March 2000

SEC and POB Representatives

Advise on Independence

Society Sponsors Leadership Forum

At a February 29 NYSSCPA forum for firm managing partners and other leaders in the profession, Jess Fardella of Lankler Siffert & Wohl LLP, the independent consultant who conducted the Securities and Exchange Commission independence investigation of PricewaterhouseCoopers LLP, and Jerry Sullivan, executive director of the Public Oversight Board, advised firms on how to address auditor independence in light of current events.

NYSSCPA President-Elect P. Gerard Sokolski introduced the speakers, explaining that the forum, Maintaining Independence in a Changing World, intended to explore how the SEC report on PricewaterhouseCoopers impacts other firms and to discuss whether possible weaknesses in firms' procedures could create independence problems.

Independence Tracking Difficulty

Fardella summarized the internal investigation, beginning with questions raised in 1998 (before Coopers & Lybrand LLP and Price Waterhouse LLP merged) regarding compliance with independence rules at a Coopers & Lybrand office. He explained how although the basic core of independence rules is obvious, the different sets of rules among the SEC, AICPA, and individual firms present conceptual nuances. He emphasized that tracking independence relationships, especially in an environment of client mergers and acquisitions that create a proliferation of affiliates and subsidiaries, has become an "enormous task."

Fardella said that having a complete knowledge of the current rules is difficult and applying them can be frustrating. For instance, although the rules prohibit a CPA from owning shares in a mutual fund audited by the firm, the mutual fund's holdings are usually not an issue. Also relevant in determining independence is an investment's materiality to its holder. Further, whether a manager must abide by investment ownership rules depends on whether the office in which he or she works is significant to the audit engagement, and "significance" is determined by how many people from that office work on the audit.

Fardella reported that the merger complicated the investigation, which included both self-reporting and an independent examination of violations of independence rules of the SEC, AICPA, and the two legacy firms. Fardella found that approximately half of the firm's partners had independence violations, half of which involved mutual fund investments. He said that auditing mutual funds generally creates independence issues for CPA firms, partly because identifying mutual fund issuers is confusing and complicated. Moreover, a mutual fund may contract its advisory services to a subadvisor who may be an audit client, which creates an independence violation that would be detected only in an intensive investigation.

Fardella's investigation found direct prohibited investment relationships in 52 "client services" situations but said that a February 28 Wall Street Journal article was incorrect in reporting that those clients may have problems with their financial statements; the SEC's position remains that the audits of those companies will be processed in the normal course. (On March 1, The Wall Street Journal published a correction, stating that the earlier article "incorrectly implied that the SEC had suggested that the accuracy of past audits could have been affected.")

In offering lessons learned from the investigation and its aftermath, Fardella said that firms should identify all investments by the Committee on Uniform Securities Identification Procedures (CUSIP) number to facilitate uniform tracking. He pointed out that gathering information on investments requires a considerable time commitment: Rather than relying on their memory or a broker's, professionals must also look at spouse and dependents' holdings and consider whether parents have named them as trustee or executor. He said that individuals should use the tools given to them and "approach independence confirmations with the same mindset, discipline, and vigor they would apply as an auditor providing services to a client."

Fardella acknowledged that while obtaining information from partners and employees may be unpleasant and uncomfortable, firms must make independence rules part of the corporate culture so professionals will translate this into their everyday lives.

"If a firm is to rest relatively easy regarding its compliance with the rules independence has to be woven very centrally into the fabric of the firm, such as what PricewaterhouseCoopers is now doing," he said.

POB Examines Other Firms

Sullivan said that while historically many rules do not make sense and need revision to better address CPA practice in today's world, in the meantime CPA firms must come into compliance. He said the POB is reviewing compliance with independence rules at AICPA SEC Practice Section firms.

"I think we don't have an easy job," Sullivan said, adding that companies have an increasingly difficult time finding auditors who do not have independence issues with larger clients.

He explained that the POB has three categories for compliance reviews from SECPS members: Big Five firms, second-tier firms (200300 SEC clients per firm), and the remaining 1,290 firms, for which Sullivan said the SECPS will have to rely on peer reviews for the independence oversight.

Sullivan said that the AICPA changed its SECPS membership rules to require all firms to develop real-time tracking for their client restricted lists, plain English rules, a comprehensive confirmation process with all professional staff, statistically sound sampling to validate self-reporting, and a disciplinary system with penalties.

In discussing the POB's planned review of the other four Big Five firms, Sullivan said the SECPS executive committee had developed five approaches and was seeking input from the profession before making a decision. He reported that while the SECPS executive committee had met with the other four firms and "credit scored" their likeliness to have independence violations, the firms are not homogeneous and cannot be compared to each other. He also said that it is important that the POB's report be defensible, noting that he expects Congress to hold hearings on auditor independence next year.

"A priority is to bring the rules into the twenty-first century," Sullivan said.

Disclosure Questioned

The presentation also included a question-and-answer session, during which audience members asked for details on the PricewaterhouseCoopers report and the AICPA and POB efforts to address the issues raised. One attendee questioned whether the firm's earlier peer reviews reflected the independence problem indicated by Fardella's report. Sullivan said he has read the previous peer review and believes it was done appropriately, noting that the existing peer review rules did not go to the depth of the investigation.

Another attendee asked for disclosure of the names of the PricewaterhouseCoopers partners found to have independence violations.

"PricewaterhouseCoopers hasn't disputed the seriousness of the violations in the report, and it is not my job to make moral judgments," Fardella said. "The SEC determined that in making the report public the names could not be disclosed because no one has been the subject of a public proceeding, and people should respect that line until there is a public proceeding."

See the related articles in the January and February issues of The Trusted Professional for more on the Fardella report and a new AICPA-mandated quality control system for SECPS firms, and the March issue of The CPA Journal for more on the February 29 Society event. *