Asahi & Co.

January 10, 2003

Mr. Jonathan G. Katz
Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, NW, Washington, DC, 20549-0609
United States of America
Electronic mail address: rule-comments@sec.gov

Reference: File No. S7-49-02

Dear Mr. Katz:

Asahi & Co. ("Asahi") very much appreciates this opportunity to comment on the Proposed Rule of "Strengthening the Commission's Requirements Regarding Auditor Independence" by the Securities and Exchange Commission ("SEC") in Release No. 33-8154; 34-46934; 35-27610; IC-25838; IA-2088, FR-64 ("Release"). Asahi is one of the four largest public accounting firms in Japan. Asahi has approximately 2,700 professionals working out of 39 offices across Japan. We provide our clients with a broad range of audit, attest, and advisory services. The Proposed Rule would have a significant impact on our firm, our personnel, and our clients.

We share the Commission's goal of protecting the integrity and independence of the accounting profession, but believe that certain of the proposals will weaken the profession without enhancing auditor independence. The attached addresses our general observations and comments as to proposals in the Releases that affect accounting firms.

Our responses to questions in the Release are in red. Should you have any questions about our response, please contact Teruo Ozaki at 81-3-3266-7233 or teruo.ozaki@jp.kpmg.com.

Respectfully submitted,

Shigeru Iwamoto
Managing Partner
Asahi & Co.

Attachment

Cc: Teruo Ozaki, Deputy Managing Partner of Asahi & Co.
Masaji Tomiyama, Executive Partner of Asahi & Co.

Strengthening the Commission's Requirements Regarding Auditor Independence

Securities and Exchange Commission

17 CFR PARTS 210, 240, 249 and 274

[RELEASE NOS. 33-8173: 34-47137; IC-25885: File No. S7-02-03]

Proposed rule

II. Discussion of Proposed Rules

§ 210.2-01 Qualifications of accountants

A. Conflicts of Interest Resulting from Employment Relationships

Questions for public comments

• Is the one-year cooling-off period sufficiently long to achieve an appearance of independence by the accounting firm? If not, what period would be appropriate?

  Yes. A one-year period would mean that the executive would not have participated in the most recently completed audit.  

• Is the term audit engagement team sufficiently clear? If not, what changes would improve the description to describe the group of accountants who would be covered?

  Yes, the definition is clear. We believe that the rule should apply NOT to professional employees but only to all partners, principals, and shareholders participating in an audit, review, or attestation engagement of an audit client, including those conducting concurring or second partner reviews. We believe that senior managers, managers and staff should NOT be subject to the requirement of cooling-off period.

• Is the phrase commencement of the audit sufficiently clear? If not, what changes would improve the description? Is that the appropriate time to mark the commencement of the period? Is there a better mark?

  No, we do not find the phrase "commencement of the audit" sufficiently clear. The procedures associated with the planning of an engagement can be any number of procedures, such as a meeting with the client CFO to get an update on client matters. In addition, on many larger engagements, engagement team members are at the client's offices year round. Planning and audit procedures, such as verification of inventories and tests of internal controls, are effectively year round tasks, even though a formal planning document may be prepared in late summer or early fall. Instead of trying to define at what time the pace of planning and organizing for the year-end audit significantly increases, perhaps it would be easier to set an arbitrary time, such as three months before the fiscal year-end.

  Paragraph (c)(2)(iii)(B)(1)(i) also seems to propose that the date of the commencement of the audit will depend on whether the former employee of the accounting firm joins the audit client before or after the client's fiscal year-end. We do not understand the logic of this.

• Is the phrase commencement of review procedures sufficiently clear? If not, what changes would improve the description?

  We do not understand why the proposed rule defines the commencement of audit procedures as the earlier of the date of the commencement of the audit or the date of the commencement of review procedures. The Act clearly states that the cooling-off period is intended to be "the one-year period preceding the date of the initiation of the audit." A review is not an audit. A one-year period preceding the date of the initiation of the audit captures those who participated in the prior year's audit. That's good enough and is consistent with the Act. We see no reason to unnecessarily complicate matters be introducing the "earlier of" formula of the proposed rule.

• Is it appropriate that the cooling-off period provisions apply to employment relationships involving audit engagement team members and their audit clients? Should the requirements be limited to audit clients who are issuers as defined in Section 205 of the Act?

• Are the appropriate officers covered by the proposed rule? If not, which additional individuals should be subject to the cooling-off period provision? For example, should national office personnel who would be excluded under the proposal be included?  

