March 2000


In January 1999, the SEC censured Pricewaterhouse-Coopers for violation of auditor independence rules and improper professional conduct. As part of its settlement with the SEC, the firm agreed to an internal review by an independent individual or firm appointed by the SEC and to report any additional independence violations by partners or professionals involving ownership of securities of public audit clients.

The SEC appointed Jess Fardella of Lankler Siffert & Wohl LLP to supervise the internal review. Fardella's report, released this January, disclosed that a substantial number of PricewaterhouseCoopers professionals, particularly partners, had violated the independence rules. The review found excusable mistakes but also attributed the violations to laxity and insensitivity to the importance of independence compliance.

In the report, PricewaterhouseCoopers acknowledges that the review disclosed widespread independence noncompliance, reflecting serious structural and cultural problems in the firm.

The internal review included two key parts:

* The firm's professionals were requested to self-report independence violations; and
* The independent consultant randomly tested a sample of the responses for completeness and accuracy.

Almost half of the firm's 2,698 partners self-reported at least one independence violation, with an average of five violations. Of 8,064 reported violations, 81.3% were reported by partners and 17.4% by managers. Almost half of the reported violations involved direct investments by the professional in securities, mutual funds, bank accounts, or insurance products associated with a client.

However, the random testing of the self-reporting process indicated that a greater percentage of individuals had independence violations than were reported. Fardella's report identified key weaknesses in the systems Pricewaterhouse-Coopers used to prevent or detect independence violations, including the reliance on self-reporting, insufficient education about the rules, and inadequate documentation of how reported violations were resolved.

At the SEC's request, the Public Oversight Board will sponsor similar independent reviews at other firms and oversee development of enhancements to quality control and other professional standards.

PricewaterhouseCoopers itself recognizes the magnitude and far-reaching implications of this report--to the firm itself as well as to the professional community and its integrity. The firm's first priority is restructuring its independence system.

A New Compliance System, but Some Concerns Remain

Peter Frank, the firm's global managing partner of risk management, explained that the firm's new automated independence compliance system requires partners and managers to enter investments (and those of immediate family members) within five days of purchase. The system is continuously updated so partners and professional staff can identify institutions with which they are prohibited from dealing by the independence rules.

The firm has also instituted ongoing, random compliance audits, which Frank says will be the key control element in its efforts to enforce strict compliance with the independence rules. In addition, the firm is reviewing all of its policies, procedures, systems, and controls.

"Certain rules are extremely complicated, highly technical, and often lack economic or logical substance," Frank said. "It is difficult to control the investment activities of family members, especially when spouses have their own careers and independent incomes and when many of the investments are automatically set up by employers of spouses and relatives. Many of our personnel found themselves with inadvertent violations caused by investment vehicles such as 'cash sweeps' in brokerage accounts, which automatically invest excess funds in mutual funds that are prohibited if the firm audits the firm or its advisor.

"However, we have recognized that we need to do a much better job of teaching our people the intricacies of the rules and the importance of compliance."

Regarding the role of PricewaterhouseCoopers' culture in the independence violations, Frank said, "We do not believe there is a cultural issue at PricewaterhouseCoopers. We identified 1,800 individuals--out of our total universe of 36,000--that had some level of infractions. Objectivity and integrity have been and remain one of the cornerstones of this firm. The policies we are putting in place will help ensure that all our people are more sensitive to the complexities of the independence rules and the need for 100%--not just virtual--compliance. Intentional violations, which represented a very small number of the total, have not and will not be tolerated."

On the broader, longer-term implications of the SEC's findings to the CPA professional community, Frank said, "We have identified a problem and are working diligently to correct the procedures and actions that led to these infractions. We think it is safe to say, however, that no firm is immune to the complexities of the independence rules that have evolved nonsystematically since 1933, or to the changes that have taken place in business and our society in that time--complex business relationships, the explosive growth of an integrated economy, dual careers, Internet trading, and a host of other changes--that make the task of complying with complex, sometimes counterintuitive rules all the more daunting." *

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