undertook a public or private offering of its securities, or the securities of a subsidiary or affiliate. Some questions raised include:

* Would investors perceive an auditor as independent from a client who invests in the firm?

* Would independence be impaired if an investor has a financial interest in a public accounting firm and then retains that firm to audit other companies in which the investor has an ownership interest?

* What is the impact on independence of a CPA firm's fiduciary responsibility to its minority investors who are also audit clients?

* How would indemnification agreements among investment advisors, underwriters, and bankers affect the independence of a CPA firm that is also the auditor for these firms?

* What would be the impact on independence of public ownership if the firm's focus was on making consensus quarterly results as opposed to the integrity and objectivity necessary for an independent audit?

The SEC also posed questions regarding independence with respect to clients of a financial services firm that has acquired a CPA firm when a portion of the audit is performed by employees of the financial services firm.

Valuation services are another topic of concern. The letter inquired whether the auditor, who is expected to skeptically second-guess the financial statement numbers prepared by management, may be the source of entries that appear in the financial statements that are the subject of his or her examination. The SEC feels the actual work involved in performing valuations needs to be carefully looked at, and a determination made as to what work impairs independence.

The SEC also requested that the ISB study mutual fund audits and investments. One of its questions was whether an auditor can audit some but not all of the funds under common management of a fund manager and invest, either directly or through a benefit plan such as a 401(k) plan, in the funds the auditor does not audit.

The letter addressed legal advisory services, and Turner pointed to a press report stating that an international CPA firm is considering future acquisition of a New York law firm, which raises concerns about a potential conflict between the attorneys' client advocacy role and the CPAs' public interest role.

The last topic in the letter involved executive compensation and actuarial consulting. The SEC said it has had inquiries regarding these issues and wants the ISB to adopt rules accordingly.

In closing, Turner cautioned that the ISB's Independence Issues Committee "appears to provide an auditor's perspective on independence." The SEC would like to see more input from investors and other users of financial statements.