  The proposed rule applies to a former partner, principal, shareholder, or professional employee of an accounting firm who is in a "financial reporting oversight role," which is defined in the proposed rule to include several officers not mentioned in Section 206 of the Act and several, such as the director of internal audit and the treasurer, who do not have "direct responsibility for oversight over those who prepare the registrant's financial statements." We see no reason to include the director of internal audit or the treasurer as executive positions to which the proposed `cooling-off" period should apply.

  We do not believe that national office personnel of the accounting firm should be included as members of the audit engagement team for purposes of the proposed rule.

• Should the proposed rules apply equally to large firms/companies as small firms/companies? Would the proposed rules impose a cost on smaller issuers that is disproportionate to the benefits that would be achieved? Why or why not? Should there be an exemption to this requirement for smaller businesses?

  We believe that the proposed rule should apply equally to large and small firms and companies.

• The "cooling off" period applies to all entities in the investment company complex. Is this too broad? Why or why not?

  An investment company complex comprises a staggering array of entities. If the cooling-off period rule were to apply to all members of audit engagement teams of entities in the complex, it would cast far too wide a net. It would apply, for example, the engagement partner of a single fund of a huge complex who may have the opportunity to work for a subsidiary of an investment company that had no responsibility for the fund the engagement partner audited. A materiality standard should apply. We also do not believe that the rule should apply to members of audit engagement teams that audit immaterial subsidiaries of registrants.

• Should the Commission include exceptions subject to certain criteria? If so, what should these criteria be?

  Although we are reluctant to eliminate the possibility of exceptions to a rule, it is difficult to imagine a situation in which a company were to have a dire need for an executive and a member of the company's accounting firm audit engagement team was the only person qualified for the position.

B. Services Outside the Scope of the Practice of Auditors

[Questions for public comments]

• Are there other non-audit services that are incompatible with Rule 2-01(b) or that raise independence concerns? If so, what are they, and why do they raise independence concerns?

  No. The proposed list of prohibited non-audit services has been developed after years of spirited discussions between the SEC staff and the accounting profession in the United States, submissions of opinions to proposed rules, deliberations in Congress, opinion pieces in serious and not-so-serious journals, and now the efforts of the SEC staff to expand on the guidance provided in the Act and SEC rules enacted two years ago. We think that the proposed list is more than comprehensive and includes services that are neither prohibited under the Act nor of a nature that jeopardize auditor independence.

• Is the meaning of the general principles sufficiently clear?

  No, the meaning of the general principles is by no means clear. The general principles set forth in the preliminary note to rule 2.01 rest on whether a relationship or the provision of a service (a) creates a mutual or conflicting interest between the accountant and the audit client; (b) places the accountant in the position of auditing his or her own work; (c) results in the accountant acting as management or an employee of the audit client; or (d) places the accountant in a position of being an advocate for the audit client. The SEC staff proposes to supplement these general principles with the "simple principles" noted in the legislative history summarized in the discussion as to the proposed rules related to services outside the scope of the practice of auditors. As we understand them the four "simple principles" largely overlap the "general principles" and are that, in order to be independent, a public company auditor should not (a) audit its own work, (b) function as part of management or as an employee of the audit client, (c) act as an advocate of its audit client, or (d) be a promoter of the issuers stock or other financial interests. These general principles and simple principles, when combined with a standard of having to be independent in appearance as well as in fact, create a basis for arguing that auditors can provide absolutely no services to a public audit client other than the audit services. Artfully wielded, they comprise a supple and powerful weapon with which one may assail the accounting profession confident that the profession cannot argue back based on these principles and standard alone.

  As an example, if one argues that providing advice as to the design of a compensation plan or aspects of an audit client's management or organization structure are prohibited because these are management functions, then one can argue that virtually everything a company does is a management function, including tax preparation and strategy, legal planning, systems planning and implementation, strategies to cut costs and improve operational efficiency, and so on. The list is endless, and since these are all management functions, the auditor should not perform them or advise on them one argues strictly that performance of management functions is incompatible with auditor independence.

  As another example, if providing advice as to the design and implementation of internal accounting and risk management controls should be prohibited because the auditor may audit its own work, then providing advice as to internal accounting and risk management controls in a management letter at the end of an audit (or in a meeting with the Board of Directors) should also be prohibited. From a strict perspective of principles and standards, they are no different. In their discussion of the proposed rules relative to non-audit services and management functions, the SEC staff tries to argue that providing consultation advice as to the design and implementation of internal accounting and risk management controls is "fundamentally different" than recommending improvements in the internal accounting and risk management controls of an audit client, because, the staff argues, the latter service is "an integral part of any audit" and "can be extremely valuable to companies, and ... may facilitate the performance of a high quality audit." It seems clear to us that the two services are not fundamentally different, and both can be valuable to companies and improve the quality of audits, but the staff does not want to admit the breakdown in their logic. The staff is right, auditors should continue to recommend improvements in controls; but they are also wrong, the two services are not fundamentally different.

