December 2000

SEC Beefs Up Monitoring After Issuing Final Independence Ruling

WASHINGTON D.C.—Just one day after unanimously approving auditor independence and market structure rules, the Securities and Exchange Commission also beefed up its accounting industry monitoring division.

On Nov. 16, the SEC announced that it had promoted 10 of its current staffers to the role of senior assistant chief accountant, a newly created position within the SEC’s Division of Corporate Finance. According to the SEC, the new position is responsible for administering accounting disclosure policy and the management of the accounting program for the individual offices under the direction of the assistant directors.

“The creation of these positions emphasizes our commitment to accounting issues and our accounting program,” said SEC Corporate Finance Division Director David Martin. “Their experience and expertise will bring strength and stability to our management team.”

The move comes one day after the SEC announced it had reached a compromise with the American Institute of CPAs and four of the Big Five accounting firms: PricewaterhouseCoopers, Deloitte & Touche, Arthur Andersen, and Ernst & Young.

After months of discussion and debate, the SEC announced its final rules on the revised standards for auditor independence on Nov. 15. The Commission’s final version of the rules differs significantly in some areas from the draft it originally proposed last June.

A major difference is that auditing firms will not be prohibited from offering nonaudit services to their audit clients, with the exception of operating or supervising the operations of the client’s information technology systems. A firm can, however, continue to provide IT consulting services to an audit client under restricted circumstance, provided the client’s management informs its audit committee.

The originally proposed rules would have banned audit firms from offering consulting services to their audit clients altogether.

Another major change is that the “four principles governing auditor independence,” a source of controversy in the original proposal, have been removed from the text of the rule. These principles—stating that an auditor should not have a mutual or conflicting interest with the audit client, audit his or her own work, function as management or an employee of the audit client, or act as an advocate for the audit client—will be published as preliminary notes to the ruling.

At the announcement of the final ruling, SEC Chair Arthur Levitt said, “I firmly believe that today’s result strikes a balance that serves the interests of America’s investors while remaining flexible and adaptable for the unforeseen changes in tomorrow’s marketplace.”

Background

The final ruling follows weeks of meetings, hearings, and negotiations between the SEC and those who opposed the rules set forth in the Commission’s June proposal, namely three of the Big Five accounting firms—KPMG, Arthur Andersen, and Deloitte & Touche—and the American Institute of CPAs.

These groups argued that the rules, in their draft version, were unnecessarily strict and would be harmful to accounting firms. Particularly offensive to these groups was the proposed ban on consulting services. They asserted that there is no evidence that offering consulting services to audit clients would impair a firm’s independence.

Levitt Speaks Out

The battle has been at times heated, and both sides have expressed their frustration with the other over the rules. Levitt’s exasperation surfaced during a question-and-answer session following a speech he delivered Nov. 4 at Fordham University School of Law.

“My experience with this group has defied all experiences I’ve ever had with any other group,” Levitt said, in reference to the AICPA. “Their inability to ever speak about the public trust is unlike any other constituent we deal with.

“It’s that fortress mentality—it’s that unwillingness to compromise—they fail to realize what a public relations fiasco they are creating for themselves.”

Levitt said that even his dentist had complained about the proposal’s opposition.

“For the dentists of America to be accusing the auditors of trying to get away with murder,” he said, “is really, really something.”

When asked at the question-and-answer session about reports of possible compromises the SEC might have been considering, Levitt said that the compromises they had considered harmonized almost completely with proposals submitted by Ernst & Young and PricewaterhouseCoopers.

He expressed gratitude for the cooperation of these two firms but said that “one of the difficulties we’ve had is that the firms want to add wording that seems to ignore the possible impacts of appearance [of independence]—and the SEC just can’t do that.”

On Oct. 24 at the AICPA fall Council meeting in Las Vegas, Levitt called for cooperation between the Institute and the Commission on the issue, saying, “It’s what we do together—not alone—from this point forward that will set an enduring course for the future of this great profession.”

