Commission Adopts Rules Strengthening Auditor Independence
FOR IMMEDIATE RELEASE
2003-9
Washington, D.C., January 22, 2003 — The Securities and
Exchange Commission today voted to adopt rules to fulfill the mandate of
Title II of the Sarbanes-Oxley Act of 2002, strengthen auditor
independence and require additional disclosures to investors about the
services provided to issuers by the independent accountant.
The Commission approved measures that will
- revise the rules related to the non-audit services that, if provided
to an audit client, would impair an accounting firm's
independence;
- require that certain partners on the audit engagement team rotate
after no more than five or seven consecutive years, depending on the
partner's involvement in the audit, except that certain small accounting
firms may be exempt from this requirement;
- establish rules that an accounting firm would not be independent if
certain members of management of that issuer had been members of the
accounting firm's audit engagement team within the one-year period
preceding the commencement of audit procedures;
- establish rules that an accountant would not be independent from an
audit client if any "audit partner" received compensation based on the
partner procuring engagements with that client for services other than
audit, review and attest services;
- require the auditor to report certain matters to the issuer's audit
committee, including "critical" accounting policies used by the
issuer;
- require the issuer's audit committee to pre-approve all audit and
non-audit services provided to the issuer by the auditor; and
- require disclosures to investors of information related to audit and
non-audit services provided by, and fees paid to, the auditor.
Non-Audit Services
Section 201 of the Sarbanes-Oxley Act lists nine non-audit services
that, if provided by the accounting firm, impair the firm's independence.
The rules approved for adoption by the Commission, will define the
prohibited services as follows.
- Bookkeeping or other services related to the accounting records
or financial statements of the audit client
The rules
will prohibit an accountant from auditing the bookkeeping work performed
by his or her accounting firm.
- Financial information systems design and
implementation
Consistent with our previous rules,
these rules will prohibit the accounting firm from providing any service
related to the audit client's information system, unless it is
reasonable to conclude that the results of these services will not be
subject to audit procedures during an audit of the audit client's
financial statements. These rules will not preclude an accounting firm
from working on hardware or software systems that are unrelated to the
audit client's financial statements or accounting records as long as
those services are pre-approved by the audit committee.
- Appraisal or valuation services, fairness opinions, or
contribution-in-kind reports
Appraisal and valuation
services include any process of valuing assets, both tangible and
intangible, or liabilities. Fairness opinions and contribution-in-kind
reports are opinions and reports in which the firm provides its opinion
on the adequacy of consideration in a transaction. These rules will
prohibit the accountant from providing such services unless it is
reasonable to conclude that the results of these services will not be
subject to audit procedures during an audit of the audit client's
financial statements.
- Actuarial services
These rules will prohibit an
accountant from providing to an audit client any actuarially oriented
advisory service involving the determination of amounts recorded in the
financial statements and related accounts for the audit client unless it
is reasonable to conclude that the results of these services will not be
subject to audit procedures during an audit of the audit client's
financial statements. The accountant, however, may assist a client in
understanding the methods, models, assumptions and inputs used in
computing an amount.
- Internal audit outsourcing services
These rules
will prohibit the accountant from providing any internal audit service
that has been outsourced by the audit client that relates to the audit
client's internal accounting controls, financial systems or financial
statements unless it is reasonable to conclude that the results of these
services will not be subject to audit procedures during an audit of the
audit client's financial statements.
During the conduct of
the audit or when providing attest services related to internal
controls, the auditor evaluates the company's internal controls and, as
a result, may make recommendations to the audit client for improvements
to the controls. Doing so is a part of the accountant's responsibilities
under GAAS or applicable attestation standards and, therefore, is not a
prohibited service.
- Management functions or human
resources
Consistent with our proposal, the final rules
will prohibit the accountant from acting, temporarily or permanently, as
a director, officer or employee of an audit client, or performing any
decision-making, supervisory, or ongoing monitoring function for the
audit client.
These rules also will provide that an
accountant's independence is impaired with respect to an audit client
when the accountant seeks out prospective candidates for managerial,
executive or director positions; acts as negotiator on the audit
client's behalf; or undertakes reference checks of prospective
candidates. Under the rule, an accountant's independence also will be
impaired when the accountant engages in psychological testing or other
formal testing or evaluation programs, or recommends or advises the
audit client to hire a specific candidate for a specific job.
- Broker or dealer, investment adviser, or investment banking
services
Acting as a broker-dealer (registered or
unregistered), promoter or underwriter on behalf of an audit client and
similar activities will make the accountant an advocate for the audit
client and will impair the accountant's independence.
- Legal services
An accountant will be prohibited
from providing to an audit client any service that, under circumstances
in which the service is provided, could be provided only by someone
licensed, admitted, or otherwise qualified to practice law in the
jurisdiction in which the service is provided.
- Expert services unrelated to the audit
These
rules will prohibit an accountant from providing expert opinions or
other expert services to an audit client, or a legal representative of
an audit client, for the purpose of advocating that audit client's
interests in litigation or in a regulatory or administrative proceeding
or investigation. An accountant's independence will not be impaired,
however, by an accountant providing factual accounts or testimony or
explaining the positions taken or conclusions reached during the
performance of any service by the accountant.