  These two examples illustrate that there are clearly trade-offs and judgments as to whether auditor objectivity is truly distorted when considering the effects of providing non-audit services to audit clients. The principles and appearance standard cannot be the sole criteria for assessing auditor independence. Their "meaning" is by no means clear.

1. Bookkeeping or Other Services Related to the Audit Client's Accounting Records or Financial Statements of the Audit Client

[Questions for public comments]

• Should the definition of bookkeeping be further clarified? If so, how?

  No comment.

• Does the definition cover all the bookkeeping services that would impair an accountant's independence?

  The definition is broad enough.

• Should an auditor be permitted to provide bookkeeping services to an audit client if it is not reasonably likely that the results of those services will be subject to audit procedures during the audit of the client's financial statements? Why or why not?

  We do not believe that a rule based on whether the results of bookkeeping services are "reasonably likely" to be subject to audit procedures is workable. Audit procedures encompass analytical reviews, including reviews of the financial results of clearly immaterial subsidiaries and divisions, discussions with management, discussions other auditors, and other such procedures that cover most audit client activities. Can we say that the results of certain bookkeeping services are "not reasonably likely" to be subject to audit procedures? A clear materiality standard would be better.

• Is the standard of reasonably likely sufficiently clear? If not, should we use some other standard? If so, what standard should we use?

  No comment.

• Is the phrase "preparing statutory statements which form the basis of U.S. GAAP statements" sufficiently clear? If not, how might the phrase be revised?

  We believe that the phrase " preparing statutory statements which form the basis of U.S. GAAP statements" is sufficiently clear.

2. Financial Information Systems Design and Implementation

[Questions for public comments]

• Is an auditor's independence impaired when the auditor helps select or test computer software and hardware systems that generate financial data used in or underlying the financial statements? Why or why not?

  The Act prohibits accounting firms from providing financial information systems design and implementation services. This prohibition appears to be aimed at large systems design and implementation consulting projects. Most of the large firms have spun off or sold these consulting operations. To expand the prohibition to cover even helping an audit client select or test computer software and hardware systems would be going too far. A company's auditors are quite knowledgeable about the company's systems, internal controls and business operations. They can provide insights and expertise based on the company's particular needs that third parties cannot provide. Would this activity impair the auditor's independence? We don't think so. The auditor and the client share a concern for accurate and efficient accounting systems. Providing help in system design and implementation contributes to system quality and efficiency and the integrity of financial reporting. Accounting firms have provided such help from their earliest years.

• Whether a system is used to generate information that is "significant" to the audit client's financial statements may depend on the size of the engagement. Does the magnitude as a percentage of either audit fees or total fees of the fees for such services make a difference on whether performance of the service impairs independence?

  We don't understand the logic of this question. Whether a system is used to generate information that is "significant" to the audit client's financial statements probably doesn't depend so much on the size of the engagement as the nature of the engagement. The issue of whether the magnitude of the fees of a non-audit service engagement relative to audit fees from the client impairs independence would appear to be independent of the type of non-audit engagement. If the concern is that the auditor would feel more constrained about reporting on the flaws in an accounting system resulting from a large fee non-audit engagement than on those resulting from a smaller fee engagement, it is difficult to say. Practically speaking, the audit client will learn of any problems with the system before the auditor will, and, in our experience, will not be shy about expressing dissatisfaction. The issue of the impairment of independence resulting from providing systems design and implementation services has always struck us as more apparent than real, the result of overzealous application of the general principles and appearance standard.

3. Appraisal or Valuation Services, Fairness Opinions, or Contribution-in-Kind Reports

[Questions for public comments]

• Does providing valuation or appraisal services that are unrelated to the financial statements, such as for certain regulatory purposes, impair an accountant's independence?

  We do not believe so.

• Does providing valuation or appraisal services for tax purposes impair an accountant's independence?

  We do not believe so. 

• Are there certain types of appraisal or valuation services, or certain instances in which they are provided, that do not raise auditor independence concerns? Are there circumstances in which an accounting firm may be required by law or regulation to provide such services, either in the United States or abroad?

  No comment.