It soon became evident, however, that such cooperation would be harder to come by than Levitt had apparently hoped: AICPA board members indicated to various publications that the organization might pursue legal action against the SEC if its final rules on auditor independence failed to address the Institute’s concerns.

An article in Corporate Financing Week quoted Bill Ezzell, a partner at Deloitte & Touche who sits on the AICPA board, as saying, “If the ruling ignores our concerns, then we’ll look to take legal action against the rule in compliance with administrative procedures.”

In a speech delivered to the National Association of State Boards of Accountancy’s annual meeting on Sept. 18, Levitt reprimanded the Institute for opposing the proposed rules.

Characterizing it as out of touch with the majority of its members, Levitt chastised the AICPA for opposing the SEC’s calls for greater independence, accusing the Institute of stonewalling the Commission and ignoring the needs of small firm practitioners. He contended that the Institute is promoting a “commercialization of the significant responsibilities well performed by America’s professional auditors.”

“It baffles and sorrows me,” Levitt said, “to see an apparent willingness by some to discount the very ideals that give the profession its credibility—a willingness to reap the benefits of this public-mandated franchise but largely ignore the premise of its responsibilities.”

AICPA Voices Concerns

Following Levitt’s speech, AICPA Chair Kathy G. Eddy (vice chair at the time) rebutted many of Levitt’s indictments in a speech of her own. Eddy disagreed with Levitt’s accusation that the AICPA has abandoned small firm practitioners.

“I am offended, as a small firm practitioner,” Eddy said, “that the chairman would suggest that small firms have been abandoned by the AICPA. I am here to tell you that I am proof that the AICPA provides a professional home for small firm practitioners.”

One of the AICPA’s foremost complaints is what former Chair Robert K. Elliott (then chair) in his testimony called the SEC’s “rush to judgment” on the proposal.

“It’s a hasty and premature issuance of a hastily and poorly drafted rule proposal followed by an inadequate comment period,” Elliott said. The SEC allotted 75 days between the proposal’s submission and final adoption dates.

AICPA President and CEO Barry Melancon argued that, in addition to the insufficient comment period, the time allotted the AICPA to voice its concerns in the hearing was also insufficient.

“Public hearings such as today’s, involving 40 witnesses, turn the process into more of a ritual than a real dialogue,” Melancon said.

In response to such complaints, SEC Commissioner Laura Unger expressed disappointment in the fact that, after the release of the proposal, the AICPA launched a massive letter-writing campaign to Capitol Hill instead of discussing its concerns in person with the SEC.

“We talk about the deteriorating relationship between the accounting profession and the SEC, but what kind of a relationship are we talking about?” she said.

The AICPA and the Big Five are not the only groups that have expressed concerns about the SEC’s methods of bringing the rules into being. In early October, it was reported that a group of congressional representatives was planning to add a provision to government-spending legislation that would block the SEC proposal.

The Clinton administration released a statement saying that it opposed any such plans, saying that the SEC “should be permitted to continue this deliberative process in the interest of maintaining the integrity of America’s financial markets.”

New York Weighs In

The New York State Society of CPAs weighed in on the auditor independence issue as well. In the Sept. 13 public hearing in New York City and in comments sent to the SEC on Sept. 25, the NYSSCPA held that the standards should be guidelines rather than rules.

In its comments, the Society agreed with the goals of the proposed rules but concluded that the proposal went too far in restricting the nonaudit services accountants can offer their audit clients.

“We agree with the general standard for auditor independence and the need for overriding principles,” Society President P. Gerard Sokolski stated, in the Society’s comments. “However, these four governing principles should not be determinants of independence, but should be used to help formulate independence rules.”

The Society also expressed concern that the restrictive nature of the proposed regulations would inadvertently harm small businesses, especially those in small communities where CPA firms may be the only source of certain business services.

At the hearing, NYSSCPA President-Elect Nancy Newman-Limata and Vice President Jo Ann Golden explained the Society’s concerns, including the possible effect the proposed rules could have on smaller SEC registrants.