January 2000

SEC Report Finds Violation of Rules on Investments in Audit Clients

News Breaks at Society's Auditing Conference

By Danielle D'Angelo

An independent report, prepared at the Securities and Exchange Commission's request, found that the majority of PricewaterhouseCoopers LLP partners have violated the SEC's and the profession's independence rules regarding holding investments in CPA firms' audit clients.

The report says that almost half of PricewaterhouseCoopers partners--1,301 out of a total of 2,698--self-reported at least one independence violation. Close to half of the reported violations involved direct investments by PricewaterhouseCoopers professionals in securities, mutual funds, bank accounts, or insurance products associated with a client. The combined results of the self-reporting and random tests of those reports indicated that approximately 86.5 percent of the firm's partners and 10.5 percent of all other PricewaterhouseCoopers professionals had independence violations.

Auditing Conference Attendees Hear News First

The SEC released the report on January 6, the same day that Shaun O'Malley, retired chair and senior partner of Price Waterhouse LLP warned while speaking at the NYSSCPA Auditing Conference that the "shoe was about to fall" from the SEC on an auditor independence matter. Conference chair William Stocker, moments after O'Malley's speech, read from a just released SEC statement announcing the report's findings.

An independent consultant, Jess Fardella, an attorney from the New York firm of Lankler Siffert & Wohl LLP, conducted the investigation and drafted the report as a result of the SEC's censuring of PricewaterhouseCoopers in January 1999 regarding findings of independence rules violations in the firm's Tampa office. As part of the settlement with the SEC, PricewaterhouseCoopers agreed to the internal review and to report any additional instances in which the firm's partners or professionals owned securities of public audit clients of PricewaterhouseCoopers in contravention of applicable independence rules and regulations. Fardella's report summarizes findings of two aspects of the internal review: Results from the SEC's request last March that PricewaterhouseCoopers professionals self-report independence violations, and a random test conducted of a sample of the responses for their completeness and accuracy.

The report found that six out of 11 partners at the senior management level who oversee PricewaterhouseCoopers's independence program self-reported violations. Each of the 12 regional partners who help administer the firm's independence program reported at least one violation; one reported 38 violations and another reported 34 violations. Thirty-one of the 43 partners who comprise PricewaterhouseCoopers's board of partners and its U.S. leadership committee self-reported at least one violation. Random tests indicated that 77.5 percent of PricewaterhouseCoopers partners failed to self-report at least one independence violation.

"Violations and the failure to report violations appear to have resulted, for the most part, from a range of reasons that included excusable misstate, various forms of laxity, and an insensitivity to the importance of independence compliance, rather than from a deliberate circumvention of the independence rules or reporting requirements," the report said.

The report indicates that the system for monitoring independence at PricewaterhouseCoopers and its two precedecessor firms, Price Waterhouse LLP and Coopers & Lybrand LLP, which merged in 1998, relied on individual professionals matching their investment holdings with lists of clients. Under a new system instituted in response to the SEC's initiatives, PricewaterhouseCoopers professionals will report their investments to the firm's KnowledgeCurve System, an electronic database from which the firm will determine if there are independence issues. According to the agreement with the SEC, this self-reporting system will be subject to audit.

POB to Review Other Firms

The SEC also announced that, at its request, the Public Oversight Board will sponsor similar independent reviews at other firms and will oversee development of enhancements to quality control and other professional standards.

"This report is a sobering reminder that accounting professionals need to renew their commitment to the fundamental principle of auditor independence," SEC Chief Accountant Lynn E. Turner said.

The AICPA issued a statement following the release of the report that also addressed allegations by some in the profession that many of the SEC rules regarding CPAs are out of date.

"The SEC has a right to expect the profession to adhere to the rules," AICPA President Barry Melancon said. "The profession has a right to expect that the regulatory environment remains modern."

See http://www.sec.gov to download a copy of the 131-page report.

POB Panel Report Due Soon

O'Malley spoke at the NYSSCPA Auditing Conference in his role as chair of the POB's Panel on Audit Effectiveness and presented an update on the panel's work. As with many of the recent initiatives affecting the profession, the POB formed the panel as a direct result of SEC Chair Arthur Levitt's criticisms of auditors and corporate managements' "earnings management" practices, first addressed by Levitt in a September 1998 speech. O'Malley said the panel expects to issue a draft report at the end of February that will contain recommendations to the various constituents in the financial reporting process--the SEC, the Auditing Standards Board, the AICPA, and accounting firms--for improving the effectiveness of audits of publicly owned companies. See the February issue of The Trusted Professional for more details on O'Malley's speech, and watch upcoming issues for updates on related independence issues.

James L. Craig, Jr., CPA contributed to this article.