• Should we provide an exemption for such services provided to a foreign private issuer by its accountant where local law requires such services (e.g. contribution in-kind reports)?

  Yes

• The Commission staff, when providing interpretations of the application of the auditor independence rules to contribution in-kind reports, has worked with foreign jurisdictions to accommodate the statutory requirements in those jurisdictions.³⁸ Should the Commission's rules provide that similar practices or arrangements be permitted where contribution in-kind reports are required by foreign statute?

  Yes

4. Actuarial Services

[Questions for public comments]

• Are there certain circumstances under which an accountant can provide actuarial services to an audit client without impairing independence?

  No comment.

• Have we appropriately described the actuarial services prohibited by the Act?

  We believe so.

5. Internal Audit Outsourcing

[Questions for public comments]

• Is the definition of the "internal audit function" sufficiently clear?

  Yes, the definition of "internal audit function" is sufficiently clear.  

• We solicit comment on whether an exception should be provided for small businesses. If so, what criteria should we consider in providing such an exception?

  The same rules should apply to the small businesses as to large. The size of the business is not the issue, it is the availability of audit outsourcing firms in the companies area.  

• Does it impair an auditor's independence if the auditor does not provide to the client outsourcing services related to the internal audit function of the audit client, but rather performs individual audit projects for the client?

  We find the logic as to why performance of the internal audit function for an audit client impairs auditor independence to be strained. If there were not an internal audit function, the auditor would be required to expand his or her own audit work on client internal controls, and the auditor would rely on his or her own firm's work as part of the audit. Why is it a violation of the auditor's independence if the auditor relies on his or her firm's "own" work if performed as part of the internal audit function, but not a problem if performed as part of the audit? We are puzzled.

  It seems to us that the real issue that some feel is important is not that the auditors' independence might be impaired, but that the client might not feel that it were getting two separate viewpoints as to client , financial reporting, and performance. Current SEC independence rules address this concern with the requirement that not more than 40% of total hours expended on internal audit activities be performed by the audit firm. We presume that the head of internal audit would not be from the audit firm.

  For these reasons, we do not believe that auditor independence would be compromised if the auditor were to perform individual audit projects.

• Are there safeguards that can be established by the auditor that would allow the audit client to outsource the internal audit function to the auditor without impairing its independence?

  We believe that there are such safeguards, that auditors have successfully provided outsourcing services to audit clients with such safeguards, such as requiring the head of internal audit not be from the auditing firm, and that the current SEC rule as to providing no more than 40% of internal audit services provides an additional safeguard.

• Would it impair the auditor's independence if the auditor performs only operational audits that are unrelated to the internal controls, financial systems, or financial statements?  

  No, the auditor's independence would not be impaired if the auditor performs only operational audits that are unrelated to the internal controls, financial systems, or financial statements.. As noted above, we believe that auditors could also perform audit projects related to internal controls, financial systems, or financial statements.

• Is additional guidance necessary to distinguish the services that would be prohibited under this proposed rule from those services that would be permitted as operational audits?

  Yes, the proposed rule prohibiting "any internal audit services related to the internal accounting controls, financial systems, or financial statements, for an audit client" is far too restrictive.

6. Management Functions.

[Questions for public comments]

• Do services related to designing or implementing internal accounting controls and risk management controls result in the auditor auditing his or her own work? Would such services impair an auditor's independence when the auditor is required to issue an opinion on the effectiveness of the control systems that he or she designed or implemented?

  The question as to whether services related to designing and implementing internal accounting controls and risk management controls result in the auditor auditing his or her own work is not the right question and it is a misleading question. It is misleading in that it uses ""his" or "her" to refer to the auditor's firm and creates the impression that the same person is performing both functions. In most cases, the team performing the systems work will be separate from the audit team. Auditors take pride in what they do and they live in a litigious environment that provides strong incentive to do the right thing. If we put the word "firm's" after "his or her", we solve the problem, but then the question is not the right question. Of course the auditor is auditing his or her firm's own work, but that doesn't settle the issue, unless one wants to use the general principles and appearance standard as means of forcing auditors to provide nothing but audit and to enter a monkish Order of Auditors. Auditors have long provided audit clients with advice and more extensive consulting services as to the design and implementation of internal accounting controls and risk management controls. The auditor has considered provision of these services as an inherent aspect of his or her job as auditor, and the auditor's understanding of client systems, businesses, risks, and transaction flow place the auditor in a good position to improve systems quality, the audit process, and financial reporting and serve the public good. It is in the auditor's and the client's mutual interest to create more effective and efficient accounting systems, improve audit quality, and strengthen the financial reporting process.

