January 9, 2003
Jonathan G. Katz
Secretary
U. S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
File No. S7-49-02 Proposed Rule: Strengthening the Commission’s
Requirements Regarding Auditor Independence
Members and Staff of the Commission:
The American Institute of Certified Public Accountants (the “AICPA”) respectfully
submits the following comments on the proposed rules of the Securities and Exchange
Commission (the “SEC” or the “Commission”) to enhance the independence of
accountants that audit and review financial statements and prepare attestation reports
filed with the Commission (the “Proposed Rule”). The AICPA is the largest professional
association of certified public accountants in the United States, with approximately
350,000 members in business, industry, public practice, government and education.
The AICPA is firmly committed to working with the Commission to implement the
provisions of the Sarbanes-Oxley Act of 2002 (the “Act”) and rebuild the faith of
investors who depend on accounting professionals for accurate, timely and relevant
financial information. We applaud the enormous effort put forth by the members and
staff of the Commission to implement the Act under the extraordinarily tight time
constraints mandated by Congress.
We support the Commission’s proposal to strengthen the profession’s independence rules
as they relate to financial statement audits of public companies. Throughout its history
the AICPA has been deeply committed to auditor independence. It is a core tenet of the
accounting profession, which has a more than 100-year history of working to uphold
auditor independence. All members of the profession engaged in auditing and attest
services are required to maintain independence from audit clients in accordance with
detailed and regularly updated independence rules, interpretations and ethics rulings.
The AICPA supports many of the Commission's proposed rules on auditor independence,
and our comments and observations offered herein are intended to assist the Commission
in fully implementing both the letter and spirit of the Act and are designed to improve
upon the Commission's proposal. We stand ready to meet with the Commission and its
staff to further clarify our recommendations.
The comments reflect our strong belief that the Commission should limit its current
rulemaking efforts to implementation of the provisions of the Act without creating
requirements that go beyond it unless there is a clear need for such additional action. We
believe that any such need should develop as the result of implementing the Act in the
months ahead.
The AICPA is also concerned about the likely impact of certain of the proposed rules on
small publicly traded businesses and the accounting firms that audit them. We believe
that the Commission should take special care in this critical rulemaking to address the
rule’s impact on the complexities and costs of operating small publicly traded businesses,
and on the ability of smaller audit firms to serve them. As explained in our comments, it
is our belief that the Commission has both the authority and discretion to provide
appropriate relief to small businesses through regulatory exemptions that will allow it to
implement the Act in a manner consistent with the public interest and protection of
investors, and at a time of great concern about the vitality of our economy.
Executive Summary
Consistent with our pledge to work with the Commission to implement both the letter and
the spirit of the Act, the AICPA offers comments, observations and recommendations
regarding the following substantive areas of the Proposed Rule (listed in the order that
they appear in the Proposing Release):

Conflicts of Interest Resulting from Employment Relationships (i.e., CoolingOff). We believe that, when a member of the audit engagement team accepts
employment with an audit client, the public is more thoroughly protected through a
combination of restrictions and meaningful safeguards. Imposing a “cooling-off”
period alone, as required by the Act, would not sufficiently mitigate the threats to
auditor independence. Therefore, in order to adequately protect the public interest,
we recommend that the Commission, in addition to the mandatory cooling-off
requirement, strengthen its proposal by incorporating the specific safeguards set forth
in Independence Standards Board (“ISB”) Standard No. 3, Employment with Audit
Clients. In addition, we are concerned that the "cooling-off" restriction as proposed
would impose an undue regulatory burden on smaller publicly-held businesses that
Congress did not contemplate when it enacted the Act.

Bookkeeping, Appraisal and Valuation, and Actuarial Services. We recommend
that the Commission retain the limited exceptions that exist under the current SEC
rule for bookkeeping, appraisal and valuation, and actuarial services. We believe such
exceptions remain necessary and are consistent with both the letter and spirit of the
Act.

Internal Audit Services and Financial Information Systems Design and
Implementation. We recommend that the Commission should define more
specifically what is meant by “internal audit services” and “financial information
systems design and implementation.” We believe the Commission may be
prohibiting appropriate services that it did not intend to prohibit or were not
contemplated by the Act. We have provided a description of such services in our
specific comments.
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
Management Functions. We believe there are no circumstances under which an
accounting firm can perform or assume management functions or responsibilities for
an audit client without impairing independence.

Human Resources. We support the Commission’s Proposed Rule. However,
contrary to the discussion in the Proposing Release, we disagree that advising an audit
client with respect to the design of a management organization structure constitutes a
management function that would impair independence. We recommend that the
Commission adopt what is in the Proposed Rule and conform the discussion in the
Adopting Release to the text of the Final Rule.

Advisory and Financial Planning Services. We support the Commission’s
Proposed Rule on broker-dealer, investment adviser or investment banking services.
However, we believe it is important that the Commission clearly indicate that the
Final Rule does not prohibit accountants from providing investment advisory or
personal financial planning services for audit clients if, during the performance of
such services, the auditor does not recommend the securities of other attest clients or
assume management functions.

Legal Services. We believe that the Commission’s current guidelines governing
legal services are sufficient and represent a sensible position with respect to services
provided inside and outside of the United States. We are concerned that the
Commission’s proposal will lead to disparate results in different jurisdictions.

Expert Services. We recommend that the Commission revise its definition of prohibited
expert services to focus on the reason for the prohibition — “the appearance that the
accountant is acting as the client’s advocate in pursuit of the client’s interests.” Not
all expert services involve such advocacy or create such an appearance. For example,
accountants frequently advise clients privately about a myriad of matters which can in
no way be termed advocacy. In addition, the federal courts recognize an “expert” as
someone with specialized knowledge, skills, training, and experience in a particular
area who presents conclusions and judgments with integrity and objectivity. Further,
accountants are called upon frequently to explain their actions to regulatory
authorities, such as the SEC and the IRS, in non-public settings which do not involve
any appearance of advocating the interests of the client. We have proposed a
definition that would allow for such expert services consistent with the underlying
principle.

Tax Services. We agree with the Commission that congressional and administrative
intent is clear (i.e., "a broad array of tax services are contemplated by the Act as
permissible services for auditors to provide their clients, with audit committee preapproval"). We believe the Commission needs to ensure that its Adopting Release
clearly reflects that intent with respect to tax services. We also recommend that the
Commission specifically recognize that tax minimization services are appropriate,
while precluding auditors from advising audit clients on tax transactions for which
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there is no business purpose other than tax avoidance, except those that are consistent
with the intent of applicable tax laws.

Partner Rotation. We support the Commission’s objectives underpinning the
partner rotation requirement for auditors of publicly-held companies and the
requirements of the Act in this regard. We are concerned, however, with the breadth
of the Commission’s proposal both with respect to the number of partners it covers
and the length of the “time out” period. We believe that the Proposed Rule will
reduce audit quality and that the public would be best served if the Commission
adopted what is stated explicitly in the Act. The Final Rule should provide for an
exemption for small publicly traded business and smaller public accounting firms that
audit the financial statements of publicly-held companies, because partner rotation,
for these firms, is tantamount to firm rotation, a concept that Congress contemplated
but rejected pending further study.

Forensic Audits. We support the performance of forensic audits as an investigative
tool when there is a suspicion or evidence of fraud. However, a forensic audit is not
the appropriate tool to mitigate the effects of a partner rotation exemption. We
recommend alternative safeguards, such as Public Company Accounting Oversight
Board (“PCAOB”) review and inspection.

Compensation. A CPA firm’s audit personnel, including partners, should be
rewarded and penalized based on both quantitative and qualitative measures, such as
technical expertise and audit performance, and support a rule that would prohibit
members of an audit engagement team from being directly compensated for selling
non-audit services to their publicly-held audit client. However, we do not believe that
the Commission’s rule should prohibit an individual from sharing in the firm’s total
profits or receiving compensation from a profit pool, which may include fees for
permitted non-audit services that have been approved by the client’s audit committee.

Communication with Audit Committees. We support the Commission’s proposal
to enhance communication with audit committees and believe the suggested
additional requirements supplement the existing requirements of Statement on
Auditing Standards (“SAS”) 61, Communication with Audit Committees. We offer a
number of comments that we believe will help strengthen the Commission’s proposed
communication process.

Disclosure of Principal Accountants’ Fees. We believe that the proposed changes
to the proxy disclosure rules regarding the principal accountant’s fees, in general,
provide more meaningful information to investors than the Commission’s current
proxy disclosure rules. We believe, however, that the disclosure would be more
meaningful if “audit-related fees,” which are proposed as a separate categorical
disclosure, were combined with audit fees and the required disclosures were
accompanied by a description of the services provided in a sub-categorical disclosure.
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
Transition. We believe that a reasonable, orderly transition period is necessary and
appropriate for the effective implementation of the Act.
THE SEC’S BROAD EXEMPTIVE AUTHORITY
As many of these comments and recommendations suggest, the AICPA believes that the
Commission has the authority to craft appropriately tailored exceptions or exemptions
from the auditor independence restrictions set forth in the Act. Certain statements in the
Proposing Release, however, suggest that the Commission is concerned that the Act
limits its ability to exercise its statutory authority to adopt such exemptions. In particular,
the Release implies that Congress did not intend to allow the Commission to exercise its
existing authority under the Securities Exchange Act of 1934 (the “Exchange Act”) when
implementing the Act. As a threshold matter, we believe such a view would be mistaken.
Nothing in the Act amends Section 36(a) of the Exchange Act, which provides:
the Commission, by rule, regulation, or order, may conditionally or
unconditionally exempt any person, security, or transaction, or any class
or classes of persons, securities, or transactions, from any provision or
provisions of this title or of any rule or regulation thereunder, to the extent
that such exemption is necessary or appropriate in the public interest, and
is consistent with the protection of investors.
Most of the Act’s auditor independence provisions are drafted as amendments to Section
10A of the Exchange Act and, accordingly, fall within the purview of the Commission’s
authority under Section 36.
Several other factors support the conclusion that the Commission’s general exemptive
authority was unaffected by the Act. First, Section 3(c)(2) of the Act states that:
[n]othing in this Act or the rules of the Board shall be construed to impair
or limit . . . the authority of the Commission to set standards for
accounting or auditing practices or auditor independence, derived from
other provisions of the securities laws or the rules or regulations
thereunder, for purposes of the preparation and issuance of any audit
report, or otherwise under applicable law.
Through this provision, Congress explicitly recognized that the Commission had the
authority, prior to the Act, to establish independence standards, and should continue to
exercise that authority in a manner consistent with the public interest and the protection
of investors.
Second, despite some statements in the Proposing Release suggesting that the
Commission has little discretion when implementing the auditor independence provisions
of the Act, the Commission clearly recognizes that it retains broad discretion with respect
to the proposed rulemaking. In particular, the Proposing Release contains numerous
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questions soliciting comments as to whether the Commission should craft exemptions.
For example, the Commission asks whether it is appropriate to exempt small publiclyheld businesses or smaller public accounting firms from the employment with clients
(“cooling-off”), audit partner rotation and internal audit outsourcing provisions of the
Act. Furthermore, the SEC’s proposals regarding audit partner rotation and
compensation — which the Commission acknowledges exceed any rulemaking
obligations imposed under the Act — indicate that the Commission believes that it has
considerable discretion when proposing rules to “carry out” the requirements of the Act.
Third, Congress has followed a practice of expressly limiting the Commission’s general
exemptive authority under Section 36. It did not do so here. For example, Section 36(b)
of the Exchange Act specifically provides that the Commission may not exercise its
Section 36(a) authority to exempt any person, security or transaction (or classes thereof)
from the provisions of the Exchange Act governing the regulation of government
securities brokers and dealers. The Act, however, did not limit the Commission’s
authority to exempt persons, securities or transactions from the operation of Section 10A,
as amended. Indeed, if Congress intended the provisions of the Act to be self-executing,
without any exercise of discretion by the SEC, it would have been unnecessary to direct
the Commission to adopt rules to “carry out” those provisions.
Accordingly, we believe the Commission clearly has both the authority and discretion to
craft exemptions, categorical or otherwise, that it considers necessary or appropriate in
order to implement the Act in an effective manner consistent with the public interest and
protection of investors.
AICPA COMMENTS, OBSERVATIONS, AND RESPONSES TO SPECIFIC
QUESTIONS POSED IN THE COMMISSION’S PROPOSING RELEASE,
ORGANIZED BY TOPIC1
Alternative Approach: Moving Regulation S-X Rules to Exchange Act Rules

We seek comment on this alternative approach. We also seek comment on
whether any of the current auditor independence rules or definitions under
Regulation S-X, the substance of which we do not propose to change in light of
the Sarbanes-Oxley Act, should also be made into Exchange Act rules, or
conversely, whether any of the particular proposed or existing rules relating to
audits should stay in Regulation S-X even if all or most of the remaining
proposed rules are adopted as Exchange Act rules.
We agree that implementing the independence provisions of the Act as amendments
to Regulation S-X, as proposed by the Commission, is the better approach. We do
not perceive any benefit to converting the independence regulations into separate
Exchange Act rules. To the contrary, members of the profession traditionally have
looked to Regulation S-X to locate the independence rules and relocating these
1 Topics are italicized and in bold face.
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provisions could well result in confusion for the accounting profession with little, if
any, benefit. Moreover, moving these regulations is unnecessary to “make explicit”
that violations of these regulations would be punishable as Exchange Act violations,
since the Sarbanes-Oxley Act (and proposed Rule 10A-2) expressly addresses this
point. We believe that the most effective and least confusing approach would be to
leave the independence rules where they are, in the context of Regulation S-X and its
accompanying definitions.
Conflicts of Interest Resulting from Employment Relationships
We believe that, when a member of the audit engagement team accepts employment with
an audit client, the public is more thoroughly protected through a combination of
restrictions and safeguards (i.e., policies and procedures).2 We do not believe that
imposing a “cooling-off” period is necessary or sufficiently mitigates the threats to
auditor independence, but recognize that the Act requires one. Specifically, a cooling-off
period would not safeguard against the potential risks associated with a former auditor’s
acceptance of employment with an audit client because of the potential for evading its
objectives. For example, a company could employ the former firm professional in a
“non-financial reporting oversight role” for a one-year period and then promote the
professional to a senior-level position such as Controller. Therefore, in order to
adequately protect the public interest, we recommend that the Commission, in addition to
the required cooling-off requirement, strengthen its proposal by incorporating the specific
safeguards set forth in ISB Standard No. 3, Employment with Audit Clients. The
Commission recognized the importance of the ISB No. 3 safeguards, as evidenced by the
inclusion of such safeguards in its current rule,3 and we believe that these safeguards are
still necessary in order to protect auditor independence. Accordingly, we believe it is
necessary to incorporate the additional ISB No. 3 safeguards into the rule.

Is the one-year cooling-off period sufficiently long to achieve an appearance of
independence by the accounting firm? If not, what period would be
appropriate?
We do not believe that it is necessary or appropriate to go beyond the requirements of
the Act and extend this period beyond the one-year requirement. Rather, as noted
above, we recommend that the ISB No. 3 safeguards be incorporated into the rule to
protect auditor independence and strengthen the Proposed Rule.