Audit Committee Pre-Approval of Services Provided by Auditor
Sections 201 and 202 of the Sarbanes-Oxley Act provide that an issuer's
audit committee must pre-approve allowable services to be provided by the
auditor of the issuer's financial statements. The rules will implement
those sections of the Act by requiring that the audit committee
pre-approve all services. In doing so, the audit committee may establish
policies and procedures for pre-approval provided they are consistent with
the Act, detailed as to the particular service, and designed to safeguard
the continued independence of the accountant.
Consistent with the Act, the rules also will reflect a de minimis
exception solely related to the provision of non-audit services for an
issuer. This exception waives the pre-approval requirements for non-audit
services provided that all such services (1) do not aggregate to more than
five percent of total revenues paid by the audit client to its accountant
in the fiscal year when services are provided; (2) were not recognized as
non-audit services at the time of the engagement; and (3) are promptly
brought to the attention of the audit committee and approved prior to the
completion of the audit by the audit committee or one or more designated
representatives.
Disclosures to Investors of Services Provided by the Auditor
Section 202 of the Sarbanes-Oxley Act will require disclosure in
periodic reports of non-audit services approved by the audit committee.
The rules will require that issuers provide, in their annual reports, fees
paid to the independent accountant for (1) audit services, (2)
audit-related services, (3) tax services, and (4) other services.
Additionally, the disclosures must include the audit committee's policies
and procedures for pre-approval of services by the independent accountant
as well as the percent of fees paid subject to the de minimis
exception.
Permitted Non-audit Service — Tax Service
Section 201 of the Sarbanes-Oxley Act specifically provides that "a
registered public accounting firm may engage in any non-audit service,
including tax services," that is not expressly prohibited, after audit
committee pre-approval. Accordingly, accountants will be able to continue
to provide tax compliance, tax planning and tax advice to audit clients,
subject to audit committee pre-approval requirements. There are, however,
some circumstances where providing certain tax services to an audit client
would impair the independence of an accountant, such as representing an
audit client in tax court or other situations involving public
advocacy.
Audit Partner
The rules will define a new term-audit partner-for purposes of the
requirements for partner rotation and partner compensation. An audit
partner will be defined as a partner who is a member of the audit
engagement team who has responsibility for decision-making on significant
auditing, accounting and reporting matters that affect the financial
statements or who maintains regular contact with management and the audit
committee. The term audit partner will include the lead and concurring
partners as well as partners who serve the client at the issuer level,
other than a partner who consults with others on the audit engagement team
regarding technical or industry-specific issues, and the lead partner on
subsidiaries of the issuer whose assets or revenues constitute 20% or more
of the consolidated assets or revenues of the issuer.
Partner Rotation
Section 203 of the Sarbanes-Oxley Act specifies that the lead and
concurring partner must be subject to rotation requirements after five
years. The rules will specify that the lead and concurring partner must
rotate after five years and be subject to a five-year "time out" period
after rotation. Additionally, certain other significant audit partners
will be subject to a seven-year rotation requirement with a two-year time
out period.
Compensation
The new rule will provide that an accountant is not independent if, at
any point during the audit and professional engagement period, any audit
partner earns or receives compensation based on that partner procuring
engagements with the audit client to provide any services other than
audit, review or attest services.
Cooling Off Period
Section 206 of the Sarbanes-Oxley Act establishes a one-year cooling
off period before a member of the audit engagement team may accept
employment in certain, designated positions with an issuer. The rules,
therefore, will provide that an accounting firm is not independent if a
member of management involved in overseeing financial reporting matters
was the lead partner, the concurring partner, or any other member of the
audit engagement team who provided more than ten hours of audit, review or
attest services for the issuer within the one year period preceding the
commencement of the audit of the current year's financial statements.
Auditor Communication With Audit Committee
Section 204 of the Sarbanes-Oxley Act directs the Commission to issue
rules requiring timely reporting of specific information by accountants to
audit committees. In response to the Act, the rules will require the
accounting firm to report, prior to the filing of its audit report with
the Commission, to the audit committee (1) all critical accounting
policies and practices used by the issuer; (2) all material alternative
accounting treatments of financial information within GAAP that have been
discussed with management, including the ramifications of the use of such
alternative treatments and disclosures and the treatment preferred by the
accounting firm; and (3) other material written communications between the
accounting firm and management.
Small Business/Small Firm Considerations
We recognize that some of these provisions may impose an undue burden
on certain smaller accounting firms. Accordingly, the rules will provide
that firms with fewer than five audit clients and fewer than ten partners
may be exempt from the partner rotation and compensation provisions,
provided each of these engagements is subject to a special review by the
Public Company Accounting Oversight Board at least every three years.
Foreign Considerations
Foreign accounting firms or foreign private issuers may face additional
issues in implementing certain rules. Changes to the proposed rule
relating to the depth of partner rotation and the scope of personnel
subject to the "cooling off" period apply to foreign accounting firms.
Moreover, additional time is being afforded to foreign accounting firms
with respect to compliance with rotation requirements. The release also
provides guidance on the provision of non-audit services by foreign
accounting firms, including the treatment of legal services and tax
advice. The SEC also stands ready to work with other regulatory bodies on
these issues.
These measures will be effective 90 days after their publication in the
Federal Register, with appropriate transition periods for various
provisions.
* * *
The full text of detailed releases concerning each of these items will
be posted to the SEC Web site as soon as possible.
http://www.sec.gov/news/press/2003-9.htm