  Would such services impair an auditor's independence when the auditor is required to issue an opinion on the effectiveness of the control systems that he or she designed or implemented? Again, let's replace "he or she" with "his or her firm." There is clearly an argument that the auditor's independence would appear to be compromised in this situation, but one can just as well argue that if anybody is interested in developing effective control systems in this situation, it is the auditor, both because of the auditor's inherent interest in effective controls at the client and because of the auditor's concern with the integrity of his or her attestation report.

• Do services related to assessing or recommending improvements to internal accounting controls and risk management controls result in the auditor auditing his or her own work? Would such services impair an auditor's independence when the auditor is required to issue an attestation report on the effectiveness of the control systems that he or she has assessed or evaluated for effectiveness?

  No comment.

• We request comment on whether there are circumstances under which an accounting firm can perform or assume management functions or responsibilities for an audit client without impairing independence?

  The answer to this question depends on what is meant by "management functions and responsibilities." If, as SEC staff appears to argue in the Discussion of the Proposed Rules ("Discussion") virtually everything done at a company can be considered a management function, then there are many circumstances under which an accounting firm can perform management functions for an audit client without impairing independence. The accountant can, in our opinion, for example, perform certain internal audit functions, assess or recommend improvements to internal accounting and risk management controls, assist in the design and implementation of accounting systems, advise as to compensation systems, advise as to employee training and job performance evaluation systems, advise as to organizational structure, consult as to non-accounting systems and procedures, consult as to improvements in supply chain processes, advise as to tax matters, advise as to cash management procedures, and so on.

  The narrower definition in the proposed rule -- "acting, temporarily or permanently, as director officer, or employee of an audit client, or performing any decision-making, supervisory, or on-going monitoring function for the audit client" -- seems to capture a more acceptable, limited definition than that implied in the Discussion. We believe, however, that performing certain internal audit functions for an audit client, with proper safeguards, would not jeopardize auditor independence.

7. Human Resources

[Questions for public comments]

• Are there additional types of human resource and employee benefit services that impair an auditor's independence?

  The proposed rules are consistent with rules currently in effect. In the Discussion, however, the SEC staff comments "under the proposed rule, an auditor's independence is also impaired when the auditor advises an audit client about the design of its management or organizational structure." We see no reason for such advisory service to be considered an impairment of auditor independence. 

• Would an auditor's independence be impaired if the auditor provided personnel hiring assistance for only non-executive or non-financial personnel?

  We do not believe so.  

• Does it impair an auditor's independence if the auditor provides consultation with respect to the compensation arrangements of the company's executives?

  Our answer depends on what the question means. We do not believe that the auditor should provide direct consultation as to amount of compensation of individual company executives. However, we believe that the audit firm can provide advice as to the compensation system for directors and other employees.

8. Broker-Dealer, Investment Adviser Or Investment Banking Services

[Questions for public comments]

• We solicit comment on the scope of the proposal. Are there other securities professional services that the rule should expressly identify as impairing independence?

  We believe that the scope of the proposal is appropriate.

• Would an auditor's independence be impaired if the auditor acted as a securities analyst covering the sector or industry of an audit client?

  We do not believe that it is appropriate for the auditor to act as a securities analyst covering the sector or industry of an audit client. 

• Should we adopt rules that would clarify when the auditor is acting as an unregistered broker-dealer? If so, what should those rules be?

  Perhaps, we'll defer to those more knowledgeable on this matter.

9. Legal Services

[Questions for public comments]

• Are there any particular legal services that should be exempted from the rule?

  No comment.  

• Would making the rule's application depend upon the jurisdiction in which the service is provided leave the rule subject to any significant uncertainty, or pose the prospect of any significant complexity or unfairness?

  No comment.  

• Should there be any exception for legal services provided in foreign jurisdictions? For example, in some countries only a law firm may provide tax services. Should a foreign accounting firm be permitted to provide, through an affiliated law firm, tax or other services that a U.S. accounting firm could provide to a U.S. audit client without impairing the firm's independence? Why or why not?

  No comment.  

• Should there be an exception for legal services provided to issuers in foreign jurisdictions? Should any such exception be tailored to avoid undermining the purpose of the restriction? For example, could fees for legal services be limited to a small percentage (e.g., 5% or 10%) of the amount of fees for audit services? Could partners providing audit services be prohibited from being involved in the provision of legal services or from receiving compensation based on such services?

  No comment.  

• Should any such exception have a "sunset" provision that would both allow foreign private issuers a transition period and allow the Commission to review the situation regarding legal services?