Is the term “audit engagement team” sufficiently clear? If not, what changes
would improve the description to describe the group of accountants who would
be covered? Are the appropriate officers covered by the proposed rule? If not,
2 In fact the proposed revision to AICPA Interpretation 101-2, Employment or Association with Attest
Client, incorporates the safeguards set forth in ISB No. 3, Employment with Audit Clients, in addition to
other specific requirements.
3 Commission’s Auditor Independence Requirements, Securities Act Release No. 33-7919, 65 Fed. Reg.
76009 at n.313 (Dec. 5, 2000) (hereinafter “December 2000 Release”).
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which additional individuals should be subject to the cooling-off period
provision? For example, should national office personnel who would be
excluded under the proposal be included?
We believe the term “audit engagement team” is clear. For purposes of the coolingoff provision, however, it is too broad. The SEC defines audit engagement team to
include:
all partners, principals, shareholders, and professional employees
participating in an audit, review, or attestation engagement of an audit
client, including those conducting concurring or second partner reviews
and all persons who consult with others on the audit engagement team
during the audit, review, or attestation engagement regarding technical or
industry-specific issues, transactions, or events.
We do not believe that it is necessary to subject “all persons who consult with others
on the audit engagement team during the audit, review, or attestation engagement” to
the cooling-off requirement. Such individuals generally have limited involvement
with respect to the audit as a whole and their participation is typically confined to
specific issues or transactions. Accordingly, it is highly unlikely that their knowledge
of the client or involvement with the audit team could adversely influence the quality
or effectiveness of the audit if such individuals later were to accept employment with
the audit client.
Excluding these individuals from the definition of “audit engagement team” would be
consistent with the Commission’s treatment of this group of individuals under the
“partner rotation” requirement which indicates that:
[p]artners assigned to “national office” duties (which can include both
technical accounting and centralized quality control functions) who may
be consulted on specific accounting issues related to a client are not
considered members of the audit engagement team even though they may
consult on client matters regularly. While these partners play an
important role in the audit process, they serve, primarily, as a technical
resource for members of the audit team. Because these partners are not
involved in the audit per se and do not routinely interact or develop
relationships with the audit client, we do not believe that it is necessary to
rotate the involvement of these personnel.
Accordingly, we recommend that the rule expressly exclude this group of persons
from the definition of audit engagement team for purposes of the cooling-off
requirement, but that ISB No. 3 safeguards be applied.

Should the proposed rules apply equally to large firms/companies as small
firms/companies? Would the proposed rules impose a cost on smaller issuers
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that is disproportionate to the benefits that would be achieved? Why or why
not? Should there be an exemption to this requirement for smaller businesses?
Limiting the ability of companies to hire the most qualified person could reduce the
quality of financial reporting. Many businesses often look to their auditors as
potential candidates to fill internal accounting and financial positions when in need of
qualified individuals who have accounting and financial expertise, since the members
of the audit engagement team are quite familiar with the company’s financial
reporting requirements and accounting policies and procedures. A business can
therefore significantly benefit from such individuals’ expertise and existing
knowledge of the company’s business and operations. Companies also benefit from
hiring individuals they have grown to know and in whom they have developed
confidence as a result of the audit relationship. To the extent that businesses are
having difficulty locating qualified and willing board members and senior
management staff, the cooling-off provision would only exacerbate these challenges.4
We do not believe that forcing a company to choose between the right person for the
job or its accounting firm is the correct answer, especially if both are right for the job.
The proposed expanded cooling-off requirement would serve as a disincentive to
public companies from employing a member of their audit team — who may be the
most qualified individual to perform the job.
We also believe that the burden imposed by the cooling-off requirement on small
businesses will be significantly greater than for large companies. Specifically, large
companies generally have the resources to attract more qualified employees through
internal and external recruiting efforts and are able to offer higher compensation and
enhanced benefits. These types of incentives are often not available to smaller
businesses and therefore having the ability to look to audit personnel as potential
candidates is even more crucial. In addition, many small businesses are located in
small, remote locations that make it difficult to attract and locate potential candidates.
Accordingly, we do not believe that such a requirement as it relates to small
businesses serves the public interest or that Congress contemplated the burden
imposed on small businesses when it enacted the Act. We therefore encourage the
Commission to consider controls for small publicly-held businesses, other than a
cooling-off requirement. For example, the Commission could require that, when a
member of the audit engagement team becomes employed by a small issuer, the
engagement be subject to an in-depth evaluation by the PCAOB in the year of or after
the individual accepts employment. We believe that an enhanced PCAOB evaluation,
coupled with the ISB No. 3 requirements and the audit committee’s enhanced role in
ensuring independence of the auditor, is sufficient to mitigate the potential threats to
independence that might occur under such circumstances.
4 In its December 2000 Release, the Commission noted itself that, “a cooling off period unnecessarily
restricts the employment opportunities of former professionals.” Id. at 76042.
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
Should the Commission include exceptions subject to certain criteria? If so,
what should these criteria be?
Section 206 of the Act applies only to those individuals who accept employment with
an audit client as the “chief executive officer, controller, chief financial officer, chief
accounting officer, or any person serving in an equivalent position.” However, the
Commission’s definition of “financial reporting oversight role” is broader than what
is required by the Act and would encompass all roles in which the person is:
in a position to or does exercise influence over the contents of the
financial statements or anyone who prepares them, such as when the
person is a member of the board of directors or similar management or
governing body, chief executive officer, president, chief financial officer,
chief operating officer, general counsel, chief accounting officer,
controller, director of internal audit, director of financial reporting,
treasurer, or any equivalent position.
We believe that, for purposes of the cooling-off restriction, the requirement should
not extend to a “member of the board of directors or similar management or
governing body” unless the individual also serves on the company’s audit committee.
Such other members of the board generally play a far less extensive role in the
company’s financial reporting and the safeguards required by ISB No. 3 are sufficient
to protect against any threat to the auditor’s independence. Furthermore, in today’s
environment there is a greater need for competent and qualified board members and
to limit the pool of qualified and financially literate persons would appear to only
exacerbate the problem, contrary to the public interest. We therefore recommend that,
for purposes of the cooling-off provision, the definition of “financial reporting role”
exclude members of the board (exclusive of the audit committee members) and that
such individuals instead be subject to the ISB No. 3 safeguards.
In addition, we believe that the cooling-off requirement should only apply to those
members of the audit engagement team who accept employment with the issuer,
rather than the audit client. Specifically, we believe that the other requirements set
forth in the Proposed Rule combined with the ISB No. 3 safeguards are sufficient to
mitigate any threat to independence when a member of the audit engagement team
accepts employment with an affiliate of the issuer.
Services Outside the Scope of the Practice of Auditors

Is the meaning of the general principles sufficiently clear?
We support the Commission’s view that the three general principles enumerated in
the legislative history of the Act for auditors of public companies were intended to
provide guidance to the Commission in defining the scope of the prohibited services.
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As is the case with any overarching norm, these principles will not provide clear
answers in all situations where a question may arise.5
In addition to identifying these three core principles, the Proposing Release appears to
embrace a fourth principle not cited in the legislative history: the need to avoid
“mutual or conflicting interests” with audit clients. We recognize, however, that this
principle is identified in the existing Preliminary Note to Rule 2-01 of Regulation SX, as a general standard for accountants to consider when assessing auditor
independence.
This principle was excluded from the list prescribed in the legislative history of the
Act. We do not believe that its omission was an oversight and respectfully urge the
Commission to amend the Preliminary Note to Rule 2-01 to emphasize the three
principles endorsed by Congress and eliminate the fourth principle. In our
experience, the concept of “mutuality of interest” is too vague and malleable to serve
as an effective principle. Moreover, nothing in the Proposing Release provides
meaningful guidance as to the scope of activities that this concept is intended to
address. As a result, the endorsement of this concept as a “core principle” would tend
to foster uncertainty and inconsistent applications in practice.
Bookkeeping or Other Services Related to the Audit Client’s Accounting Records or
Financial Statements of the Audit Client
We recommend that the Commission incorporate into Proposed Rule 2-01(c)(4)(i) its
long-standing exception allowing a public company’s audit firm to provide bookkeeping
services in emergency/unusual situations and de minimis bookkeeping services to foreign
divisions or subsidiaries of the client. The existing exceptions are limited, serve
legitimate needs and have not been abused. Some businesses faced with emergencies
will find it impossible to complete their financial statements if they cannot obtain
assistance contemplated by the current exemption. The need for such an exception was
made evident by the tragic events of September 11, 2001.6 These exceptions are both
extremely narrow and rarely invoked, and we see no reason why the SEC should not
continue to provide for them in its Final Rule.

Should the definition of bookkeeping be further clarified? If so, how?
We believe that further clarification of what would constitute prohibited bookkeeping
services would be helpful. As noted in Samuel L. Burke’s March 4, 2002 letter to
Patrick F. Gannon (Chairman, Florida Institute of Certified Public Accountants),
5 See infra pp. 25 - 27, discussing the advocacy principle in relation to Expert Services.
6 Bookkeeping Services Provided by Auditors to Audit Clients in Emergency or Other Unusual Situations,
17 C.F.R. § 211 (2001). This release expressed the view of the Commission that auditors of the financial
statements of registrants may provide certain bookkeeping services to those audit clients directly affected
by the events of September 11, 2001.
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independence impairment when providing certain bookkeeping assistance to an audit
client depends on the auditor’s degree of participation. This letter further states that:
as stated in the Frequently Asked Questions document issued by the SEC’s
Office of the Chief Accountant which was quoted in your letter of
December 19, 2001, an auditor is not necessarily precluded from assisting
a client with preparing financial statements. While the distinction between
rendering professional advice and assuming a managerial role is subtle
and may sometimes be unclear, the Commission has provided a
framework that may be utilized in making this determination. In the
Codification, the Commission stated, “managerial responsibility begins
when the accountant becomes or appears to become, so identified with the
client’s management as to be indistinguishable from it. In assessing
whether this degree of unity has been reached, the basic consideration is
whether, to a third party, the client appears to be (i) substantially
dependent upon the accountant’s skill and judgment in its financial
operations, or (ii) is reliant only to the extent customary for that type of
consultation or advice.
The auditor may consider many factors in evaluating the extent of his or
her involvement in the construction of financial statements for an audit
client. Determinations of the auditor’s involvement in this capacity depend
on the facts and circumstances of the particular case. The following are
examples of operating characteristics that should be considered by the
auditor:




What is the level of management’s financial reporting expertise?
Has management taken full responsibility for the judgments and
results of the financial statement preparation process?
Has the audit client sustained a level of financial expertise that
enables the company to maintain its own books and records and
avoid a de facto delegation of financial reporting responsibilities
to the auditor?
Is the level of auditor assistance functionally equivalent to that of a
member of the management team?
With regard to recommending modifications to the footnotes or basic financial
statements of an audit client, Mr. Burke’s letter also states that:
the auditor may provide the client with resources, research materials,
advice and comments on the presentation that is proposed by
management. This involvement may also include the provision of editorial
suggestions that may improve the transparency and clarity of the
information presented. Such advisory services do not necessarily fall
within the ambit of proscribed management functions. The Staff believes
that this type of advice and assistance is generally in the public interest as
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it more often than not results in improved financial reporting and
constitutes a logical and effective way for registrants to adopt and comply
with complex accounting and financial reporting standards.
We agree that providing the types of professional advice and assistance described
above to an audit client does not constitute assuming a managerial role and is
consistent with the general principles. We recommend that the Commission’s Final
Rule provide similar guidance on the types of bookkeeping services (i.e., those that
would constitute professional advice and assistance) that would be permitted.

Should an auditor be permitted to provide bookkeeping services to an audit
client if it is not reasonably likely that the results of those services will be subject
to audit procedures during the audit of the client’s financial statements? Why
or why not?
If the Commission should decide to permit bookkeeping services to an audit client in
situations where it is "not reasonably likely" that the results of those services will be
subject to audit procedures, we recommend that the Commission explicitly make
clear that under no circumstances, could the auditor perform management functions
or assume the role of management.
Financial Information Systems Design and Implementation
The Commission’s Proposed Rule 2-01(c)(4)(ii) provides that an accountant is not
deemed independent if the accountant designs or implements a hardware or software
system that aggregates source data underlying the financial statements or generates
information that is significant to the audit client’s financial statements taken as a whole.
We believe it is important that the SEC clarify what is meant by “design or implement”
and provide additional guidance as to the types of services that are expressly prohibited
under the rule. For example, if the auditor assists a client with installing prepackaged
software, such as Quick Books, would this be considered “implementing” the client’s
software system, resulting in an impairment of independence? It is also unclear whether
assisting an audit client with installing routine upgrades to its existing systems would
result in an impairment under the proposed rule. We believe that these types of routine
installations of prepackaged software, which currently are common activities, would not
impair independence provided that the specific safeguards currently required by the
Commission are followed.7 These services pose little or no self-review threat, and none
7 Safeguards required under the current rule are: (1) the audit client’s management has acknowledged in
writing to the accounting firm and the audit client’s audit committee, or if there is no such committee then
the board of directors, the audit client’s responsibility to establish and maintain a system of internal
accounting controls in compliance with Section 13(b)(2) of the Exchange Act; (2) the audit client’s
management designates a competent employee or employees, preferably within senior management, with
the responsibility to make all management decisions with respect to the design and implementation of the
hardware or software system; (3) the audit client’s management makes all management decisions with
respect to the design and implementation of the hardware or software system including, but not limited to,
decisions concerning the systems to be evaluated and selected, the controls and system procedures to be
implemented, the scope and timetable of system implementation, and the testing, training, and conversion
13
of the other core principles would be violated provided the audit client makes all
decisions in connection with the system and the auditor is not involved in establishing the
system’s controls as part of the systems installation. As we note below under the section
Management Functions, we do not believe it would be appropriate for the auditor to
issue an opinion on management’s assessment of the adequacy of the company’s control
systems, as required under Section 404 of the Act, when he or she has designed or
developed the controls associated with any appropriate installation.
With regard to “designing” a client’s software system, we believe independence would be
impaired in situations where the auditor was involved in determining the actual
specifications of the systems software. In cases where the auditor had no involvement in
developing or designing the software, we see no reason why the auditor would be
unwilling to challenge the integrity and efficacy of the client’s financial or accounting
information system during the audit.
We believe that the real threat to independence exists when an auditor installs a client’s
financial information system that is developed or designed by the auditor or where the
auditor makes significant modifications to a client’s existing financial information
system.

Is an auditor’s independence impaired when the auditor helps select or test
computer software and hardware systems that generate financial data used in or
underlying the financial statements? Why or why not?
We believe that independence should not be considered impaired when an auditor
assists the client in determining an appropriate software or hardware system most
suitable for the client’s needs. Making recommendations or providing advice to the
client regarding the most appropriate computer software and hardware systems should
always be permitted, provided the client is in a position to make an informed
judgment on the results of the service, appropriately oversees the performance of the
service, evaluates the adequacy of the service and any resulting findings, makes all
decisions with respect to which software or hardware system to purchase, and
establishes and maintains internal controls over the performance and implementation
of the service.
The General Accounting Office (“GAO”) recognized the importance of having the
auditor provide such advice as reflected in its new independence standard.
Specifically, the implementation guidance for the GAO standard states that an auditor
“may provide the audited entity its opinion on various software packages based on its
plans; (4) the audit client’s management evaluates the adequacy and results of the design and
implementation of the hardware or software system; and (5) the audit client’s management does not rely
on the accountant’s work as the primary basis for determining the adequacy of its internal controls and
financial reporting systems.
14
experience with and knowledge of the effectiveness of these packages at other
organizations and based on its knowledge of the audited entity’s needs.”8
We also agree with the GAO’s position that activities such as training the client on its
financial information system should be permitted and do not impair independence.
We recommend that the Commission expressly permit the provision of such advice
and training in its Final Rule.

Whether a system is used to generate information that is “significant” to the
audit client’s financial statements may depend on the size of the engagement.
Does the magnitude as a percentage of either audit fees or total fees of the fees
for such services make a difference on whether performance of the service
impairs independence?
In our view, the level of the auditor’s fees in designing or implementing such a
system is wholly unrelated to whether the information generated from that system
may be significant to the audit client’s financial statements.
Appraisal or Valuation Services, Fairness Opinions, or Contribution-in-Kind Reports

Does providing valuation or appraisal services that are unrelated to the financial
statements, such as for certain regulatory purposes, impair an accountant’s
independence?
We do not believe independence would be impaired if an accountant performs a
valuation or appraisal service that is unrelated to the financial statements.
Specifically, where such services have no impact on the financial statements, the
accountant would not be in a position of reviewing his or her own work during the
audit of the financial statements. In the Proposing Release, the Commission states
that, "[t]he proposals do not prohibit an accounting firm from providing such
services for non-financial reporting (e.g., transfer pricing studies, cost segregation
studies) purposes.”
We agree that, consistent with the three principles set forth in the Act, such services
would not impair independence provided the auditor does not perform any
management functions or make management decisions.

