SEC Proposes Sweeping Rules; Ripple Effect Could Impact Firms that Audit Private Companies.

Putting the very future of the CPA profession on the line, the Securities and Exchange Commission in late June proposed sweeping rules that, if enacted in their current form, would force a restructuring of the accounting profession. The most threatening rule would prohibit accounting firms performing audits for SEC registrants from providing most non-audit services for those clients or any of their affiliates.

Going one step further, however, the Institute believes that the ripple effect of state boards of accountancy, the Department of Labor, the General Accounting Office, federal banking regulators, and other agencies adopting similar rules to "harmonize" with the SEC would in essence make its rule applicable to all accounting firms that provide both audit and non-audit services to a client. Such a drastic measure would cripple even smaller firms.

While the AICPA has supported other SEC initiatives to focus attention on the importance of auditor independence, the SEC's new proposals are draconian and unwarranted, especially given the conclusions of the independent Panel on Audit Effectiveness which was formed by the Public Oversight Board at the SEC's request. In its draft report issued this June, the panel concluded that it found no instances where providing non-audit services to an audit client had a detrimental effect on the quality of the audit. In fact, in one-fourth of the audit engagements it reviewed in which consulting services also were provided, the services were found to have a positive impact on the effectiveness of the audit.

Ten categories of non-audit services were specified by the SEC as being off limits under the proposed rule: (1) bookkeeping or other services related to the audit client's accounting records or financial statements; (2) financial information systems design and implementation; (3) appraisal or valuation services, fairness opinions or contribution-in-kind reports; (4) actuarial services; (5) internal audit outsourcing; (6) assumption of decision-making, supervisory or ongoing monitoring functions; (7) human resources; (8) broker-dealer, investment adviser or investment banking services; (9) legal services; and (10) expert services.

Moreover, the SEC proposes to reserve the right to prohibit still other services, by applying both broad "catch-all" provisions and an "appearance"-based standard, under which an accountant will not be recognized as independent if the accountant "would not be perceived by reasonable investors to be ... capable of exercising objective and impartial judgment...." Because of resulting uncertainties as to what is or is not permitted, firms of all sizes may feel compelled to avoid or discontinue particular services altogether, even if that service is not expressly prohibited.

In addition, the proposed rule would impute to an accounting firm the activities of virtually any entity with which the accounting firm has a commercially valuable business relationship by deeming such an entity an "affiliate of the accounting firm." Accounting firms, therefore, would be precluded from entering into almost any joint venture or partnership, since the firm's independence could be impaired as a result of the activities of other parties in which it may have only an immaterial investment, or with which it may be associated in only limited respects, but does not control. What's more, regional alliances or cooperative agreements between accounting firms could result in each firm being required to be independent of each other firm's clients. The restrictions similarly would extend to any alliance or cooperative agreement with overseas accounting and other firms (such as legal service providers).

Another significant provision of the proposed rule is a new disclosure requirement for public companies that would reinstate a proxy disable similar to one put into effect by the SEC in 1978, but revoked in 1982. The proposal would require a company to disclose in its annual proxy statement any service received from its principal accountant, unless the amount of such service was less than the lesser of $50,000 or 10% of the audit fee.

Extensive discussion of the SEC's proposals took place at the AICPA Board of Directors' meeting in July. The board concluded that modernization of the rules relating to financial interests and family relationships was needed and overdue, but that the proposed restrictions on non-audit services were not in the public interest, as they would strip the profession of skills needed to meet its auditing responsibilities in the New Economy. In addition, the Independence Standards Board has been working on financial interests, family relationships and employment with clients for a number of months. The ISB's process, which the AICPA supports, includes public participation, and the Institute believes the ISB is the appropriate body to set independence standards for auditors of public companies. Add to that the findings of the Panel on Audit Effectiveness and the potential impact on firms of all sizes, and the board instructed the AICPA to make every attempt to prevent adoption of the rules as proposed.

To that end, the AICPA will testify before the SEC at a hearing on the proposed rules on Sept. 13. More importantly, the Institute is mobilizing the grassroots support of its membership to speak out against this intrusive proposed regulation. Members of the SEC Practice Section and the Private Companies Practice Section, members in business and industry, and Key Person, Political Leadership Cabinet and state CPA society contacts are encouraged to contact the SEC and members of Congress during the proposal's comment period. All of the communications materials prepared for the campaign--a letter to members, a summary of the proposals, instructions for commenting, and message points--are available on the AICPA Web site (www.aicpa.org/belt/sec/letter.htm).

You may want to consider the proposals and comment as well--the comment period ends on Sept. 25. To read the proposal in its entirety, view it on the SEC's Web site at www.sec.gov/rules/proposed/34-42994.htm.

We will keep members informed about the proposal's developments and our progress through future reports in The CPA Letter.

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