  No comment.

10. Expert Services

[Questions for public comments]

• Are there circumstances in which providing audit clients with expert services in legal, administrative, or regulatory filings or proceedings should not be deemed to impair independence?

  No comment.  

• Should an auditor be permitted to serve as a non-testifying expert for an audit client in connection with a proceeding?

  No comment.  

• Is the definition of prohibited expert services appropriate? Why or why not?

  No comment.  

• Is the distinction between advocacy and providing appropriate assistance to an audit committee sufficiently clear?

  No. We agree that it is important that auditors be allowed to assist the audit committee in their capacity as the investors' representatives. If the auditor were to undertake a forensic audit or other investigative procedures, it would be impossible for him or her to do so without assuming what others may interpret to be an advocacy role. The distinction could not be maintained in practice.

  To prohibit an auditor from being an advocate for his or her audit client is to ask the impossible. Japanese accounting firms are private, for-profit businesses in competition with each other to provide services to clients. Quality of service is a key feature of that competition. Directors and management expect their accounting firms to act in what they believe is the company's interest to the extent permissible by law and professional standards. In other words, clients expect a certain level of advocacy. What constitutes acceptable or unacceptable advocacy is, to some extent, a matter of professional judgment. Awareness of the importance of that judgment and care not to do the unacceptable have long governed the accountants' profession and will continue to do so.

11. Tax Services

[Questions for public comments]

• We request comment on whether providing tax opinions, including tax opinions for tax shelters, to an audit client or an affiliate of an audit client under the circumstances described above would impair, or would appear to reasonable investors to impair, an auditor's independence.

  In Japan, accounting firms do not provide tax services. Tax services are provided through separate legal entities some of which have names similar to those of related accounting firms with which they also have financial and contractual business relationships. Tax firms have long provided an array of services to audit clients of their related accounting firms, including development of tax planning strategies to reduce tax burdens and provision of opinions on such strategies. We do not believe that provision of these services has compromised auditor independence. Tax professionals are not in business to embarrass their related accounting firms; accountants know not to sacrifice professional integrity and judgment in auditing client tax accounts.

• Are there tax services that should be prohibited by the Commission's independence rules?

  No.

• Is it meaningful to categorize tax services into permitted and disallowed activities? If so, what categories and related definitions would make the demarcation meaningful?

  We do not believe that it is necessary to prohibit certain tax services, and therefore do not find it meaningful to categorize tax services into the permitted and the prohibited. If a decision is made to prohibit certain tax services, then categorization and criteria as to the permitted and the disallowed will of course be necessary.

C. Partner Rotation

[Questions for public comments]

• 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?

  [Our comment to above all questions]

  We do not believe that the Commission should adopt rules requiring that issuers engage forensic auditors periodically to evaluate the work of the financial statement auditors. We believe that new lead engagement partner rotation rules and the inspection and investigation powers of the Public Company Accounting Oversight Board established by the Act are sufficient additional safeguards.

• This proposed rule would apply to the audits of the financial statements of "issuers." Should the Commission consider applying this rule to a broader population such as audits of the financial statements of "audit clients" as defined in 2-01(f)(6) of Regulation S-X? Why or why not?

  We do not believe that there would be benefit to applying the rule to the broader population encompassed by "audit clients" as defined in 2-01 (f)(6) of Regulation S-X.

• For organizations other than investment companies, the rotation requirements would apply to significant subsidiaries of issuers. Should a different approach be considered? Is so, what approach would be appropriate?

  We believe that the rotation requirements should apply to the lead engagement partners on the issuer and significant subsidiaries of the issuer.

• Should the rotation requirements apply to all partners on the audit engagement team? If not, which partners should be subject to the requirements?

  The rotation rules should apply only to the lead engagement partners on the audit of the issuer and significant subsidiaries of the issuer.

• Is the proposed guidance sufficiently clear as to which audit engagement team partners would be covered by the rule? Is the proposed approach appropriate? If not, how can it be improved?

  The proposed guidance as to which audit engagement partners would be covered by the rule is too sweeping. We believe that the intent of the Act is met if the rotation rules are limited to the lead engagement partners on the audits of the issuer and significant subsidiaries.

• Is the exclusion of certain "national office partner" personnel from the rotation requirements appropriate?

  Yes  

• Is the guidance on national office partners who are exempted from the rotation requirements sufficiently clear?

  Yes  

• Is the distinction between a member of the engagement team and a national office partner who consults regularly (or even continually) on client matters sufficiently clear?