Does providing valuation or appraisal services for tax purposes impair an
accountant’s independence?
We do not believe that providing valuation or appraisal services for tax purposes
impairs an auditor’s independence, provided the auditor does not, under any
circumstance, perform management functions or make management decisions.
8
GOVERNMENT AUDITING STANDARDS NO. 74, ANSWERS TO INDEPENDENCE STANDARD QUESTIONS
(2002).
15
In addition, the auditor must establish an understanding with the audit client
regarding the limitations of the engagement and management’s responsibilities to
designate a management-level individual, who is in a position to make an informed
judgment on the results of the service, to:



be responsible for overseeing the valuation or appraisal service;
evaluate the adequacy of the appraisal or valuation service and any resultant
findings; and
make all management decisions with respect to the appraisal or valuation
service.
The Proposing Release notes, “[o]ur proposals do not prohibit an accounting firm
from providing such [valuation and appraisal] services for non-financial reporting.”
We believe that so-called “tax only” valuations are made for non-financial reporting
purposes. In fact, the two examples given in the Proposing Release — transfer
pricing studies and cost segregation studies — are principally tax-driven. We believe
that the Commission makes an appropriate distinction between financial and nonfinancial reporting.
Recognizing that most tax valuation engagements fall within the purview of nonfinancial reporting would be consistent with the Commission’s approach to this
subject in its December 2000 Release. In that release, the Commission concluded
that valuations for non-financial purposes did not impair auditor independence where
the results of the valuation do not affect the financial statements. Further, a specific
provision was included exempting valuations “performed for the planning and
implementation of a tax-planning strategy or for tax compliance services.” We
believe it would be appropriate to continue both exceptions but, at the very least, we
would urge the Commission to include descriptive language in the discussion of the
Adopting Release noting that most tax valuation engagements are for the purpose of
non-financial reporting.
An example of the difference in conclusions reached regarding independence can be
found in purchase accounting. If an audit client acquires the assets of another
company, the audit firm may be asked to undertake a valuation of the purchased
assets. If the purpose of the engagement is to determine allocated values under tax
accounting principles (the tax basis of fixed assets for future tax depreciation, for
example), the valuation is for non-financial reporting purposes and the engagement
should not impair independence. If the valuation of those same assets is undertaken
for purchase accounting under SFAS No. 141, independence would be impaired.

Are there certain types of appraisal or valuation services, or certain instances in
which they are provided, that do not raise auditor independence concerns? Are
there circumstances in which an accounting firm may be required by law or
regulation to provide such services, either in the United States or abroad?
16
In addition to valuation or appraisal services for tax purposes, we believe there are
other circumstances where appraisal or valuation services do not threaten auditor
independence. The SEC’s current rule provides for an exception in situations where
“the accounting firm’s actuaries value an audit client’s pension, other postemployment benefit, or similar liabilities, provided that the audit client has
determined and taken responsibility for all significant assumptions and data.”
However, Proposed Rule 2-01(c)(4)(iii) would prohibit such services. In its
December 2000 Release, the Commission acknowledged that"[a]ccountants
historically have provided pension assistance to their audit clients, and if
appropriate persons at the audit client determine the underlying assumptions and
data, we believe that independence is not impaired.”
Such pension-related services are typically obtained to comply with regulatory
requirements. For example, such valuation/actuarial work is subject to audit by the
IRS and reviewed by the U.S. Department of Labor and the Pension Benefit Guaranty
Corporation and therefore, is subject to scrutiny by these organizations. In addition,
these valuations are performed under specific, detailed standards established by the
Financial Accounting Standards Board and are also subject to actuarial practice
guidelines. Accordingly, we believe that these types of valuation/actuarial services
are a tightly controlled professional service and should be treated differently from
other traditional appraisal and valuation services. We also believe that any exemption
for these services should be included under Proposed Rule 2-01(c)(4)(iv), as they are
more readily characterized as actuarial services, rather than valuation services.
In summary, we see no reason for the Commission to change its current position and
believe that this narrow exception should be incorporated into the Final Rule. In all
cases, however, the auditor should be prohibited from performing management
functions or making management decisions in connection with these services.
The Proposing Release also states that the Proposed Rule:
does not limit an accounting firm from utilizing its own valuation
specialist to review the work done by the audit client itself or an
independent, third-party specialist employed by the audit client, provided
the audit client or the client’s specialist (and not the specialist used by the
accounting firm) provides the technical expertise that the client uses in
determining the required amounts recorded in the client financial
statements.
We agree that this conclusion is appropriate and consistent with the three overarching
principles since, in those instances, a third party or the audit client is the source of the
financial information subject to the review or audit, and the accountant will not be
reviewing or auditing his or her own work. We recommend, however, that this be
explicitly stated in the Commission’s rule.
Actuarial Services
17

Are there certain circumstances under which an accountant can provide
actuarial services to an audit client without impairing independence?
The Commission’s Proposed Rule 2-01(c)(4)(iv) would prohibit any actuariallyoriented advisory service involving the determination of amounts recorded in the
financial statements and related accounts for the audit client, where it is reasonably
likely that the results of these services will be subject to audit procedures during an
audit of the client’s financial statements.
We believe that there are certain actuarial-related services that would not result in an
impairment to an auditor’s independence. For example, under the current SEC rule,
the Commission recognized four types of actuarial services for an insurance company
audit client that would not constitute an assumption of the insurance company
management’s role or responsibilities, and would not impair the auditor’s
independence provided certain conditions are met.9 As discussed above (see
Appraisal or Valuation Services) there are also actuarial services that are
compliance-driven, such as where the accounting firm’s actuaries value an audit
client’s pension, other post-employment benefit, or similar liabilities. We believe that
such compliance-oriented services should be expressly permitted under Proposed
Rule 2-01(c)(4)(iv).
Finally, the Proposing Release states that the “proposed rules provide that the
accountant may utilize his or her own actuaries to assist in conducting the audit
provided the audit client uses its own actuaries or third-party actuaries to provide
management with the primary actuarial capabilities.” This is not, however, explicitly
stated in the Proposed Rule. We agree that such assistance would not impair
independence and recommend that this be expressly stated in the rule.

Have we appropriately described the actuarial services prohibited by the Act?
It appears that all actuarial services that result in amounts recorded in the financial
statements would be prohibited under the Commission’s Proposed Rule. As noted
above, we believe that there are certain actuarial services that should not be deemed
to impair independence.
Internal Audit Outsourcing

9
Is the definition of the “internal audit function” sufficiently clear?
Those actuarial services are: (i) assisting management to develop appropriate methods, assumptions, and
amounts for policy and loss reserves and other actuarial items presented in financial reports, based on the
company’s historical experience, current practice, and future plans; (ii) assisting management in the
conversion of financial statements from a statutory basis to one conforming with GAAP; (iii) analyzing
actuarial considerations and alternatives in federal income tax planning; and (iv) assisting management in
the financial analyses of various matters, such as proposed new policies, new markets, business
acquisitions, and reinsurance needs.
18
We do not believe so. The Commission’s Proposed Rule 2-01(c)(4)(v) states that an
auditor is not independent when the auditor performs internal audit services related to
the internal accounting controls, financial systems or financial statements for an audit
client. While we understand that the Act restricts internal audit outsourcing, it does
not provide a definition of precisely what is covered. Presumably, it should only be
those services that violate one of the three basic principles. Therefore, we believe it
is imperative that the Commission explicitly identify the types of services that would
be included, as well as excluded, under the definition of “internal audit services.” For
example, extended audit procedures (i.e., services involving an extension of the
procedures that are generally of the type considered to be extensions of the
accountant’s audit scope applied in the audit of the client’s financial statements), such
as confirming accounts receivable and analyzing fluctuations in account balances,
should not impair independence, even if the extent of such testing exceeds that
required by generally accepted auditing standards ("GAAS"), and should not be
considered internal audit services. As the Commission is aware, Footnote 397 of the
SEC’s December 2000 Release expressly permitted such services:
[i]n addition, performing procedures that generally are considered to be
within the scope of the engagement for the audit of the audit client’s
financial statements, such as confirming accounts receivable and
analyzing fluctuations in account balances, would not impair the
accountant’s independence, even if the extent of testing exceeds that
required by GAAS. For example, if an accountant in normal
circumstances would plan to observe ten percent of an audit client’s
inventory, but at the audit client’s request the accountant observes 50% of
inventory on hand, the accountant’s independence would not be impaired.
Additional or extended auditing procedures result in a higher quality audit and should
not be discouraged — in fact, they should be encouraged. We therefore recommend
that the Commission explicitly exclude these types of extended audit procedures from
the definition of internal audit services.

We solicit comment on whether an exception should be provided for small
businesses. If so, what criteria should we consider in providing such an
exception?
We believe that publicly-held small businesses with less complex operations and
limited staff may determine that the costs outweigh the benefits of having a full-time
internal audit department and staff. In such cases, it may be necessary for the audit
firm to extend its audit procedures to obtain sufficient, competent evidential matter to
support the auditor’s report. As we noted above, such extended audit procedures,
even if beyond those required by GAAS, should always be permitted (and, indeed,
encouraged by the Commission) and should be excluded from the definition of
internal audit services for purposes of the rule.
19

Does it impair an auditor’s independence if the auditor does not provide to the
client outsourcing services related to the internal audit function of the audit
client, but rather performs individual audit projects for the client?
We do not believe independence would be impaired if an auditor performed
individual audit projects for the client, provided the six specific safeguards required
under the current SEC rule were satisfied.10 Such projects are presumably
nonrecurring in nature and would not result in the outsourcing of the internal audit
function, as we believe Congress intended. The Proposing Release acknowledges
that the rule is not intended to include “nonrecurring evaluations of discrete items or
programs that are not in substance the outsourcing of the internal audit function.” We
recommend that this be expressly stated in the Final Rule.

Would it impair the auditor’s independence if the auditor performs only
operational audits that are unrelated to the internal controls, financial systems,
or financial statements?
We do not believe that operational audits unrelated to the internal controls, financial
systems or financial statements would impair independence. Such audits would not
result in a self-review threat or violate any other core independence principle.
Accordingly, we recommend that the Commission continue to exclude such services
from the definition of internal audit services and expressly so provide in the rule.
Management Functions

Do services related to designing or implementing internal accounting controls
and risk management controls result in the auditor auditing his or her own
work? Would such services impair an auditor’s independence when the auditor
is required to issue an opinion on the effectiveness of the control systems that he
or she designed or implemented?
We believe that in situations where the auditor designs (i.e., is involved in
developing and establishing) or implements a client’s internal accounting and risk
management controls, a self-review threat would exist that could not be mitigated by
specific safeguards. Under such circumstances, we do not believe it would be
10 The current safeguards require the following: (1) the audit client’s management has acknowledged in
writing to the accounting firm and the audit client’s audit committee, or if there is no such committee then
the board of directors, the audit client’s responsibility to establish and maintain a system of internal
accounting controls in compliance with Section 13(b)(2) of the Exchange Act; (2) the audit client’s
management designates a competent employee or employees, preferably within senior management, to be
responsible for the internal audit function; (3) the audit client’s management determines the scope, risk,
and frequency of internal audit activities, including those to be performed by the accountant; (4) the audit
client’s management evaluates the findings and results arising from the internal audit activities, including
those performed by the accountant; (5) the audit client’s management evaluates the adequacy of the audit
procedures performed and the findings resulting from the performance of those procedures by, among
other things, obtaining reports from the accountant; and (6) the audit client’s management does not rely on
the accountant’s work as the primary basis for determining the adequacy of its internal controls.
20
appropriate for the auditor to issue an opinion on the effectiveness of internal controls
over financial reporting that he or she designed.

Do services related to assessing or recommending improvements to internal
accounting controls and risk management controls result in the auditor auditing
his or her own work? Would such services impair an auditor’s independence
when the auditor is required to issue an attestation report on the effectiveness of
the control systems that he or she has assessed or evaluated for effectiveness?
We do not believe that independence would be impaired when an auditor assesses or
recommends improvements to the client’s internal accounting and risk management
controls. As part of a financial statement audit, an audit of the effectiveness of
internal controls over financial reporting or as part of another attest engagement (e.g.,
a review of financial statements or a SysTrust engagement performed under the
attestation standards), an auditor may observe weaknesses in a client’s internal
accounting or risk management controls. We believe that the public is well served,
and independence should never be considered impaired, when an auditor makes
recommendations or provides advice to a client on how to improve the effectiveness
of its internal controls or risk management controls, provided the client makes the
ultimate decision on how to correct an identified weakness.
As the Commission points out in the Proposing Release, these services “can be
extremely valuable to companies, and they may also facilitate the performance of a
high quality audit.” We do not believe that such recommendations result in a selfreview threat or would impair the auditor’s independence if the auditor was asked to
report on the overall effectiveness of the client’s control system, provided the
decision to implement any of the auditor’s recommendations was made by
management.

We request comment on whether there are circumstances under which an
accounting firm can perform or assume management functions or
responsibilities for an audit client without impairing independence?
No, there are no such circumstances. We support the Commission’s Proposed Rule
2-01(c)(4)(vi) prohibiting the auditor from performing management functions and
believe that such functions should always remain with client management. In fact,
the AICPA rules on non-audit services explicitly state that, “[i]n particular, care
should be taken not to perform management functions or make management decisions
for the attest client, the responsibility for which remains with the client’s board of
directors and management.”11
The prohibition on performing management functions and making management
decisions is an overarching principle to which auditors should always adhere.
11
AICPA Code of Professional Conduct ET § 101.05.
21
Whether or not a particular service would entail performing a management function,
of course, may be open to interpretation.
Human Resources
We support the text of the Commission’s Proposed Rule 2-01(c)(4)(vii) regarding human
resources services, and note that no change is being proposed to the text of the Proposed
Rule. We are concerned, however, that the Commission may be taking certain positions
in the Proposing Release regarding the provision of human resources services that are not
reflected in the Proposed Rule and do not reflect the overarching principle surrounding
the performance of certain human resources services — namely, that the auditor cannot
function as part of management of the audit client. For example, the Proposing Release
indicates that an auditor’s independence is impaired when the auditor advises an audit
client about the design of its management or organization structure.
We disagree with that suggestion. In our view, advising an audit client about the design
of its management or organization structure is (a) not a service that impairs auditor
independence because the auditor is merely advising the client and not performing
management functions, and (b) a service that is far removed from human resources
activities. For example, advising on management or organizational structures focuses on
institutional (as opposed to personnel-specific) issues, such as advice about facility
layout, office locations, or division or unit organization. The Proposing Release makes
the blanket assertion that human resources restrictions are necessary because assisting
management in “human resource selection or development” places the auditor in a
position of having an interest in the success of the employees the auditor has selected,
tested or evaluated, and that observers may perceive that an auditor would be reluctant to
suggest the possibility that those employees failed to perform their jobs appropriately
because doing so would require the auditor to acknowledge shortcomings in its human
resources service. We appreciate the Commission’s observations. However, as discussed
above, advising about organizational structure in an institutional context has little, if any,
relation to individual client personnel. And, even if the advisory services did not have an
institutional focus, an assumption should not be made that such services would result in
the auditor’s identifying with any particular individual in the manner suggested by the
Proposing Release.

Are there additional types of human resource and employee benefit services that
impair an auditor’s independence?
We would consider the acts of hiring client employees, terminating client employees
and committing the client to employee compensation or benefit arrangements to be
human resources activities that impair the auditor’s independence.

Would an auditor’s independence be impaired if the auditor provided personnel
hiring assistance for only non-executive or non-financial personnel?
22
We believe that the proscribed activities listed in the Commission’s Proposed Rule 201(c)(4)(vii)(A)-(E) are appropriate with respect to the designated personnel, and do
not believe that any benefit is achieved by expanding their scope to personnel other
than managerial, executive and director positions. However, we believe that the
auditor’s independence would be impaired with respect to any personnel if the auditor
were to make decisions, including those involving human resources and personnel
policy, on the audit client’s behalf; interpret human resources policies without
management’s concurrence; commit the client to the terms of a personnel contract; or
consummate a personnel contract on behalf of the audit client.

