Institute of Chartered Accountants in England & Wales10 January 2003 PLW/EXE/fil/ltrs/jp Mr Jonathan G Katz
Dear Sir Proposed Rule: Strengthening the Commission's Requirements Regarding Auditor Independence - File No S7-49-02 My Institute responded on December 24 2002 to the Commission's Proposed Rule Regarding Auditor Independence. I am now writing following my meeting on 7 January with Samuel Burke and Paul Munter of the office of the Chief Accountant, with regard to two matters where the Institute believes the Proposed Rule will have the inappropriate and no doubt unintended consequence of reducing rather than increasing audit quality outside the US. This reduction in audit quality will affect the financial statements of both the overseas affiliates of US issuers and of foreign issuers. My Institute has responsibilities in the UK, delegated to it by the UK Government, for many aspects of maintaining audit quality, and we therefore share with the Commission an overall objective of restoring confidence to the capital markets by ensuring companies provide reliable financial statements underpinned by high quality auditing. B11. Tax Services The Sarbanes-Oxley Act of 2002 properly does not place any prohibition on the provision of tax services other than requiring pre-approval by the Audit Committee. The Commission's commentary, as published with its proposed Auditor Independence Rule, nevertheless suggests that the Commission may exercise its authority to prohibit certain as yet unspecified categories of tax services. We do not believe the provision of any tax service should be prohibited by the Commissioner's Independence Rules. Furthermore, we consider that any attempt to categorise tax services into permitted and disallowed activities will fail to achieve the Commission's objective. Precise drafting which is capable of being interpreted outside the US will not be possible, as is demonstrated by the commentary in the Proposed Rule. Issuers executives and Audit Committees will be driven to conclude that wide areas of tax advice, if not all tax work, should not be handled by the issuer's auditors. This may lead to a fragmentation of the accounting profession. An audit firm without significant tax capability will be less able to audit effectively the tax accrual included in an issuer's financial statement. A narrower, largely "audit only" profession would emerge, which would be less attractive to potential new entrants to the profession and would over time reduce the quality of audit partner. In the medium term, this measure would be seen to have done more damage to the audit quality than any possible infringement of auditor independence. In view of the potential significant damage to audit quality if the above scenario were to develop, the Institute urges the Commission not to prohibit any category of tax services in the rules it is required by law to issue by January 26, 2002 to implement various provisions of the Sarbanes-Oxley Act. Instead, if the Commission concludes that the public interest so requires, a reasonable period of further study with respect to one or more categories of tax services could be undertaken in order to enable the Commission to determine, with the benefit of further public comment, whether there is a need to go beyond the statute This would also allow consideration to be given to alternative safeguards to auditor independence. For example, I would offer one alternative for consideration in the light of UK experience. In the (unusual) circumstances where an element of the tax accrual is material to the financial statements, and where the outcome is subjective or otherwise significantly uncertain, if the tax advice had been rendered by the auditor's firm the auditor should not rely on that advice but instead the issuer should be required to obtain an independent second opinion (probably, but not necessarily, from Legal Counsel) on which the auditor would base his audit opinion. C Partner Rotation We support the principle of audit partner rotation, and believe that Section 203 of the Sarbanes-Oxley Act of 2002 is an appropriate measure (we require in the UK the lead audit partner to rotate every five years). An extension of the rule to all partners on the engagement team will, however, reduce rather than improve audit quality. Outside the most developed economies the audit firms simply do not have a sufficient number of partners (and nor could they obtain them) to provide for rotation to a partner with appropriate industry, language and other relevant skills. Nor would a forensic auditor from another audit firm necessarily have the appropriate skills; in many countries the profession is small and these skills reside with a very limited number of people. It is my view that rotation of the lead engagement partner and other audit partners engaged at the issuer's head office provides a sufficient safeguard against loss of independence. I would not necessarily oppose, however, an extension of the rotation requirement to significant subsidiaries (defined by asset value or turnover) provided the threshold was set at a high enough level (say 25% of the issuer's financial statement) and provided the rotation period allows for an additional two years for an incoming partner to work on the audit to gain relevant experience and expertise. Indeed, in the UK we have allowed the lead engagement partner to work on the audit engagement team for a period of two years prior to becoming the lead partner without this counting towards the five year term in order that he/she may gain relevant knowledge about the issuer's business, systems, controls and people, either in the home country or overseas as appropriate. I have deliberately confined my comment to the most significant points of concern for the audit of foreign issuers and for overseas affiliates of US issuers, but would be very willing to provide any further information which the Commission would find helpful.
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