  Yes  

• Should certain partners performing non-audit services for the client in connection with the audit engagement be excluded from the rotation requirements?

  Yes. The rotation rules should apply only to the lead engagement partners on the audit of the issuer and significant subsidiaries of the issuer.

• Should additional personnel (such as senior managers) be included within the mandatory rotation requirements?

  No.  

• Is it appropriate to provide transitional relief where the proposed rules are more restrictive that the provisions of the Sarbanes-Oxley Act?

  The need for transitional relief will depend on what final rules are adopted. If the proposed rules become final without change, many firms with SEC registrant clients may find that they do not have the resources to provide appropriate industry expertise and meet the rotation requirements, and transitional relief may be necessary to allow time to resolve the matter.

• Are there situations in foreign jurisdictions that extended partner rotation could be modified with additional safeguards or limitations that would recognize the jurisdictional requirements as well as logistical limitations that may exist?

  No comment.

• Should the rotation requirements be different for small firms? What changes would be appropriate and why? If so, how should small firms be defined?

  This issue should be addressed by the smaller firms. 

• Would the proposed rules impose a cost on smaller firms that is disproportionate to the benefits that would be achieved?

  This issue should be addressed by the smaller firms.

• Is the five-year "time out" period necessary or appropriate? Would some shorter time period be sufficient, such as two, three or four years? Should there be different "time out" periods based on a partner's role in the audit process?

  The current SECPS requirement is two years. We believe that is adequate. A two-year hiatus provides ample assurance that there will be a "fresh look" at audit and accounting issues.

• If a partner rotates off an engagement after fewer than five years, should the "time out" period also be reduced? Why or why not? If so, how much should the reduction in the time out period be?

  If a five-year time out rule is adopted, if a partner rotates off after fewer years, a shorter time out period should be required. A simple rule would be for the time out period to be the same as the number of years on the engagement.

• Are the partner rotation requirements, as proposed, for investment company issuer's or other entities in the investment company complex too broad? Should we only prohibit a partner from rotating between investment company issuers within the same investment company complex? Why or why not?

  Yes, the proposed partner rotation requirements for engagement partners on entities within an investment company complex are too broad. The restriction should apply only to engagement partner on audits of issuers and significant subsidiaries of issuers.

• The proposed rules would not require all partners on the audit engagement team to rotate at the same time. Should it? Why or why not?

  No, the rules should not require that all partners on the audit engagement team to rotate at the same time. That would deny the accounting firm too much experience and understanding. In addition, a certain amount of rotation occurs in less than the maximum period for a variety of reasons, and a requirement that all partners rotate when one reaches the five-year limit would have ludicrous results.

D. Audit Committee Administration of the Engagement

[Questions for public comments]

• Should the Commission create other exceptions (beyond the de minimis exception) that would allow an audit committee to adopt a policy that contracts that are recurring (e.g., due diligence engagements in connection with a series of insignificant acquisitions) and less than a stated dollar amount (such as $25,000) or less than a stated percentage of annual revenues (such as 1% or 5%) could be entered into by management and would be reviewed by the audit committee at its next periodic meeting?  

• Is allowing the audit committee to engage an auditor to perform non-audit services by policies and procedures, rather than a separate vote for each service, appropriate? If so, how do we ensure that audit committees have rigorous, detailed procedures and do not, in essence, delegate that authority to management?  

• Should more or fewer aspects be left to the discretion of the audit committee?  

• Are there specific matters that should be communicated to or considered by the audit committee prior to its engaging the auditor?  

• What, if any, audit committee policies and procedures should be mandated to enhance auditor independence, interaction between auditors and the audit committee, and communications between and among audit committee members, internal audit staff, senior management and the outside auditor?  

• Our proposed rules do not contain exemptions for foreign filers. Are there legal or regulatory impediments which may make it difficult for certain foreign filers to comply? If so, what safeguards can these foreign filers employ to ensure that they comply with the proposed rules?  

• Our proposed rules requiring the audit committee to pre-approve non-audit services to be provided by the company's auditor do not contain an exemption for foreign filers. Are there legal or regulatory impediments which may make it difficult for certain foreign filers to comply? If so, what safeguards can these foreign filers employ to ensure that there is an authorization process to pre-approve such services that is separate from management?  

• In addition to legal or regulatory impediments, are there practical impediments which would make it difficult for certain foreign filers to comply with the pre-approval requirements? If so, what are these impediments? What safeguards can such an entity establish to better implement the proposed rules (which is to separate the decision to engage the auditor for non-audit services from management)?  