Does it impair an auditor’s independence if the auditor provides consultation
with respect to the compensation arrangements of the company’s executives?
No. Advisory services with respect to executive compensation arrangements are
acceptable services and do not constitute management functions, provided the auditor
understands his or her responsibilities not to perform management functions while
performing the service and establishes an understanding with the audit client
regarding the limitations of the engagement and management’s responsibilities to
designate a management-level individual, who is in a position to make an informed
judgment on the results of the service, to:




be responsible for overseeing the service;
evaluate the adequacy of the service and any resultant findings;
make all management decisions with respect to the service; and
establish and maintain internal controls over the performance and
implementation of the service.
Broker-Dealer, Investment Adviser or Investment Banking Services
We support the Commission’s Proposed Rule 2-01(c)(4)(viii) and note its consistency
with the AICPA rules in this area.12 Specifically, acting as a broker-dealer, promoter, or
underwriter on behalf of an audit client would impair independence. In addition,
investment advisory services which entail making investment decisions on behalf of the
audit client or otherwise having discretionary authority over an audit client’s investments,
executing a transaction to buy or sell an audit client’s investment, or having custody of
assets, would also impair independence since such services involve management
functions. We also agree with the Commission that an auditor should not, in an
investment adviser capacity, recommend his or her audit client’s securities to investment
clients. However, we believe it is important that the rule not be construed to prohibit
12
AICPA Interpretation 101-1C states that independence shall be considered to be impaired if during the
period covered by the financial statements or during the period of the professional engagement, a partner
or professional employee of the firm was simultaneously associated with the client as a: (1) director,
officer, or employee, or in any capacity equivalent to that of a member of management; (2) promoter,
underwriter, or voting trustee; or (3) trustee for any pension or profit-sharing trust of the client. Id. at ET
§ 101.02.
23
accountants from providing investment advisory or personal financial planning services
for attest clients, provided such services do not involve recommending the securities of
other attest clients or assuming management functions such as those described above.
The SEC’s December 2000 Release specifically stated that “[c]urrent AICPA rules
specify investment advisory services that accountants may provide to audit clients
without impairing their independence...Accountants may continue to provide those
services without impairing their independence.”
We recommend that the Commission explicitly confirm that such investment advisory
services would not impair independence to avoid any confusion in this area.
Legal Services

Would making the rule’s application depend upon the jurisdiction in which the
service is provided leave the rule subject to any significant uncertainty, or pose
the prospect of any significant complexity or unfairness?
As the Commission is aware, there are different regulatory regimes governing the
practices of law and accounting in other countries. Basing the application of the legal
services restriction on the non-uniform laws of the countless jurisdictions in which
such services are provided undoubtedly would result in inconsistent and unreasonable
results. For example, there are some jurisdictions where certain tax services regularly
provided by accountants in the United States must be provided by a professional
licensed to practice law. In these jurisdictions, the Commission’s proposed approach
would prohibit a public accounting firm and any associated law firm from providing
tax services to an audit client, even though the Act expressly contemplates that a
registered public accounting firm could provide such tax services to an audit client.
We submit that both practicality and international comity dictate that the Commission
avoid adopting an approach that implicates the myriad of irreconcilable foreign laws.
We believe that the Commission’s current guidelines governing legal services are
effective and represent a more sensible position with respect to services provided
outside of the United States.

Should there be any exception for legal services provided in foreign
jurisdictions? For example, in some countries only a law firm may provide tax
services. Should a foreign accounting firm be permitted to provide, through an
affiliated law firm, tax or other services that a U.S. accounting firm could
provide to a U.S. audit client without impairing the firm’s independence? Why
or why not?
As indicated above, we believe that adopting a legal services restriction that would
lead to disparate results in different jurisdictions is inadvisable and impractical.
Accordingly, the AICPA believes that the Commission should retain its current legal
services provision.
24

Should there be an exception for legal services provided to issuers in foreign
jurisdictions? Should any such exception be tailored to avoid undermining the
purpose of the restriction? For example, could fees for legal services be limited
to a small percentage (e.g., 5% or 10%) of the amount of fees for audit services?
Could partners providing audit services be prohibited from being involved in the
provision of legal services or from receiving compensation based on such
services?
The AICPA believes that a carefully tailored exemption for legal services provided to
issuers in foreign jurisdictions is appropriate. Consistent with the Commission’s
current approach, legal services provided outside the United States should be
permitted “where local law does not preclude such services and the services relate to
matters that are not material to the consolidated financial statements of an SEC
registrant or are routine and ministerial.”13 This provision strikes the appropriate
balance between prohibiting advocacy and accommodating the different regimes and
practices in foreign countries.
Expert Services

Are there circumstances in which providing audit clients with expert services in
legal, administrative, or regulatory filings or proceedings should not be deemed
to impair independence?
The Proposing Release, quoting Senator Sarbanes, states that, “[a] public company
auditor, to be independent, should not act as an advocate of its audit client (as it
would if it provided legal and expert services to an audit client in judicial or
regulatory proceedings).” It follows that the principle underlying the prohibition on
expert services is advocacy in a public setting. We support the prohibition of expert
services in adversarial and public regulatory or judicial proceedings where the auditor
acts as the client’s agent, rather than an independent, objective professional.
However, not all “expert services” as defined in the Proposing Release involve
advocacy.
Accordingly, we question whether serving as a testifying expert actually creates a
situation where the accountant is acting as the client’s advocate in pursuit of the
client’s interests. The federal courts recognize an expert as someone with specialized
knowledge, skills, training, and experience in a particular area who presents
conclusions and judgments with integrity and objectivity.14 The expert’s function is to
assist the trier-of-fact in understanding complex or unfamiliar concepts after having
applied reliable principles and methods to sufficient relevant data. As such, we do
13
December 2000 Release, supra note 3, at 76051.
14
See FED. R. EVID. 702. In addition, the AICPA’s Code of Professional Conduct requires members to
maintain objectivity and integrity, and prohibits subordinating his or her judgments to others. ET §
102.01.
25
not believe that serving as a testifying expert impairs independence in fact. We
recognize, however, that providing an expert opinion in an adversarial public
proceeding could create the appearance that the auditor is acting as the client’s
advocate. In addition, we also believe that an auditor would be acting as the client's
advocate in situations where the auditor represents the client in presenting matters in
a public regulatory or judicial setting.
Therefore, we recommend a narrowly tailored rule to address such circumstances and
that the restriction be limited to the reason for the rule and that the performance of
expert services not involving advocacy, therefore, should not impair independence.
Further, we do not believe companies should be denied use of the specialized skills
and expertise of their auditors in situations where such services do not create the
appearance that the auditor is acting as the client’s advocate.
For example, the SEC may challenge a registrant’s application of an accounting
principle in a filing on which the auditor provided a clean audit opinion. The auditor
concurs that the registrant’s application of the accounting principle is appropriate.
Because of the auditor’s background and conclusions on the issue, the registrant
reasonably might seek the auditor’s assistance in articulating and defending the use of
the accounting principle before the SEC. Yet, under the Proposed Rule, even such
seemingly natural outgrowths of the audit could be called into question, since the
SEC might view such services as the rendering of an expert opinion in a regulatory
proceeding. Furthermore, it is questionable whether the carve out from the
prohibitions described in the Proposing Release for serving as a “fact witness” would
apply, since the auditor in such circumstances not only would be providing a factual
summary of the judgments the auditor made during the course of the audit, but also
would be explaining the client’s position before the SEC.

Should an auditor be permitted to serve as a non-testifying expert for an audit
client in connection with a proceeding?
Yes. In addition to the reasons stated above, a non-testifying expert generally serves
as an adviser to the client or to the client's attorney(s). We believe such advisory
services would not create the appearance of acting as the client's advocate. Further,
we do not believe it is appropriate to deny companies access to advice from its
knowledgeable and experienced auditors.

Is the definition of prohibited expert services appropriate? Why or why not?
We do not believe that the Proposed Rule provides an appropriate definition of
prohibited expert services. In addition, it is confusing to describe the prohibited
service as “providing expert opinions for an audit client . . . or acting as an advocate
for an audit client in such proceedings,” since the purported basis for precluding
expert services in such venues is that it involves acting as an advocate.
26
Accordingly, for all the reasons stated in this section, the AICPA recommends that
the Commission revise the proposed expert services provision to state, “[p]roviding
expert opinions for an audit client in connection with adversarial and public
administrative, regulatory or judicial proceedings; provided, however, that serving as
an advisor, fact witness or providing information to judicial, administrative, or
regulatory bodies regarding the substance of work performed by the public
accountant is permissible.”
We also suggest that the Commission tighten its discussion of tax-related expert
services so that major pertinent points in the area are found in the same section. For
example, in the Proposing Release, the Commission states that:
[w]e note that the terms used by Congress could be construed very
broadly. We nevertheless believe that Congress did not intend to ban any
service that could conceivably fall within one of the prohibited categories
of services. Both the language in the Act and the legislative history argue
against such a broad construction . . .For example, tax services would
seem to be among the services that are provided by an “expert.”
However, it is clear that Congress did not wish to ban all expert services
because the Act specifically provided for an auditor to be able to perform
certain services, including tax services, if the audit committee approves
them in advance.
While this language is as relevant to the concept of tax services as it is to expert
services, it is found in a different part of the Proposing Release, and the specific
discussion of expert services is almost totally devoid of reference to tax services.
Separating the comment from its specific context makes the rule more difficult to
interpret. We suggest that the final rules would be more coherent if the
Commission’s Adopting Release recognizes in the expert services discussion that
expert services do not generally include tax services.

Is the distinction between advocacy and providing appropriate assistance to an
audit committee sufficiently clear?
The distinction between advocacy and providing appropriate assistance to an audit
committee is clear, but is based on a premise that concerns us. The Commission
asserts that “an auditor who takes on such duties either directly or by being engaged
by the audit client’s legal counsel takes on a role as an advocate for the client.”
We are concerned that this statement suggests that any CPA who is engaged by any
client’s legal counsel takes on the role of an advocate for the client. The role of the
CPA in providing expert advice entails a duty both ethically and to the court requiring
integrity, objectivity and freedom from conflict of interests. A CPA providing such
expert advice does not become an advocate for the client. We do not believe the
Commission’s premise is sound, and thus risks significantly harming the public's
ability to acquire these important services.
27
Tax Services
The Act provides that a registered accounting firm “may engage in any non-audit service
(including tax services)” not specifically prohibited by the Act and approved in advance
by the client’s audit committee.15 The Commission’s Proposing Release similarly
emphasizes that, "[n]othing in these proposed rules is intended to prohibit an accounting
firm from providing tax services to its audit clients when those services have been preapproved by the client’s audit committee." Congressional and administrative intent is
clear: tax services are permissible services for auditors to provide their audit clients, with
audit committee pre-approval.
General Comments
We note that while references to tax services are made in numerous parts in the
Proposing Release’s discussion of non-audit services, the specific section on “Tax
Services” is somewhat ambiguous — in part, because it is necessary to refer to other
sections to locate further tax service comments. The fact that tax service discussions or
references are found in various sections of the Proposing Release results in a lack of
focus that we would recommend be corrected in the Adopting Release.
For example, the Proposing Release notes the following with regard to “Principal
Accountants’ Fees,” "[t]ax compliance generally involves preparation of original and
amended tax returns, claims for refund and tax payment-planning services. Tax
consultation and tax planning encompass a diverse range of services, including
assistance and representation in connection with tax audits and appeals, tax advice
related to mergers and acquisitions, employee benefit plans and request for rulings or
technical advice from taxing authorities.” Clearly, this recognizes that tax services are
permissible. Accordingly, similar language belongs in the section on “Tax Services” so
that it is not necessary to refer for guidance to a tangentially related section a number of
pages removed from the primary discussion of the subject.
Similarly, the Proposing Release’s discussion of valuation and appraisal services cites
transfer pricing studies and cost segregation studies as permissible services, since they
are non-financial reporting services. However, they are also tax-driven in many cases,
and much of that work will be performed by or directed by members of an audit firm’s
tax department. These services should also be described in the “Tax Services” section of
the Commission’s Adopting Release.
Still elsewhere in the Proposing Release, the following tax services are cited with
approval: preparation of returns and refund claims; assistance and representation in
connection with tax audits and appeals;16 tax advice in connection with mergers and
acquisitions and benefit plans; requests for rulings or technical advice; transfer pricing
engagements; and cost segregation studies.
15
Emphasis added.
16
This is consistent with the statutory right granted to CPAs. See 5 U.S.C. § 500(c).
28
Accordingly, we recommend the Commission’s Adopting Release provide guidance to
audit committees and registered public accounting firms not only by acknowledging, as
does the Proposing Release, that nothing in the Commission’s revisions to Rule 2-01 is
intended to prohibit accounting firms from providing pre-approved tax services to audit
clients, but also by including examples of tax services (such as those in these paragraphs)
that are considered permissible. Those examples would need to be identified as “not allinclusive,” so as to avoid a bright-line test under which services not described would be
considered impermissible.
Tax Strategies / Tax Shelters
While we welcome the Commission’s acknowledgement that auditors may provide a
broad variety of tax services to their audit clients, we have a significant point of concern
with one example of a non-allowable tax service that is set forth in the Proposing
Release: “the formulation of tax strategies (e.g., tax shelters) designed to minimize a
company’s tax obligations.” The issue of what is a “tax shelter” is a difficult one; indeed,
the Congress, the Treasury Department, the Internal Revenue Service and tax practitioner
organizations have all been trying to devise an appropriate definition of the term for the
past several years – without success. Moreover, we would like to emphasize that it is
clearly inappropriate to equate tax minimization advice or strategies with the pejorative
term “tax shelter.”
Congress has enacted a federal tax statute of incredible complexity. Inevitably, for many
business activities, a taxpayer will have the right to choose among more than one way to
accomplish or report a business transaction, and will expect its accountant to advise on
the tax costs of alternative approaches. Providing information and advice on options
available for minimizing tax liability would not be considered by anyone (including the
Internal Revenue Service) to be a tax shelter in the great majority of instances, nor should
those activities result in treating the auditor as an advocate or a de facto part of
management.
In its essential character, the activity of developing tax strategies to minimize a
company’s tax obligations is ultimately of significant value to a company’s shareholders
and, by reference, to financial markets in general. Minimizing tax obligations generally
results in lower costs of capital, increases in free cash flow, increases in funds available
to make dividend distributions, increases in after-tax earnings per share, and greater value
for a company’s equity holders. Minimizing tax obligations has long been recognized as
a legally supportable activity, and generations of tax professionals have been encouraged
to assist clients in accomplishing that objective.17
For example, in Commissioner v. Newman, Judge Learned Hand opined, “[o]ver and over again courts
have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible.
Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more that the
law demands; taxes are enforced extractions, not voluntary contributions. To demand more in the name
of morals is mere cant.” 159 F.2d 848, 850-51 (2d Cir. 1947).
17
29
Any activity that results in less tax than an alternative activity is, in its fundamental
sense, a tax shelter since it reduces the overall tax burden on the taxpayer.18 Many tax
shelters are not only contemplated, but in fact, mandated by congressional passage of
specific sections of the tax code.19 These congressional choices for providing tax-based
incentives can, in the broadest sense, fairly be called tax shelters. Accordingly, the use of
the term “tax shelter” is too vague and does not help identify appropriately permitted or
prohibited services and, therefore, should not be used. In our experience, we have found
that tax compliance activities (i.e., reporting annual results of activities to tax authorities),
tax representation activities (i.e., explaining to tax authorities the rationale for what was
reported on previous tax returns) and tax minimization activities (i.e., formulating
strategies to reduce future outlays for taxes) are all essential components of tax services.
We recognize, however, that not all activities that result in tax minimization are
appropriate. Therefore, we would urge the Commission to draw a clear line between the
very limited class of tax services that accounting firms may not provide to public
company audit clients and the great bulk of tax services which may be provided to such
clients, with audit committee approval. Unless such a clear line is set out, there is every
prospect that the rule will have the consequence, unintended by the Congress and the
Commission, of chilling audit committee consideration of tax services by their auditors.
Tax law itself has developed a body of case and regulatory law that disallows the desired
results of certain transactions. Perhaps the most well-known of these provisions is the
“business purpose” doctrine, which disallows the desired results of a transaction where,
upon analysis, it appears that there was not a substantial business purpose other than tax
avoidance as the principal motivation for the transaction.20 Accordingly, the
Commission’s Adopting Release should distinguish tax strategies serving a legitimate
business purpose from those that have no business purpose other than tax avoidance,
unless they are consistent with the intent of applicable tax laws.
Other judicial doctrines operate as backstops against overly aggressive taxpayer
activities. The penalty provisions of the Internal Revenue Code, as administered by the
Internal Revenue Service, also constrain overly aggressive taxpayer activities. On the
other hand, some specific sections of the Internal Revenue Code exist specifically to
provide incentives for taxpayers to enter transactions for which they would otherwise find
18
For example, claiming accelerated depreciation for personal property (as opposed to using the straightline method over the asset’s actual useful life) is a tax shelter since it is method of “matching” costs
against income that results in less tax being imposed than would result from using the alternative straightline method. If an audit firm proposes to an audit client that it use the accelerated depreciation method as
opposed to straight-line, it is proposing a tax minimization strategy.
19
For example, depreciation for real property, although calculated on the straight-line basis, does not use
the actual useful life of the asset, and thus usually spreads the cost over fewer years than would the
comparable financial accounting useful life. The amortization of intangible assets is mandated over a
statutory 15-year period, regardless of the actual (usually longer) useful life. Incentive provisions, such as
the immediate expensing of certain items of personal property, provide tax deductions sooner than
financial accounting principles would allow expenses to be matched against revenues.
20
Gregory v. Helvering, 293 U.S. 465, 468-69 (1935).
30
no particular motivation (such as the tax credit for investments in low-income housing),
and we believe that the clear congressional intent of encouraging such transactions should
be respected.
In summary, we recommend that, consistent with the above observations, the
Commission’s Adopting Release should recognize that tax minimization activities are
appropriate and, in fact, are in the public interest. In recognition of the concerns that
auditors not overstep appropriate bounds, however, we further recommend that the
Commission preclude auditors from advising audit clients on tax transactions for which
there is no business purpose other than tax avoidance (except, of course, those that are
consistent with the intent of applicable tax laws).
Partner Rotation
We wholeheartedly agree with and support the Congress’ and the Commission’s
objectives behind a partner rotation requirement for auditors of issuers — to assure audit
quality while providing a periodic fresh look at an issuer’s financial statements. In fact,
the AICPA’s SEC Practice Section has required lead audit partner rotation for decades,
with certain exemptions.21 The Practice Section requirements were adopted after
thorough consideration of the effects of the requirements on SEC clients22 and their audit
firms, and have served the public well for over twenty-five years.
We believe that any requirement adopted by the Commission should meet four basic
criteria:




it must ensure that the partners assigned to the audit have the requisite experience
and knowledge and are independent;
it should not reduce audit quality;
it should not impose unnecessary costs to registrants and society; and
it should not impede timely financial reporting.
21
Existing SEC Practice Section membership requirements provide that a member firm must assign a new
audit partner to be in charge of each SEC engagement that has had another audit partner-in-charge for a
period of seven consecutive years, and prohibit such incumbent partner from returning to in-charge status
on the engagement for a minimum of two years, except as follows:
(1)
(2)
(3)
22
This requirement does not apply to member firms that have less than five SEC
audit clients and less than ten partners;
An audit partner who has been the audit partner-in-charge of an SEC audit client
for seven consecutive years may continue to serve in that capacity for audits for
periods ending within two years from the date the firm becomes a member, or
within two years from the date the firm no longer qualifies for the exemption in
(1) above, whichever is later; and
An application for relief is granted by the peer review committee on the basis of
unusual circumstances.
The SEC Practice Section defines “SEC client” in the SECPS Reference Manual § 1000.
31
We fully support the importance of a “fresh set of eyes;” yet the benefit of a “fresh set of
eyes” must be appropriately balanced with the cost of loss of continuity and institutional
knowledge that a recurring partner brings to an audit engagement. We believe that it is
crucial to the health and welfare of the U.S. financial markets that partners assigned to
audit engagements are the most competent, knowledgeable and experienced individuals,
and that any rule or requirement that would discourage this, without any compelling
reason or overriding benefit, would be detrimental to the well-being of the American
economy. When experience, knowledge and skill are not appropriately matched to an
audit engagement, audit quality and investor confidence suffer. A decrease in audit
quality is a mistake that we cannot afford to make.
As the Commission is aware, many issuers operate in extremely complex industries, have
intricate business models, and conduct numerous complex business transactions. In
addition, many business activities are the result of unique local and national economies.
All of these components require a myriad of highly-skilled auditors, many of whom
specialize in a single industry or the accounting treatment of a specific type of
transaction. The disadvantages of a rule that unduly restricts the continued availability of
partners utilized on such engagements should not be overlooked. To rotate partners who
are not responsible for signing off on an audit engagement, who understand a registrant’s
business environment and who can facilitate and enhance the audit would be detrimental
to the financial markets and serve little purpose. If a firm does not have the depth of
experience and knowledge in its partner ranks, inappropriate over-reliance will be placed
on lower level staff and inexperienced partners.
Our Recommended Approach
We believe that the Act strikes an appropriate balance between the goals of achieving a
fresh look and continuity and, accordingly, recommend that the Commission not go
beyond what Congress required.
The Act states that:
it shall be unlawful for a registered public accounting firm to provide
audit services to an issuer if the lead (or coordinating) audit partner
(having primary responsibility for the audit), or the audit partner
responsible for reviewing the audit, has performed audit services for that
issuer in each of the 5 previous fiscal years of that issuer.23
The legislative history indicates that Congress gave considerable thought to this provision
of the Act, and ultimately decided to limit the requirement to the “lead” and “review”
partners, whose roles it defined,24 and that the limitation apply in their capacity as
partners. The Senate Committee Report notes that, “[t]he bill requires a registered public
23
Emphasis added.
24
The lead partner is defined as one who is in charge of the audit engagement. The review partner is
defined as the outside partner brought in to review the work done by the lead partner and the audit team.
32
accounting firm to rotate its lead partner and its review partner on audits so that neither is
performed by the same accountant for the same issuer for more than five consecutive
years.”25 In addition, while not discussed in the legislative history, the Act could be
interpreted to provide for a one-year “time out” period.
In light of the above discussion with respect to audit quality, we believe that the public
interest would be best served if the Commission adopted what is stated explicitly in the
law and the legislative history, and not go beyond those requirements until a proper study
of the effects of the law on issuers and the audits of their financial statements can be
conducted and assessed. Hastily adopting a rule which extends the prohibition of
continued service beyond the requirements of the law could irreparably damage audit
quality. Moreover, application to all partners on an audit, including tax and other
specialists who are utilized on a limited basis as technical and industry resources, would
unnecessarily reduce the available pool of professionals who could serve on the audit
team. Both of those consequences would damage the public's interest in high quality
audits.
The Commission should recognize that while audit decisions are made every day by all
members of the engagement team, the final audit decisions are made by the lead partner
and significant decisions made by the lead partner are considered by the review partner.
Accordingly, the rotation requirements should be limited to those individuals. This
adequately protects the public, while assuring audit quality will not suffer.
Furthermore, we believe the five-year “time out” period is unnecessarily long, and places
an undue burden on both registrants and firms. The Commission will be able to achieve
its objective of a fresh set of eyes with a “time out” period of significantly less than five
years.
The AICPA’s SEC Practice Section has required a two-year “time out” period for over
twenty-five years and has periodically reassessed the appropriateness of that “time out”
period. While we believe the Commission should stay within the confines of the law for
the breadth of partners covered until proper study of the Proposed Rule’s effectiveness
can be conducted, it is our experience that a two-year “time out” period is effective. The
Proposing Release states that the five-year “time out” period is necessary because any
shorter “time out” period would fail to convince investors that rotated partners were not
being placed in a secondary role on the engagement for a year or two, only to later
resume the same role that they previously occupied and return to the prior engagement
team’s approach to accounting and auditing issues. We submit, however, that there is no
evidence that firms subject to the current requirement place the rotated partner in a
secondary role only to return as lead partner. If the Commission has a concern that firms
will not abide by the spirit of the rotation requirements and will not assign the rotated
partner to an unrelated audit engagement during the “time out” period, the Commission
should simply prohibit the rotated lead or review partner from being assigned to the audit
client in any secondary role. We recommend, however, that the Commission
25
S. REP. 205, 107th Cong. (2002).
33
acknowledge that there may be instances where the audit engagement team may need to
consult with the rotated partner on a specific transaction with respect to an audit on which
he or she participated. Such consultations are in the public interest and should not be
prohibited under the rule provided the partner is not actively involved in the audit.
Limiting the rotation requirements to the lead and review partners with a two-year “time
out” period, together with the other provisions of the Act, particularly the auditor’s new
relationship with the audit committee and the PCAOB’s inspection program, provides the
fresh look at the audit that the Commission is looking for and protects investors without
compromising audit quality.
If the Commission determines that it needs to adopt rules beyond what was contemplated
in the Act, it should consider restrictions only to lead partners auditing the client's major
subsidiaries, with differing rotation (perhaps permitting them to audit other subsidiaries)
and “time out” periods.
As stated above, we believe that the rotation of key personnel (i.e., the lead and review
partners) sufficiently mitigates the potential problems inherent in the long-term
relationship between those engagement partners and their clients. In the event the
Commission determines that the benefits of extending rotation beyond the requirements
in the Act exceed the costs to both issuers and to audit quality, the Commission should
limit the expansion of rotation requirements to those partners who provide lead audit
services to an issuer and its major subsidiaries and consider extending the rotation period
(e.g., to seven years) and reducing the “time out” period (e.g., to two years) for these
individuals. The Commission should also consider allowing the rotation of partners
between major subsidiaries and from a major subsidiary [to lead or review partner],
without independence being deemed impaired. This approach would in our view, pose a
lesser risk to audit quality than the current proposal and would assure that at least nonlead partners, partners (lead or otherwise) of non-major subsidiaries and partners who
consult in specialized areas, such as tax and other industry and accounting specialists, are
not subject to rotation requirements.
Congress contemplated, but did not mandate audit firm (versus audit partner) rotation;
therefore, an exemption for smaller public accounting firms that audit publicly-traded
companies [or issuers] from the partner rotation requirement should be provided.
The legislative history of the Act indicates that the Congress gave significant
consideration to testimony given by numerous witnesses as to whether an issuer should
be required to rotate its audit firm after a number of consecutive years, and seriously
weighed the costs of audit firm rotation (e.g., reduced audit quality and effectiveness,
increased audit costs) against the benefits (e.g., a fresh and skeptical set of eyes). While
Congress agreed that there were strong benefits to having a fresh set of eyes evaluate the
issuer periodically, it did not conclude that audit firm rotation was necessary. 26
26
Id. In addition, the Congress directed the GAO to perform a study on audit firm rotation.
34
This history is an important factor to consider in evaluating the appropriateness of an
exemption from the partner rotation rules for smaller public accounting firms. Because
smaller public accounting firms are not large enough to have a substantial number of
partners available to rotate, as noted above, a partner rotation requirement is tantamount
to firm rotation for these firms.
And, audit firm rotation has significant costs that far outweigh the potential benefits, as
government agencies (including the SEC and GAO), private organizations and members
of academia previously have concluded.27 Those costs include:




Increase in audit failures. Studies by the POB, Commission on Auditor’s
Responsibilities, and the National Commission on Fraudulent Financial
Reporting found that audit failures are three times more likely in the first two
years of an audit.28 Thus, there is a positive correlation between auditor
tenure and auditor competence.
Increased start-up costs. Changing auditors results in more frequent start-up
costs, both for the auditor and the company.
Increase difficulties in timely reporting. Mandatory rotation makes timely
reporting more difficult because audit firms need to meet a very short
“learning curve” to perform a rigorous audit.29
Loss of “institutional knowledge.” Over successive audits, audit firms
increase institutional knowledge, including, for example, their knowledge of
the client’s accounting and internal control systems and greater familiarity
within the industry in which the client operates. These benefits would be
greatly diminished by mandatory rotation.
27
See SEC OFFICE OF CHIEF ACCOUNTANT, STAFF REPORT ON AUDITOR INDEPENDENCE (1994) (indicating
that a periodic change in engagement partners responsible for audits provides a good opportunity to bring
“a fresh viewpoint to the audit without creating the significant costs and risks associated with changing
accounting firms”); PUBIC OVERSIGHT BOARD ADVISORY PANEL ON AUDITOR INDEPENDENCE,
STRENGTHENING THE PROFESSIONALISM OF THE INDEPENDENT AUDITOR, (1994) (agreeing with the Cohen
Commission’s findings concluding that rules mandating audit firm rotation are impractical from a
cost/benefit perspective); John C. Burton, A Critical Look at Professionalism and Scope of Services, J. OF
ACCT., Apr. 1980 at 50 (recognizing that problems most often occur during the initial audits by an
accounting firm); AICPA COMMISSION ON AUDITOR’S RESPONSIBILITY, REPORT, CONCLUSIONS, AND
RECOMMENDATIONS 108-09 (1978) (finding that the costs of mandatory audit firm rotation exceeds the
benefits and suggesting that many of the benefits of audit firm rotation can be achieved through firm
personnel rotation). An international study conducted in March 1997 examined the relevant literature on
the global auditing profession and the actual experiences in countries that have experimented with
mandatory rotation requirements. See Benito Arrunada & Candido Paz-Ares, Mandatory Rotation of
Company Auditors: A Critical Examination, INT’L REV. L. & ECON. (1997). It noted that countries that
have experimented in this area, such as Spain and Greece, have generally resorted back to a traditional
market system, whereby companies are free to maintain or change audit firms as they see fit.
The POB’s findings are consistent with those of our QCIC process, which found that allegations of audit
failure occur almost three times as often when the audit firm is performing its first or second audit of a
company.
29 The SEC recently adopted rules to shorten filing deadlines for annual reports on Form 10-K and
quarterly reports on Form 10-Q.
28
35



Opportunity to disguise voluntary rotations. Companies may use mandatory
rotation as a means to disguise problems in the relationship between the
company and its auditor, thus avoiding the negative marketplace reaction that
often accompanies a voluntary change in auditors.
Reduced incentives to improve efficiency and audit quality. Mandatory
rotations fail to fully reward firms that achieve greater efficiency and audit
quality, because rotation reduces potential demand. Auditors that are less
efficient and provide lesser quality services are nevertheless likely to survive
because there will constantly be companies looking for new auditors.
Conversely, the incentive for each firm to increase its market share and profits
would be reduced by the loss of clients after the maximum allowed duration.
Sharp increase in time and resources dedicated to proposal process. With
more than 16,000 public company audits, a mandatory rotation would create a
significant annual “proposal frenzy” for thousands of audits, potentially
distracting firms from the delivery of quality audits.
The AICPA’s SEC Practice Section has successfully exempted firms that have fewer than
ten partners and five SEC clients from its partner rotation requirements.30 This
exemption was provided for a number of reasons:

First, to eliminate the costs that outweigh the benefits associated with audit
firm rotation, as described above;

Second, to avoid the hardship that would otherwise be experienced by small
businesses that are considering public funding or are at a stage where they do
not need the services of a large, multi-national or regional public accounting
firm; and

