Comments of Huron Consulting Group, LLC on S7-49-02

Huron Consulting Group, LLC

January 13, 2003

Jonathan G. Katz, Esq.
Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609

Re: File No. S7-49-02

Dear Mr. Katz:

In accordance with the Sarbanes-Oxley Act of 2002, the U.S. Securities and Exchange Commission ("The Commission") has undertaken a review of its existing requirements regarding auditor independence.

Included with the proposed rules released by the Commission on December 2, 2002, the Commission brought forth for discussion the possible requirement for companies to have specialized accountants perform "a forensic audit to evaluate the work of the existing auditor, the condition of the company's internal controls, the company's accounting and reporting practices, and other matters."¹

As practitioners in the field of forensic accounting, Huron Consulting Group, LLC ² ("Huron") wishes to comment on the following questions posed by the Commission:

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?
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?
Should the Commission establish requirements for firms conducting forensic audits? If so, what should those requirements be?
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?
What are the costs and benefits of engaging forensic auditors to evaluate the work of the financial statement audit firm?³

Before responding to these questions, it is useful to provide some general observations and comments.

Our Understanding of the Objectives for the Forensic Audit Function

The pressure driving this public discussion arises in response to the widely publicized financial reporting problems of the past year. Unlike any other year in recent history, the headlines in 2002 were dominated by financial reporting calamities. However, even before 2002, financial reporting errors were on the rise. As reported in the Huron Consulting Group Study of Restatement Matters for the Five Years Ended December 31, 2001, the number of restated financial statements filed by public companies grew from approximately 120 in 1997 to 270 in 2001.⁴

To reverse this trend, many parties, including lawmakers, regulators and the exchanges, are making changes to improve management accountability, corporate governance and the audit function.

The Commission's consideration to use forensic audits as a tool to reverse this trend appears to be directed at three key components to improving our financial reporting system; detecting financial fraud, strengthening auditor independence, and providing additional resources for audit committees. As stated by the Commission,

"Some believe that having a separate set of examiners conduct periodic forensic audits would encourage financial statement auditors to take greater responsibility for the detection of fraud and illegal acts when auditing financial statements due to the fact that another set of auditors would be critically evaluating their role. Additionally, forensic audits conceivably could give the audit committees a tool to better evaluate the quality of the financial statement auditors."⁵

Inherent in this quotation are the three roles for the forensic auditor; a fraud specialist, a form of peer reviewer, as well as an audit committee consultant. Each of these roles has merit and deserves consideration and discussion.

With regard to the engagement of a fraud specialist, it is important to consider the present role and responsibility of the financial statement auditor to detect fraud. Also, a thorough evaluation of the causes underlying financial reporting problems should be made because many are not the result of fraud.

Under the recently issued Statement on Auditing Standards No. 99: Consideration of Fraud in a Financial Statement Audit (SAS 99), the financial statement auditor must place an increasing emphasis on professional skepticism, conduct discussions with company management and other company personnel to determine the risk of fraud and whether there is any known fraud at the company, design audit tests that are unpredictable and unexpected by the company and conduct tests for management override of controls on every audit. As such, the auditor has defined professional responsibilities for the detection of fraud.

While the experience and knowledge of a forensic auditor would in many circumstances be valuable and beneficial in the detection of fraud, requiring forensic auditors to perform their own procedures, separate and distinct from the financial statement auditor would create significant overlap with the financial statement auditor's present responsibilities. This dual process has the potential of creating confusion about which service provider has primary ownership for the detection of fraud and may pose the risk of shifting responsibility away from the financial statement auditor.

As to the underlying causes of recent financial reporting problems, not all restatements are the result of frauds. As detailed in our study, restatements result from problems with the interpretation of accounting rules, human and system errors, as well as ethical problems. The skepticism and analytical abilities of an experienced forensic auditor may assist in the detection of accounting rule as well as human and system error problems but not necessarily at a greater level than the ability of the financial statement auditor.

As to using the forensic auditor as a form of peer reviewer, the newly formed Public Company Accounting Oversight Board ("PCAOB") will certainly play a major role in defining how audit firms will be reviewed and scrutinized in the future. However, this process has not been clearly defined as of this time. Before commenting on this role, it does appear prudent to await the plans of the PCAOB.

Last of the above roles, is the use of the forensic auditor as a consultant to the audit committee. Audit committee advisory roles have been a subject of significant discussion but it appears at the present time to be of uncertain definition. Creating an audit committee advisory role would support the Commission's intent to improve audit committee effectiveness consistent with the designation of a committee member as a "financial expert." We will discuss this topic in more detail below.

Based on that background we respectfully submit the following comments to the proposed questions listed above.

