By Robert N. Waxman, CPA
The Commission will not recognize any certified public accountant...as independent who is not in fact independent.
-SEC Reg. S-X, Rule 2-01(b)
Last year, SEC Chief Accountant Lynn Turner sent the American Accounting Association (AAA) a letter suggesting various areas for research on auditing and other issues, including whether users of financial statements consider non-audit services to impair independence, and how disclosure of all non-audit services would affect investors’ perceptions regarding independence.
Then in June of this year, without benefit of the AAA research, the SEC released a proposal (34-42994) calling for new disclosures in annual proxy statements directly aimed at non-audit services. To justify the need for this disclosure, the SEC said it has “become increasingly concerned that the dramatic increase in the nature, number, and monetary value of non-audit services that accounting firms provide to audit clients may affect their independence.” As for the lack of research, the SEC said, “Some argue that no empirical evidence justifies our concerns. They argue that there is no evidence that providing non-audit services in general--much less particular types of non-audit services--leads to false financial reporting. Without this evidence, the argument goes, the Commission should not take steps to protect auditor independence.” The SEC argues that “[i]t is common sense ... and confirmed by studies, that a person’s decision changes when he or she has a stake in the outcome of that decision. Furthermore, common sense dictates that the more someone--including an auditor--has at stake, the more likely his or her decision is to be affected.”
Questions raised by the SEC’s “common sense”
The SEC poses many questions about the impact of nonaudit services on independence.
They ask -:
Usefulness of disclosures? Debatable
The SEC believes that its proposed disclosures about non-audit services would improve investors’ understanding of the auditor-registrant relationship and help shareholders decide how to vote their proxies in ratifying management’s selection of an auditor.
What the proposal does not explain is exactly how investors and other “stakeholders in auditor independence” can and will use these new disclosures to determine whether an auditor is independent. The auditor either is or is not independent--a yes-or-no issue. But, without specific guidance from the SEC or the Independence Standards Board (ISB), the various stakeholders are likely to disagree on when an auditor has “crossed the line.” So, absent any guidance on how investors can use the new information (other than by making a subjective evaluation of the auditor/registrant relationship), the benefits of the proposed disclosures cannot be discerned.
Nor do the new disclosures offer guidance on how much or what kind of non-audit services blemish auditor independence, and we do not know enough about the investing public’s perception of the propriety of non-audit services.
Obviously, if the list of non-audit services spells out an engagement that is already forbidden (e.g., bookkeeping, advocacy) then the disclosures would be useful to regulators. But auditors would be unlikely to undertake services that so clearly compromise their independence in the first place.
The proposal itself does not answer the following questions raised by these
These questions have no immediate answers, and I suspect they never will. What we do know is that the proposed rules, because they lack sufficient guidance for registrants, raise implementation issues. Without guidance, the final rules will be applied inconsistently, disclosures will range from overly detailed to practically boilerplate, registrants may not have the appropriate management policies in place, and registrants will implement systems to capture data that no one will need or use.
A Return to Common Sense?
. I am not yet convinced that these rules will not serve any useful purpose except to highlight that auditors may indeed perform non-audit services, and the amounts involved may be greater than the audit fee. What is more important, but is not disclosed, is how the audit partners and staff of the principal auditor are compensated. Can they share (directly or indirectly) in a bonus pool for “selling” or having “sold” non-audit services? Just how does cross-selling of services specifically damage independence? Is the sole issue perception, and if so, whose perception? Does a problem really exist? Again, more questions than answers.
The effect of non-audit services on independence is complex and irresolvably ambiguous. The only solution is for management to engage firms other than the principal auditor to perform these services, with exceptions (outlined in the release as “exclusionary rules”). The disclosures alone will not solve the problem, real or perceived. The Exhibit shows one scenario--my own: a disclosure statement, corresponding statement for audit services, and comments and observations. The SEC has not reviewed this example, and would likely suggest major revisions if it did.
From reading the proposed rulemaking, my impression is that the SEC is on a fact-finding mission. It has posed many difficult questions and is seeking input on the answers. The CPA community has an opportunity to influence the final rules and help the SEC find its way by sending the Commission comments and constructive suggestions.
Editor’s Note: The SEC’s proposed rulemaking and additional material, including comments received to date and reports from public hearings held, are posted at www.sec.gov. According to the website’s information at press time, comments are due on or before September 25.
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