Third, to preserve the quality of financial reporting for businesses that cannot
afford to hire a multi-national or regional public accounting firm or that are
located in remote locations.
Our country has always prided itself on the opportunities it offers to its citizens. We
believe that opportunities should be afforded to small businesses and that, by providing
such businesses with access to a resource they can afford, the American economy
benefits.
To give a sense of the number of firms and their clients that the Practice Section has
exempted from its partner rotation requirements, we estimate that of the 767 firms that
audit SEC clients that are members of the Practice Section, about 460 firms servicing
only 765 SEC clients31 are exempted. We would suggest the Commission consider
defining a smaller firm in several ways. Practice Section requirements currently define a
30
SECPS Manual § 1000 app. D.
31
SECPS Manual § 1000.
36
small firm as one having fewer than ten partners and auditing fewer than five SEC
clients. Another measure could be a combination of annual audit firm revenues (e.g., $10
million) and issuer market capitalization (e.g., $25 million). The Commission should
also consider exempting auditors of businesses that file with the Commission, but are not
listed on national exchanges and are not actively traded (e.g., benefit plans, limited
partnerships).
We understand and appreciate, however, the benefits of partner rotation as a control that
provides a fresh set of eyes to an audit engagement. Therefore, we would encourage the
Commission to consider other controls that would achieve this objective for small firms
under a partner rotation exemption.
For example, the Commission suggested the concept of some type of forensic auditing in
lieu of the rotation requirement. We do not believe the Commission should adopt rules
requiring that issuers engage forensic auditors periodically to evaluate the work of the
financial statement auditors in lieu of the partner rotation requirement. The concept of a
“forensic audit” does not currently exist in practice. A forensic accountant (trained in
accounting and investigative techniques) is currently utilized to assess specific issues
identified by management through complaints, government action, or other reasons. The
discipline of forensic accounting is not intended to put the forensic accountant in a
position to opine on the fairness of a company’s presentation of its financial statements
taken as a whole, but rather is undertaken to provide a client or a court of law with an
accounting analysis that will form the basis for discussion, debate, and ultimately
potentially dispute resolution regarding a specific issue. Because a forensic audit begins
when there is evidence or a suspicion of fraud, there would not be a clear indication of
what the forensic or fraud auditor would “audit” when there are no signs or suspicion of
fraud. Further, it is unclear as to what type of report a forensic auditor would deliver.
In place of the forensic audit, we would recommend something more practical and
appropriate such as a requirement that any exempted engagements be subject to a more
in-depth review by the PCAOB during its triennial inspections or perhaps moving from a
triennial inspection to an annual one for those firms. The inspection could be particularly
focused on the risks/costs associated with failure to rotate the lead and review partners.
We believe that an enhanced PCAOB inspection, coupled with audit committee review
and approval of the auditor, would achieve the objective of a “fresh look” that the
Commission is seeking to achieve.
Other Comments
We believe the Commission needs to be absolutely clear that the rule only applies to
partners in their capacity as partners, and does not reach back to audit services provided
in a non-partner position (such as manager). While we believe the language in the rule
clearly reflects this position, the Proposing Release indicates that the proposed rules are
designed to ensure that professionals (versus partners) do not “grow up” or spend their
entire career on one engagement.
37

Should the Commission adopt rules requiring that issuers engage forensic
auditors periodically to evaluate the work of the financial statement auditors? If
so, how often should the forensic auditors be engaged? What should be the
scope of the forensic auditors’ work? Would doing so obviate the need to
require partner rotation for the audit firm? Alternatively, could the company
obtain the necessary expertise by engaging other outside consultants? If so,
what type of consultants should it engage?
We do not believe the Commission should adopt rules requiring that issuers engage
forensic auditors periodically to evaluate the work of the financial statement auditors
for the purpose of obviating the need for partner rotation.
The concept of a “forensic audit” does not currently exist in practice. A forensic
accountant (trained in accounting and investigative techniques) is currently utilized to
assess specific issues identified by management through complaints, government
action, or other reasons. The discipline of forensic accounting is not intended to
evaluate the fairness of a company’s presentation of their financial statements taken
as a whole, but rather is undertaken to provide a client or a court of law with an
accounting analysis that will form the basis for discussion, debate and ultimately the
potential resolution of a dispute regarding a specific issue or set of issues. We believe
the PCAOB will be able to provide the oversight and evaluation needed to properly
assess and evaluate the work of the financial statement auditor, including requiring
enhanced inspection and monitoring procedures in circumstances of heightened risk.
As the “responsibility for the prevention and detection of fraud and illegal acts”
properly is shared by auditors, corporate management, and all financial professionals,
the AICPA has committed to designing, with the assistance of corporate America and
others, suitable anti-fraud criteria intended for public corporations. We have called
upon the Auditing Standards Board to enhance our existing attestation standard for
auditors to test and report on client anti-fraud criteria once they have been developed
— and to develop ways to communicate the results to the public. Statement on
Auditing Standards No. 99, Consideration of Fraud in a Financial Statement Audit,
stresses procedures that should be performed in every audit to consider financial
statement susceptibility to the risks of material misstatement due to fraud. In those
audits that have a higher risk profile or identified misstatements which may be
indicative of fraud, a fraud specialist or an auditor with training in forensic
procedures would likely be engaged. Further, the new fraud standard, which
incorporates the “forensic phase” recommendations of the Public Oversight Board’s
Panel on Audit Effectiveness, will require that auditors perform certain procedures on
virtually all audits to respond to the risks of fraud. Encouraging fraud training for
auditors and the use of fraud specialists, as well as inspecting firms to see that they
are complying with the new fraud audit standard, will be more effective than adding
another layer of post-audit second guessing.
38

Would the establishment of rules requiring companies to engage forensic
auditors periodically provide an opportunity to other firms to enter the market
to provide these services?
We do not believe that the benefits, if any, of providing additional opportunities to
other firms outweigh the costs to issuers of a forensic auditing requirement.
However, there is merit to encouraging audit committees to hire fraud specialists for
special projects. In addressing their responsibilities, audit committees could find a
forensic audit focused on a specific issue very valuable, particularly if the audit
committee has specific concerns regarding management’s integrity.

Should the Commission establish requirements for firms conducting forensic
audits? If so, what should these requirements be?
As discussed above we do not believe forensic audits should be required. However, if
such forensic audits were required, presumably the standards should be at least as
high as those for firms performing audits in accordance with generally accepted
auditing standards. A major difference, however, exists between the two processes.
In a financial statement audit, the goal of rendering an opinion on the financial
statements is clear; therefore, audit procedures responsive to that goal can readily be
designed. Without suspicion or evidence of potential fraud, the goal of a forensic or
fraud audit is unclear. As a result, there is no clear indication of where a forensic
audit would start or what a forensic audit would cover.

Should issuers be given a choice between engaging forensic auditors periodically
and having the audit partners on their engagement team be subject to the
rotation requirements? Why or why not?
No. See all the reasons stated above.

What are the costs and benefits of engaging forensic auditors to evaluate the
work of the financial statement audit firm?
If the Commission is asking whether the costs of a forensic audit of the entire set of
financial statements is more than the cost of a financial statement audit under GAAS,
we believe that the cost would be substantially higher. We do not believe that such a
tremendous increase in costs would be justified.

This proposed rule would apply to the audits of the financial statements of
“issuers.” Should the Commission consider applying this rule to a broader
population such as audits of the financial statements of “audit client” as defined
in 1-01(f)(6) of Regulation S-X? Why or why not?
Consistent with Section 203 of the Act, the Commission’s proposal on partner
rotation applies to “issuers.” We recommend that the rule should not be revised to
apply instead to “audit clients.” As defined by Rule 2-01(f) of Regulation S-X, an
39
“audit client” means any entity whose financial statements are being audited,
reviewed or attested to, as well as any “affiliate” of the audit client. Affiliates include
any person that, directly or indirectly, controls, is controlled by, or is under common
control with an audit client, as well as certain significant investees. Under that
definition, which may remain appropriate for purposes of other independence
requirements (such as financial interest restrictions), the audit partner rotation rules
potentially would apply to auditors of an array of individuals, corporations,
partnerships, associations, joint-stock companies, business trusts and other
incorporated organizations that are not themselves issuers of securities. We believe
that Congress did not intend this provision to have such broad and far-reaching
implications, particularly inasmuch as the overriding purpose of the Act was to better
protect investors.

For organizations other than investment companies, the rotation requirements
would apply to significant subsidiaries of issuers. Should a different approach
be considered? If so, what approach would be appropriate?
See Our Recommended Approach above.

Should the rotation requirements apply to all partners on the audit engagement
team? If not, which partners should be subject to the requirements?
See Our Recommended Approach above.

Is the proposed guidance sufficiently clear as to which audit engagement team
partners would be covered by the rule? Is the proposed approach appropriate?
If not, how can it be improved?
Notwithstanding Our Recommended Approach above, the proposed rule indicates
that all partners, principals or shareholders who perform audit, review or attest
services for an issuer or any significant subsidiaries of the issuer as a partner,
principal or shareholder must rotate off the audit, review or attestation engagement
every five years. The proposal would thus apply to all partners who perform audit
services for the issuer, including the client service partner, “line” partners directly
involved in the performance of the audit, tax partners who perform significant
services related to the audit engagement (e.g., tax accrual), partners who serve on the
engagement team that conducts the reviews of the registrant’s interim financial
information, partners who serve on the engagement team that conducts the attest
engagement on management’s report on the registrant’s internal controls, and any
other partner who is involved on a continuous basis in the audit of material balances
in the financial statements (e.g., actuarial specialists).
The Proposing Release, however, provides for exemptions that are not reflected in the
Proposed Rule. Those exemptions include:
40

partners who consult with others on the audit engagement team during the
audit, review or attestation engagement regarding technical or industryspecific issues, transactions, or events (i.e., national office type partners - as
defined in 17 C.F.R. 210.2-01(f)(7)); and

partners on the engagement team (as defined in 17 C.F.R. 210.2-01(f)(7)),
who do not perform a continuing audit function.
We believe that the language of the rule should make clear that these classes of
partners are not covered by the restriction.
Furthermore, the proposed rule indicates that all partners, principals or shareholders
who perform audit, review or attest services for an issuer or any significant
subsidiaries of the issuer as a partner, principal or shareholder must rotate off the
audit, review or attestation engagement every five years. Again, notwithstanding Our
Recommended Approach above, we believe it is important to indicate in the Final
Rule or Adopting Release that the provision applies exclusively to the work
performed on an audit, review or attest engagement as a partner, principal or
shareholder so there is no confusion that it applies to services performed by an
individual as a manager, staff or in any other non-decision making position.

Is the exclusion of certain “national office partner” personnel from the rotation
requirements appropriate?
Yes. However, see Our Recommended Approach above. Consistent with the theory
behind why these types of partners are excluded, we would suggest excluding other
partners that regularly serve the engagement team as a technical resource, such as tax
partners and other industry specialists.

Is the guidance on national office partners who are exempted from the rotation
requirements sufficiently clear?
We do not believe so. The text of the Proposed Rule should be explicit in exempting
these partners and in defining who they are. We prefer the current language used in
17 CFR 210.2-01(f)(7) which states that “all persons who consult with others on the
audit engagement team during the audit, review or attestation engagement regarding
technical or industry-specific issues, transactions, or events.” This language clarifies
the persons who fall within the current definition of “audit engagement team,” and to
whom, in our view, mandatory rotation should not apply.

Is the distinction between a member of the engagement team and a national
office partner who consults regularly (or even continually) on client matters
sufficiently clear?
41
We do not believe so. The current definition of audit engagement team in 17 CFR
210.2-01(f)(7) includes national office partners. We believe the Commission should
be explicit in its exclusion of these partners from the rotation requirements.

Should certain partners performing non-audit services for the client in
connection with the audit engagement be excluded from the rotation
requirements?
Consistent with Our Recommended Approach above and the reasons stated therein,
we believe it is appropriate to exclude all non-audit services partners from the
rotation requirements.

Should additional personnel (such as senior managers) be included within the
mandatory rotation requirements?
We do not believe this was the intent of Congress and accordingly do not believe it is
either appropriate or in the public interest to include additional personnel. We also
believe that the Commission should clarify its intent that the rotation period does not
include time spent on the audit, review or attest engagement in a position other than
as a partner, principal or shareholder.

Is it appropriate to provide transitional relief where the proposed rules are more
restrictive than the provisions of the Sarbanes-Oxley Act?
Yes. We believe it is appropriate to provide transitional relief where the proposed
rules are more restrictive that those currently required by the AICPA’s SEC Practice
Section. Transitional relief should provide for an orderly transition, take into
consideration experience and expertise of auditors, allow for a firm to stagger rotation
terms, and not harm the registrant in any way, particularly if an audit is in process.
Please see our recommendations under Transition Period later in this letter.

Should the rotation requirements be different for small firms? What changes
would be appropriate and why? If so, how should small firms be defined?
We believe smaller firms should be exempted from the rotation requirements, with
required, compensating, quality control safeguards, for the reasons described in Our
Recommended Approach above. We would suggest the Commission consider
defining a smaller firm in one of several ways. SEC Practice Section requirements
currently define a smaller firm as one having fewer than ten partners and auditing
fewer than five SEC clients. Another measure could be a combination of audit firm
annual revenues (e.g., $10 million) and issuer market capitalization (e.g., $25
million). The Commission could also consider exempting auditors of businesses that
file with the Commission, but are not listed on national exchanges and are not
actively traded (e.g., benefit plans, limited partnerships).
42

Would the proposed rules impose a cost on smaller firms that is disproportionate
to the benefits that would be achieved?
Audit partner rotation requirements are tantamount to an audit firm rotation
requirement for small CPA firms. As currently proposed, over 460 smaller CPA
firms may very well lose business as a result of the proposed requirement, and the
small public registrants those firms serve may be forced to seek services from firms
that will likely charge more for the audit and may not have the appropriate skills or
the knowledge of the industry or environment. In addition, as more fully described in
Our Recommended Approach above, audit firm rotation increases the risk of audit
failures, increases audit costs, presents difficulties for timely financial reporting and
results in a loss of institutional knowledge that is essential to audit quality.

Is the five-year “time out” period necessary or appropriate? Would some
shorter time period be sufficient, such as two, three or four years? Should there
be different “time out” periods based on a partner’s role in the audit process?
Consistent with Our Recommended Approach above, we believe that the five-year
“time out” period is unnecessary and places an undue burden on both registrants and
firms. The Commission could achieve its objective of ensuring a “fresh set of eyes”
with a “time out” period of no more than two years.
The Proposing Release suggests that a five-year “time out” period is necessary
because any shorter “time out” period would fail to satisfy investors that rotated
partners were not being placed in a secondary role on the engagement for a year or
two only to resume the same role that they had previously occupied and return to the
prior engagement team’s approach to accounting and auditing issues. We believe the
SEC Practice Section’s current two-year “time out” period has been effective and that
there is no evidence that firms subject to the requirement place the rotated partner in a
secondary role only to return as lead partner. We believe that a two-year “time out”
period appropriately balances the fresh look at accounting and auditing issues
confronted by the company with continuity and audit quality costs associated with
any rotation. If the Commission has a concern that firms will not abide by the spirit
of the rotation requirements and will not assign the rotated partner to an unrelated
audit engagement, the Commission should simply prohibit the rotated partner from
being assigned to the audit of the client in any secondary role.