Comments Addressing the Commission's Questions Regarding Forensic Auditors

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?
As discussed above, until the PCAOB has an opportunity to establish standards for the review and scrutiny of audit firms, we believe the Commission should not adopt requirements that issuers engage forensic auditors to evaluate the work of financial statement auditors.
The purpose of audit partner rotation is to support the independence of the financial statement audit function by shifting the ultimate audit responsibility for the firm's opinion to a different CPA within the audit firm. This shift is intended to bring a fresh view to the accounting judgments and policies of the issuer as well as to the delivery of the audit process. If the Commission were to require forensic auditors to evaluate the work of financial statement auditors, while it would add a layer of scrutiny, we do not believe it would offset all the intended benefits of partner rotation and therefore would not obviate the need for partner rotation.
As to the use of other consultants we will discuss the use of audit committee consultants below.
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 believe that rules requiring companies to engage forensic auditors would provide opportunities for new market entrants. Many companies do business with more than one of the major accounting firms, thereby creating numerous conflicts of interest and a resultant demand for new vendors. In addition to specialty firms, large national and regional accounting practices outside of the "Final Four" would be presented with a significant business opportunity.
Depending on the professional requirements, other service businesses may choose to invest in and pursue the market as well. However, it is possible that new or current firms without national or global networks, would have difficulty delivering resources on an immediate basis as required for certain issuers.
Should the Commission establish requirements for firms conducting forensic audits? If so, what should those requirements be?
If the Commission were to require the forensic audit function, requirements both as to qualifications (either through experience or certifications) and reporting protocols and formats would be important to manage the Commission's expectations.
At the present time, there is not a professional designation or uniform qualification process upon which a " forensic auditor" can be identified. Rather it is a self appointed title, generally used by professionals engaged in investigative and problem solving accounting services. There is a Certified Fraud Examiner designation and organization. However, financial statement audit experience is not a prerequisite to certification thus limiting its usefulness for the Commission's intended roles of the forensic auditor.
The skills required in the forensic auditor would likely need to include knowledge of accounting, auditing and financial reporting, information systems expertise and experience in the detection of financial statement errors, irregularities and defalcations. Requirements describing qualifications and experience in each of these categories would be important to achieve consistency of skills among the group of service providers that issuers may engage.
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?
As discussed above, we believe the intended benefits of audit partner rotation would not be supplanted through the requirement of a forensic audit function.
What are the costs and benefits of engaging forensic auditors to evaluate the work of the financial statement audit firm?
It would appear that the analysis of "cost and benefits" should not be limited to any one-company calculation, but rather to the market as a whole. The costs to an individual company may realize little or no visible benefit. However, if the forensic audit function achieved the apparent objectives set forth above and made improvements to the rate of financial misstatements then the benefit to the capital markets could be enormous. However, as detailed above, we believe there are several reasons why the forensic audit function may not be the best solution to be currently adopted.

Preferred Role of Forensic Auditors

If the Commission desires to utilize the skills of forensic auditors as a part of the solution to improving our system of financial reporting, then the preferred role for these professionals may be as advisors to audit committees.

A primary role of the audit committee is to interact with the external auditor as well as any internal auditors, including reviewing the auditors' plans and results. In addition, the audit committee oversees the control environment of a company, including dealing with fraud risk and detection matters. The roles described above for engaging a forensic auditor are closely aligned with the duties of the audit committee.

We believe the Commission's objectives for the forensic audit function may be in large part achieved by recommending and or requiring audit committees to engage forensic accountants or other comparable consultants for assistance in fulfilling their oversight role. This assistance may be to support a committee's "financial expert" and to possibly perform special procedures at the committee's request. In either case, with proper assistance, many audit committees may be better equipped to maximize their control and utilization over the auditors presently engaged to serve the needs of the investing public.

Thank you for the opportunity to provide our thoughts and comments related to these questions. We would welcome an opportunity to share more information about our comments if you feel it would be helpful. You may contact either Joseph J. Floyd at (617) 226-5510 or George E. Massaro at (617) 226-5550.

Very truly yours,
Huron Consulting Group, LLC
Joseph J. Floyd

____________________________

¹ Strengthening the Commission's Requirements Regarding Auditor Independence, 67 Fed. Reg. 76780-01 (2002) (Proposed December 2, 2002)
² Huron is an independent business consulting organization with over three hundred employees in five cities.
Our professionals dedicated to forensic accounting and special investigations help companies solve complex accounting problems as well as investigate financial fraud and accounting irregularities.
³ Strengthening the Commission's Requirements Regarding Auditor Independence, 67 Fed. Reg. 76780-01 (2002) (Proposed December 2, 2002)
⁴ The results from our updated study will be available on our website at www.huronconsultinggroup.com in mid to late January 2003.
⁵ Strengthening the Commission's Requirements Regarding Auditor Independence, 67 Fed. Reg. 76780-01 (2002) (Proposed December 2, 2002)