If a partner rotates off an engagement after fewer than five years, should the
“time out” period also be reduced? Why or why not? If so, how much should
the reduction in the time out period be?
In the event a partner rotates off an engagement after fewer than five years, we
believe the appropriate “time out” period is one year. Anything more would
complicate an already complex requirement and would serve no other purpose than to
penalize the public accounting firm.
43

The proposed rules would not require all partners on the audit engagement team
to rotate at the same time. Should it? Why or why not?
In addition to the views expressed in Our Recommended Approach above, we believe
it would be harmful to the investing public if all partners were rotated at the same
time, since the loss of institutional knowledge would decrease audit quality.
Audit Committee Administration of the Engagement

Should the Commission create other exceptions (beyond the de minimis
exception) that would allow an audit committee to adopt a policy that contracts
that are recurring (e.g., due diligence engagements in connection with a series of
insignificant acquisitions) and less than a stated dollar amount (such as $25,000)
or less than a stated percentage of annual revenues (such as 1% or 5%) could be
entered into by management and would be reviewed by the audit committee at
its next periodic meeting?
We believe it is extremely important to preserve the spirit of the Act’s requirement
that the audit committee is now the audit client. Consistent with this observation,
company management needs to be given the flexibility to carry out the audit
committee’s objectives. Accordingly, the Commission should create a provision that
would allow an audit committee to adopt a policy allowing recurring contracts that
are less than a stated dollar amount (set by the audit committee) be entered into by
management provided they are periodically reviewed by the audit committee.
As the Commission is well aware, the role and responsibility of the audit committee
has increased substantially as a result of the Act. However, the audit committee is not
charged with the day-to-day stewardship of the business. That responsibility rests
with management and management must be permitted to act quickly when necessary.
As such, it is important to find ways to minimize delay as to matters that would come
before the committee to allow it to focus its time on substantive issues that require
discussion and deliberation. Establishing guidelines within which management is
permitted to act is part of the internal control process of the company. Ratification by
the audit committee of a contract approved by management is the control over that
process, but it cannot be perfunctory. To ensure that all parties take their
responsibilities seriously, the internal auditor should periodically test this control and
promptly report all exceptions.

Is allowing the audit committee to engage an auditor to perform non-audit
services by policies and procedures, rather than a separate vote for each service,
appropriate? If so, how do we ensure that audit committees have rigorous,
detailed procedures and do not, in essence, delegate that authority to
management?
We believe it is appropriate, even necessary, for the audit committee to set policies
and procedures to guide management about the engagement of non-audit services
44
between meetings of the audit committee. A statement to this effect should be
incorporated into the audit committee charter and reviewed annually with the board of
directors. It is incumbent upon the board to ensure that the audit committee has
appropriate policies and procedures in place and has not delegated its responsibility to
management.

Should more or fewer aspects be left to the discretion of the audit committee?
We believe that boards of directors and audit committees, as part of the corporate
governance process, must have flexibility to adapt operating policies appropriate to
the companies which they supervise. As noted previously, it is important that the
audit committee be in an oversight role and, without abdicating its responsibilities to
management, not participate in management’s role.

Are there specific matters that should be communicated to or considered by the
audit committee prior to its engaging the auditor?
The audit committee should consider a number of factors prior to engaging the
auditor. And, audit committees should be given the flexibility to consider what
information it needs based on the many things affecting a company, such as the
nature of its business, its size and the depth of knowledge about the company and its
auditors by the board of directors and the audit committee. Some factors to consider
might include:
(1) Whether the auditor is registered with the PCAOB and is in compliance
with all applicable laws, regulations and professional standards;
(2) The auditor’s experience auditing SEC issuers;
(3) Any pending or threatened litigation against the auditor with respect to the
any work performed for the company;
(4) The length of the relationship between the company and the auditor, as
well as individual audit team members to the extent that is practical;
(5) All services provided, or recently provided by the auditor to the company;
(6) Whether the auditor is independent as required by the SEC and AICPA
independence rules, and the auditor’s communication about its
independence under ISB Statement No. 1;
(7) The role of the audit committee in testing management’s assertions
regarding the company’s internal control system;
(8) What the auditor will communicate to the audit committee during and at
the completion of the audit; and
(9) Any occasion in the past five years where the audit firm responded to the
company’s specific request for information on the treatment of a specific
accounting matter.
The audit committee should ask the auditor to describe the policies and procedures it
has in place to ensure that the audit firm, including its domestic offices and foreign
45
associated firms that are not otherwise involved in the audit, will not provide any
prohibited non-audit services to the company.

What, if any, audit committee policies and procedures should be mandated to
enhance auditor independence, interaction between auditors and the audit
committee, and communications between and among audit committee members,
internal audit staff, senior management and the outside auditor?
We believe it is inadvisable to mandate policies and procedures for audit committees.
To work most effectively, members of audit committees should be of the highest
caliber and firmly committed to the role they play in the corporate governance and
investor protection process. Audit committees need to have flexibility in how they
apply the regulations issued by the SEC and other regulators. They should be
encouraged to adopt policies and procedures, similar to the following, to enhance
auditor independence and communication among all parties with a direct stake in the
audit process:
(1) Audit committees should independently and routinely ask management,
internal auditors and the external auditors if they are aware of any situation
that would impair the auditor’s independence;
(2) Audit committees should have regular executive sessions independently with
financial managers, internal auditors and external auditors where matters such
as those described in (1) above;
(3) Internal auditors should annually confirm with members of management, at all
locations and subsidiaries, that they are aware of the auditor independence
requirements of the SEC and AICPA, and ask them to report any suspected
violations of the Act and its related regulations and report the results to the
audit committee.

Our proposed rules do not contain exemptions for foreign filers. Are there legal
or regulatory impediments which may make it difficult for certain foreign filers
to comply? If so, what safeguards can these foreign filers employ to ensure that
they comply with the proposed rules?
We urge that the Commission exercise caution when writing regulations for foreign
filers. In general, we are concerned that many of the provisions of the Proposed Rule
will place foreign filers in a paradox of being in violation of their own country’s laws
and regulations in order to be in compliance with the Act. We believe that it is in the
public interest to position our markets to be international in focus and urge the
Commission to use its authority to address this issue.
Cost/Benefit Considerations
We fully expect that the cost to maintain the audit committee in a company will increase.
For example, we believe the audit committee will need additional meetings each year
whether these meetings take place by conference call or in-person. The increased time
46
demands on the audit committee members will also result in increased compensation.
We also expect that the new responsibilities will increase the liability of the audit
committee, which will increase the cost of Director’s & Officer’s insurance and make it
harder to recruit qualified and willing audit committee members. Finally, we expect that
audit committees will hire their own advisors which will increase costs.
Compensation
We believe that an accounting firm’s audit personnel, including partners, should be
rewarded and penalized based on both quantitative and qualitative measures, such as
technical expertise and audit performance. We support a rule that would prohibit a
member of the audit engagement team, from being directly compensated for selling nonaudit services to his or her audit client, since such an arrangement has the potential to
impair the auditor’s appearance of objectivity. We do not believe, however, that the
Commission’s rule should prohibit an individual from sharing in the firm’s total profits,
or receiving compensation from a profit pool, which may include fees for permitted nonaudit services provided to that audit client, provided such services have been approved by
the audit committee.
In practice, there are many different partner profit allocation methods used by accounting
firms. These vary from more complex “unit methods” often used by larger accounting
firms to simple allocation methods used by smaller accounting firms. Regardless of the
method used, accounting firms should design their compensation allocation methods to
reward individual partners based on the quality of their work, and to penalize those who
do not perform appropriately.
With certain safeguards already in place, we do not believe that the public is served by
trying to impose a detailed rule on how an accounting firm allocates its profits. We
support the idea that a firm’s quality control system should include policies and
procedures to provide reasonable assurance that audit personnel, including partners, will
not compromise their objectivity due to the economic size or influence of any one client.
We would further support, as part of the quality inspection of each registered accounting
firm, a review by the PCAOB of the firm’s compensation system to determine whether
the firm has appropriate safeguards in place to provide reasonable assurance that an audit
partner would not compromise his or her objectivity.
The Act has already imposed a ban on certain services being provided to a public audit
client. Further, the Act has fundamentally changed the audit/client relationship. Now the
independent audit committee will hire, fire and oversee the auditor and thus the auditor
will feel that it has to meet the expectations of the audit committee, not management.
Also, an audit committee must pre-approve the audit firm’s provision of permitted nonaudit services. Therefore, when non-audit services are purchased, the audit committee
will have made an informed decision to procure these non-audit services from the
accounting firm and assured itself that the firm is independent.
47
For these reasons, we believe that the public is better served by principle-based quality
control standards that address client objectivity issues, including safeguards as to
compensation. By focusing on the firm’s quality control system, there would be no need
for firms to devote needless efforts to the creation of allocation methods that artificially
interfere with the fair allocation of profits among partners.

What economic impact will our proposal have on the current system of
partnership compensation in accounting firms?
We believe the Commission’s compensation proposal could significantly impact
partnership compensation in accounting firms. Specifically, if the Proposed Rule
were to ban sharing in firm profits in the normal course of business, firms would be
forced to create separate internal accounting systems to track fees collected from the
performance of non-audit services and fees collected from audit services on a clientby-client basis. We believe this would be both costly and impractical. Furthermore,
the Proposed Rule would serve as a disincentive for accounting partnerships as they
exist today. Many accounting firms form partnerships to take advantage of the
diverse backgrounds and services that different partners bring to the firm as well as to
ensure that the firm’s profitability is not dependent on the provision of one type of
service. The value of such partnerships would be significantly reduced if partners
were unable to share in the overall profits of the firm. This could lead to accounting
partnerships divesting of their audit practices, leaving audit firms with only narrow
expertise and resulting in less effective and less efficient audits. We do not believe
that this in the public interest.

Are there other approaches that should be considered with respect to
compensation packages that pose a concern about auditor independence? If so,
what are they?
We believe the best way to address this issue is through strong accounting firm
quality control systems and a rigorous quality inspection process. The PCAOB’s
quality inspection must be structured to, among other things, look at the firm’s
compensation system to see how audit partners are rewarded and penalized. It must
review the firm’s quality control system and the safeguards in place to provide
assurances that personnel will behave in an acceptable manner. This means analyzing
how they are paid and what behavior they are rewarded for.

Would the proposed rule change be difficult to put into practice? If so, why?
How could it be changed to be more effectively applied?
Yes. We believe that the Proposed Rule, if it were to ban sharing in firm profits in
the normal course, would be costly for accounting firms that allocate profits (versus
revenues) to implement. Also, it would be almost impossible to demonstrate
compliance. Even in the case where an audit committee makes an informed decision
to procure additional non-audit services from the accounting firm, the firm would be
required to track the profitability of that additional service and attempt to reallocate
48
that profit away from the engagement team and then prove that in allocating other
profits, they did not consider the other services the individual sold.

Should managers, supervisors or staff accountants who are members of the audit
engagement team also be covered by this proposal?
Yes. As indicated above, we support a rule that would prohibit any member of the
audit engagement team from being directly compensated for selling non-audit
services to his or her audit client.

Does this proposal cover the appropriate time period or should a measure other
than the audit and professional engagement period be considered?
The effectiveness of a firm’s system of quality control would be measured as of the
inspection period. However, in the event the Commission adopts the rule as
proposed, the audit and professional engagement period is appropriate.

Does the proposed rule cover the entire component of an audit partner’s
compensation that gives rise to independence concerns?
It is important that an accounting firm reward its audit personnel based on the quality
of their work and not solely or even primarily upon how much they sell. Because
there are many different compensation systems, we believe the Commission should
not attempt to dictate a compensation system but allow flexibility in dealing with the
issue.

Will this compensation limitation disproportionately affect some firms because
of their size or compensation structure? If so, how may we accomplish our goal
while taking these differences into account?
In terms of implementation, we believe that larger firms will be more negatively
impacted by the proposal than smaller accounting firms. Larger firms would have
more difficulty in tracking engagement profitability and would need to have multiple
complex and costly allocation procedures. However, we expect that even small firms
will have difficulty. For example, a two-partner firm in which the partners had agreed
to allocate profits equally will also be impacted and may be in breach of their own
partnership agreements.

Our proposal references compensation based on the performance or sale of nonaudit services. Is there a better test that permits partners to participate in the
overall success of the firm while addressing the influence that such services
might have on a particular auditor-client relationship?
Yes. Please refer to our responses above.
49
Definitions
Accounting Role / Financial Reporting Oversight Role
Accounting Role
We agree with the Proposed Rule's definition of "accounting role" (i.e., a role in which a
person is in a position to or does exercise more than minimal influence over the contents
of the accounting records or anyone who prepares them.) and note that it is consistent
with the SEC's current definition.32 However, we also note that there is an inconsistency
between the Proposed Rule and the discussion in the Proposing Release. Specifically, the
Proposing Release states that:
persons in an accounting role include individuals in clerical positions
responsible for accounting records (e.g., payroll, accounts payable,
accounts receivable, purchasing, sales) as well as those who report to
individuals in financial reporting oversight roles (e.g., assistant controller,
assistant treasurer, manager of internal audit, manager of financial
reporting). 33
We do not believe that individuals in clerical positions are generally in a position to
exercise any influence over the contents of the accounting records and therefore,
recommend the Commission exclude any reference to clerical positions from the
Adopting Release. However, consistent with the Commission's discussion its December
2000 Release, we believe that a person in an accounting role should include "certain
individuals, such as an accounts receivable supervisor or manager, who are relied upon
by management to calculate amounts that are placed directly into the company's
financial statements."
Financial Reporting Oversight Role
As explained in our comment under Conflicts of Interest Resulting from Employment
Relationships above, we have concerns on the scope of the “financial reporting oversight
role” definition for purposes of the cooling-off requirement. Specifically, the
Commission’s definition of “financial reporting oversight role” is broader than what is
required by the Act and would capture all roles in which the person is “in a position to or
does exercise influence over the contents of the financial statements or anyone who
prepares them, such as when the person is a member of the board of directors or similar
management or governing body, chief executive officer, president, chief financial officer,
chief operating officer, general counsel, chief accounting officer, controller, director of
internal audit, director of financial reporting, treasurer, or any equivalent position.”
32
December 2000 Release
33
Emphasis added.
50
We believe that, for purposes of the cooling-off restriction, the requirement should not
extend to a “member of the board of directors or similar management or governing body”
unless the individual also serves on the company’s audit committee. Members of the
board generally play a far less extensive role in the company’s financial reporting and the
safeguards required by ISB No. 3 are sufficient to protect any threat to the auditor’s
independence. Furthermore, in today’s environment there is an even greater need for
competent and qualified board members and to limit the pool of available people would
appear to only exacerbate the difficulties that companies will encounter in locating
qualified candidates. We therefore recommend that, for purposes of the cooling-off
provision, the definition of “financial reporting oversight role” exclude members of the
board and that such individuals instead be subject to the ISB No. 3 safeguards.
Audit Committee

Some registrants may not have designated boards of directors or audit
committees (e.g. benefit plans required to file Form 11-K). Does the definition of
audit committee sufficiently describe who should serve in this capacity where
such situations exist? If not, what additional guidance would be appropriate?
The definition, as presented, adequately describes the kind of body that should be in
the role of the audit committee. Organizations that have no designated board of
directors or audit committee should make an effort to appoint some related body to
serve in that role.
Communication with Audit Committees

In light of the requirements for the CEO and CFO to certify information in the
company’s periodic filings, should the auditor be required to communicate
information on critical accounting policies and practices and alternative
accounting treatments to management as well as to the audit committee?
Yes. Since the primary responsibility for establishing an entity’s accounting policies
rests with management, we believe that the discussion should include the CEO and
CFO as active participants.
Critical Accounting Policies and Practices

Should the auditor be required to provide additional information to the audit
committee regarding the company’s critical accounting policies?
We believe that the disclosures covered by the May 2002 proposed rules are
sufficient and that additional information should not be required.

When should the communication take place?
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We believe the communication should take place prior to the filing of the financial
statements. In addition to all of the entity’s critical accounting policies and practices
applied in its financial statements, the auditor should communicate management’s
judgments and accounting estimates, uncorrected misstatements, accounting policies
and alternative treatments and significant written communications between the
auditor and management that have been issued prior to such filing.

Should the auditor be required to provide the communication in writing?
We believe that, due to the nature of the subject matter, the communication often
would best be made through an oral discussion involving the auditor, the audit
committee and management. We are concerned that requiring the communication to
be in writing would migrate practice to boilerplate letters, and that the public is best
served by robust, open and frank oral discussions between audit committee and
auditors. If the Commission does decide to require the communication to be in
writing, the communication should indicate that it is intended solely for the
information and use of the audit committees or the board of directors and, if
appropriate, management, and is not intended to be and should not be used by anyone
other than these specified parties.
Alternative Accounting Treatments

Is the discussion of which accounting policies require communication with the
audit committee sufficiently clear?
We believe that the descriptions of the specific transactions and general accounting
policies for which alternative treatments discussed with management are required to
be communicated is sufficiently clear. However, although we assume the
Commission so intends, it is not clear that the requirements extend only to discussions
occurring during the current audit period. We believe the Final Rule should clarify
that the requirement only extends to discussions occurring during the current audit
period.

Should additional matters be required to be communicated to the audit
committee? If so, which matters?
No. We believe the required communication is sufficient.
Timing of Communications

Should the timing of these communications be required to occur before any
audit report is filed with the Commission or at some other time?
We believe that, for the communications to accomplish their intended purpose, they
should occur before any audit report is filed with the Commission. However, issuers
and their audit committees will have to understand that, if they fail to make
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themselves available to receive the communications, the auditor will not be able to
consent to the inclusion of his or her report in such filing.

Should these communications regarding critical accounting policies be required
to be in writing? If so, why?
As discussed above, we do not believe that it is necessary to require these
communications in writing. Communications such as these are best when a robust,
open and frank discussion takes place.

Do these required communications fulfill existing GAAS requirements? If not,
why?
As noted by the Commission in the Proposed Rule, AU 380 (SAS 61,as amended)
requires the auditor to ensure that certain matters are communicated to the audit
committee. While we support these required communications, we do not believe that
the Proposed Rule fulfills existing GAAS requirements. Areas where GAAS
currently requires communication that do not appear to be covered by the Proposed
Rule include; communications regarding the auditor’s responsibility under GAAS and
his or her responsibility with respect to other information in documents containing
audited financial statements, disagreements with management, consultation with other
accountants, major issues discussed prior to retention and difficulties encountered in
performing the audit.

Should these communications regarding alternative accounting treatments be
required to be in writing? If so, why?
As discussed above, we do not believe that it is necessary to require these
communications in writing. Communications such as these are best when a robust,
open and frank discussion takes place.

This proposed rule would apply to “issuers.” Should the Commission consider
applying this rule to a broader population such as “audit clients” as defined in 201(f)(6) of Regulation S-X? Why or why not?
The Commission’s proposal on communications with audit committees applies to
“issuers.” For the same reasons as discussed above in the Audit Partner Rotation
section of this letter, we recommend that the Commission not extend the scope of the
rule to “audit clients.” In addition, applying the pre-approval requirements to services
provided to “audit clients” would raise a host of practical issues if the audit clients’
affiliates did not have an audit committee or equivalent body.
Expanded Disclosure
Principal Accountants’ Fees/Audit Committee Actions
53
We believe that the proposed changes to the proxy disclosure rules regarding the
principal accountant’s fees provide more meaningful information to investors than the
Commission’s current proxy disclosure rules.
While we concur with the proposal to expand the definition of “audit fees” to include fees
for services that generally only the independent accountant can reasonably provide, such
as comfort letters, statutory audits, attest services, consents and assistance with and
review of documents filed with the Commission, we believe that the disclosure would be
more meaningful if “audit-related fees,” which are proposed as a separate category, were
combined with "audit fees". Since audit-related fees are, by definition, closely related to
the audit, investors will perceive them as such and likely would be confused by separate
categories. We would suggest, however, that the disclosure be accompanied by a
description of the services provided in a sub-categorical disclosure fees (and since reports
on internal controls are now required as part of the audit engagement, sub-categorical
disclosure of this should not be required). We further agree that segregating tax fees and
all other fees into categorical disclosures generally would provide investors with the
information they need to make investment decisions.

Is the proxy statement the appropriate location for this disclosure? If not, why?
We believe the proxy statement is the appropriate location for this disclosure.

Would expansion of the proxy disclosure of professional fees paid to the
independent auditor from three categories to four provide more useful
information to investors?
No. We believe a more meaningful disclosure would combine audit and audit-related
fees with an accompanying requirement for registrants to describe in a subcategory
the nature of the services provided. To maintain these as separate disclosure items
would be confusing. We believe the additional categories of “tax fees” and “all other
fees” are appropriate with a required subcategory description of the nature of the
services identified in the “all other fees” category.

Are the new categories of disclosure appropriate? Are they well defined, or
should they be more accurately defined? Should there be additional (or fewer)
categories?
As indicated above, we believe a more meaningful disclosure would combine audit
and audit-related fees with a requirement for registrants to describe in a subcategory
the nature of the services provided. We believe the categories of “tax fees” and “all
other fees” are appropriate with a required subcategory description of the nature of
the services identified in the “all other fees” category. We recommend, however, that
the Commission make clear that tax services related to the audit (e.g., audit of the tax
accrual) should be included in the “audit fees” category.
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
Is disclosure of two years of fees appropriate? Should the proposed additional
fee disclosures be expanded to three years or remain at one year?
We believe that only the current year fee disclosure is appropriate. Given the nature
of this disclosure we do not believe that having comparable information will be useful
information to investors.

For a registrant not subject to the proxy disclosure rules, such as foreign private
issuers, should we require that the same disclosures be placed in annual reports?
We believe that investors should have the same information available to them
regardless of the type of registrant and filer. Therefore, we would agree that a
registrant that is not subject to the proxy disclosure rules should be required to
disclose fees in a schedule to a Form 10-K or in a Form 8-K disclosure.

Is there any additional disclosure concerning the activities of audit committees
that would be beneficial to investors?
We are troubled by requiring the disclosure of specific policies and procedures of the
audit committee in a registrant’s proxy statements. We would prefer to see the proxy
statement include a disclosure that the company has adopted policies and procedures
relating to the pre-approval of the independent accountant to perform both audit and
non-audit services. In our view, additional detail regarding those procedures is not
necessary and will not aid investor decision making.

Should companies be required to provide the information in their quarterly
reports? Should it be required that the information be included in other filings
such as Form 10-Q or 10-QSB?
No. We believe that annual proxy disclosure is sufficient.

If we adopt such a requirement, should we require or permit registrants to
recalculate and report fees already disclosed for more than two years so that all
fee information is consistently reported and available?
See previous response.
Transition Period
The Act requires registered public accounting firms to comply with auditor independence
standards. As registration with the PCAOB may not be required until as late as October
2003, Congress built a transition period into the legislation. In contrast, the
Commission’s proposed independence rules would revise Rule 2-01 of Regulation S-X
and, as currently drafted, would take effect immediately upon adoption of the rule,
without any transition period. We strongly believe that a transition period is necessary
and appropriate for the effective implementation of the Act. Such transitional relief
55
should: (1) take into consideration the experience and expertise of auditors, (2) take into
account auditor continuity and audit quality, (3) allow firms to stagger rotation terms, (4)
avoid harming the registrant in any way, particularly if the audit is in process, and (5)
consider any existing exemptions from the current requirements.
Non-Audit Services
As soon as the proposed rules become effective, an audit client may be required to decide
between continuing to engage an accounting firm to audit its financial statements and
continuing to retain the firm to provide non-audit services. It may not be feasible or
appropriate for the accounting firm to cease all non-audit engagements (that are not
already restricted) immediately. The audit client may require time to find a new provider
of those services, allow the accounting firm to complete work in progress and arrange for
a smooth transition from one provider to another. Accordingly, we suggest that, for the
two-year period following the effective date of the rule, providing the non-audit services
set forth in Rule 2-01(c)(4) to an audit client would not impair an accountant’s
independence, provided: (1) the non-audit services are performed pursuant to a written
contract in effect on or before the effective date of the rule, and (2) the performance of
the services would not impair independence under pre-existing requirements of the SEC
and the accounting profession in the United States.
This approach would allow issuers to wrap-up current work and/or transition to a new
service provider with respect to engagements that were permissible for an auditor to
perform at the time they were contracted for. The Commission adopted a similar
transition approach in its December 2000 Release with respect to (1) appraisal or
valuation services, fairness opinions and internal audit services, and (2) other financial
interests and employment relationships.34
Partner Rotation
Proposed Rule 2-01(c)(6) of Regulation S-X would require the rotation of certain audit
partners who have performed audit services for an audit client for five consecutive years,
and preclude the partner from providing audit services for five additional years following
the mandatory rotation. As proposed, the partner rotation provisions would take effect
upon the rule’s adoption, requiring firms to implement changes immediately in order to
comply with these provisions.
As the Commission has noted, these rotation provisions exceed the current requirements
of the accounting profession and the Act. Without an adequate transition period for
issuers and accounting firms, the implementation of the rule would entail significant
disruption. Auditors will have to reorganize audit teams, train partners in new industries
and, in many instances, resign from engagements. In addition, it is not feasible to expect
firms immediately to identify and reassign partners with expertise sufficient to ensure
34
December 2000 Release, supra note 3, at 76054-55.
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continuity in providing quality service to clients, as partners will be required to develop
general expertise in order to serve a broader range of industries. Firms (and, in particular,
smaller firms) will need time to plan for and implement these changes.
For example, a partner currently in the fifth or sixth year of a seven-year rotation cycle
under existing rules (or a partner exempted due to firm size) will need to immediately
rotate off the engagement the day the rule becomes effective to prevent an impairment of
his or her firm’s independence. Similarly, a partner who complied with the current
standards and rotated off the engagement three years ago and has now returned to the
engagement team will be required to immediately rotate off the engagement to avoid an
impairment of independence. Without adequate time to prepare for such changes in the
composition of audit teams and the transfer of knowledge regarding current engagements,
audit quality will suffer. This is hardly the desired result of the Act. These effects would
be exacerbated for firms with several public clients, firms with few partners and
engagements with multiple partners.
We recommend that the Commission provide a two-year transition period before the
partner rotation rules become effective.35 This is consistent with the approach adopted by
the AICPA when it implemented partner rotation in the late 1970’s. This approach would
allow for a smooth transition by permitting issuers and accounting firms to mitigate the
effect of the disruptions caused by the rule changes and facilitate the staggering of audit
partner rotation cycles on large audits, as recommended by the Commission in the
Proposing Release.
Employment with Clients/Cooling-Off
Proposed Rule 2-01(c)(2) provides that independence would be impaired when a former
partner, principal, shareholder or professional employee of an audit client’s auditor is
employed in a “financial reporting oversight role” at the audit client, unless the individual
has not been a member of the audit engagement team for the audit client’s financial
statements during the one year period preceding the initiation of the audit. Under the
proposal, the cooling-off provision would become effective when the rule is adopted. We
believe that a transition period is needed to prevent disruption and unanticipated effects,
particularly if the Commission adopts a rule that applies to audit clients, rather than
issuers.
For example, as drafted, an audit firm’s independence would be impaired if an employee
who formerly worked for the accounting firm was hired by the client in March 2002 to
serve in a “financial reporting oversight role.” Although there was no restriction against
hiring the individual at the time he or she accepted employment, the audit client would be
placed in the immediate position of choosing between firing (or reassigning) the
individual and replacing the auditor. Such results are unreasonable and were not
contemplated by Congress in enacting the legislation. We suggest that the rule should
35
As discussed above, the AICPA strongly supports a small firm exemption from the partner rotation
provision.
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apply prospectively to employees hired in a financial reporting oversight role after the
effective date of the rule.36
Compensation
Depending on the nature of the rule adopted, we believe that firms could have difficulties
in complying with this requirement if there is not an appropriate transition period. We
suggest you review responses from firms of varying sizes to determine the appropriate
transition period.
General Request for Comments
Associated Person
Section 201 of the Act prohibits a registered public accounting firm, “and any associated
person of that firm, to the extent determined appropriate by the Commission,” from
performing certain non-audit services contemporaneously with the audit. The Proposing
Release, however, does not discuss whether it is appropriate to extend the application of
Section 201, or any of the auditor independence provisions of the Act, to “associated
persons.” Instead, under the structure contemplated in the Proposing Release, the SEC
would implement most of the Act’s auditor independence provisions by amending Rule
2-01 of Regulation S-X, which by its terms applies to an “accounting firm” and its
“associated entities.” Since the term “associated entities” is not defined in the SEC’s
regulations but appears broader than the term “associated persons” (which, in
comparison, is specifically defined in the Act), the Commission’s proposed regulations
broaden the requirements of the Act. In addition, they may lead to confusion as to the
range of entities to which they apply, without any discussion or finding as to whether the
broader application serves the public interest.
As noted, the Act contemplates that the Commission may extend the scope-of-services
regulations to “associated persons” of an accounting firm. We believe that, before
adopting such an approach, the Commission should publish for comment its reasons for
applying the restrictions to entities other than registered public accounting firms, such as
their “associated persons.”
Similarly, we believe that the SEC should not rush to extend the restrictions on non-audit
services and audit committee pre-approval requirements to services provided by
“associated entities” of public accounting firms.

Would the proposals related to audit committees and partner compensation help
alleviate the pressure that clients may place on engagement partners or
36
This is similar to the grandfathering approach adopted by the Commission in its December 2000 Release
with respect to (1) financial interests and employment relationships, and (2) contracts for the provision of
financial information systems design and implementation services. Id. at 76055.
58
accounting firms to acquiesce to the clients’ views on accounting issues? What
are some of the other scenarios where such pressures might exist?
Audit Committees
We support the Act’s provisions and SEC’s proposals that: (1) strengthen the
reporting relationships between auditors and audit committees, (2) require that
material written communications between auditors and management be provided to
the audit committee, (3) impose obligations on audit committees to play an active role
in monitoring corporate financial reporting, and (4) require the audit committee to
hire, fire, compensate and oversee the auditor. We believe that these elements
fundamentally change the auditor/client relationship, complement and enhance the
profession’s existing audit standards, as set forth in AU 380, Communication with
Audit Committees and help alleviate any pressure that might be placed on auditors by
management to acquiesce in their views.
Partner Compensation
We support the Commission’s proposal that an auditor of an issuer would not be
considered independent if, at any point during the audit and professional engagement
period, a partner, principal or shareholder of the accounting firm who is a member of
the audit engagement team directly earns or receives compensation based on the
procuring of engagements with that audit client to provide any services other than
audit (or audit-related), review or attest services. Although we are not aware of
specific situations in which such forms of compensation have been found to lead an
accountant to acquiesce in a client’s views on an accounting issue, we agree that the
direct compensation of an auditor for procuring any services other than audit (or
audit-related), review or attest services may create an appearance that the accountant
may not be objective. Moreover, we believe that doing anything further would be
both counterproductive and not in the public interest.
Initial Regulatory Flexibility Act Analysis
Small Entities Subject to the Proposed Rules
The Commission has indicated in its Proposing Release that the proposals would affect
small registrants and small accounting firms that are small entities. In fact, at the
Commission’s meeting on November 19, 2002, at least two Commissioners commented
on the economic impact on small business and small accounting firms and the
Commissions Chief Economist stated, “[t]here can be no doubt that the constraints
[regarding the proposal with respect to partner rotation] are more costly to, and have a
greater adverse effect on, the smaller firms.” As we have indicated throughout our
response, we are also concerned about the impact the Proposed Rule will have on small
business and small accounting firms (e.g., partner rotation and cooling-off requirements).
59

We request comment on the number of accounting firms with revenue under $6
million.
While we do not have the exact information the Commission’s is looking for, we can
provide information that may be useful in the Commission's analysis of the impact
that the proposals would have on smaller accounting firms.
As of December 10, 2002, the AICPA's SEC Practice Section had 767 firms that audit
SEC clients37 as defined by the Practice Section. Since the Commission has never
required membership in the Practice Section by auditors of SEC registrants, there is a
population of firms that we cannot identify. However, of the individual firm revenues
of 767 firms, we estimate that 565 firms servicing 2,340 SEC clients have revenues of
$6 million or less per year.
Thank you for the opportunity to comment on this Proposed Rule.
Respectfully submitted,
William F. Ezzell, CPA
Chairman, Board of Directors
37
Barry C. Melancon, CPA
President and CEO
SECPS Manual § 1000 app. D.
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