• Should the Commission provide additional specific guidance to assist audit committees when deliberating auditor independence issues? What topics would be helpful?  

• Our proposed rules would require the audit committee of an investment company to pre-approve the non-auditing services provided by the accountant of the investment company to the investment company's investment adviser and any entity controlling, controlled by, or under common control with the investment adviser that provides services to the investment company. Should the audit committee of an investment company registrant be required to approve any non-auditing services provided to the investment adviser and any entity controlled, controlled by, or under common control with the investment adviser that provides services to the fund? Should the scope of the pre-approval requirement be expanded or narrowed? Why or why not?  

• Under the proposed rules, the pre-approval of non-auditing services would permit, for purposes of determining whether a non-auditing service meets the de minimis exception, the investment company's audit committee to aggregate total revenues paid to the investment company's accountant by the investment company, its investment adviser and any entity controlled, controlled by, or under common control with the investment adviser that provides services to the fund. Should the de minimis exception be determined separately based on the total revenues paid to the investment company's accountant by each entity?  

• This proposed rule would apply to "issuers." Should the Commission consider applying this rule to a broader population such as "audit clients" as defined in 2-01(f)(6) of Regulation S-X? Why or why not?  

• In addition to the requirement that a majority of the directors who are not interested persons of the registered investment company appoint the independent accountant of a registered investment company under the Investment Company Act of 1940, the proposed rules would also require the audit committee of an investment company to separately approve the accountant. For registered investment companies, who should approve the selection of the accountant, i.e. independent directors, the audit committee, or both? If both, should the audit committee nominate the independent accountant with the independent directors making the selection?

  No comment to above all questions

E. Compensation

[Questions for public comments]

• We seek comments on all aspects of incentive compensation for audit partners, principals and shareholders and on the following:  

• What economic impact will our proposal have on the current system of partnership compensation in accounting firms?  

• Are there other approaches that should be considered with respect to compensation packages that pose a concern about auditor independence? If so, what are they?  

• Would the proposed rule change be difficult to put into practice? If so, why? How could it be changed to be more effectively applied?  

• Should managers, supervisors or staff accountants who are members of the audit engagement team also be covered by this proposal?  

• Does this proposal cover the appropriate time period or should a measure other than the audit and professional engagement period be considered?  

• Does the proposed rule cover the entire component of an audit partner's compensation that gives rise to independence concerns?  

• Will this compensation limitation disproportionately affect some firms because of their size or compensation structure? If so, how may we accomplish our goal while taking these differences into account?  

• Our proposal references compensation based on the performance or sale of non-audit services. Is there a better test that permits partners to participate in the overall success of the firm while addressing the influence that such services might have on a particular auditor-client relationship?

  [Our comment to above all questions]

  We strongly disagree with the proposal to prohibit compensation arrangements that include incentives for audit engagement partners to help procure non-audit service engagements. We think the proposal is unnecessary advised. Accounting firms are private, for-profit businesses whose partners are intended to be motivated to increase firm profits and their own compensation. We do not believe that a compensation system that includes incentives for audit engagement partners to improve audit efficiency and realization on an audit engagement impairs audit objectivity, nor, we believe, does one with incentives to help procure non-audit service engagements. The main risk that appears to be a concern of the Commission appears to be that management at an audit client would threaten to reject non-audit service engagements unless the audit engagement partner were to compromise his or her independence. We believe that the probability of such risk not great, and that it does not materially increase the risk that accounting firms face from unscrupulous management in general. We also believe that financially strong accounting firms are in a better position to maintain audit quality and objectivity than are weaker ones.

  We believe that the proposal would not be enforceable. Accounting firms are for-profit organizations that will reward those who make the greater contributions to firm profits. If encouragement of procurement of non-audit services is seen as a positive contribution to firm profits, that will be rewarded either implicitly or explicitly. Enactment of the proposal would probably not substantially change current systems of partner compensation, but would contribute to misunderstanding and mistrust between the Commission and the accounting industry.

F. Definitions

3. Accounting Role

[Questions for public comments]

• Is this proposed definition sufficiently clear? If not, what changes would make the definition clearer and more operational?

  The definition of "accounting role" would be more clear if it stated that a financial statement oversight role is considered an accounting role.

4. Financial Reporting Oversight Role

[Questions for public comments]

• Is this proposed definition sufficiently clear? If not, what changes would make the definition clearer and more operational?

  We see no reason to include the head of internal audit and the treasurer as those in an "accounting role" or "financial statement oversight role."

4. Audit Committee

[Questions for public comments]

• Some registrants may not have designated boards of directors or audit committees (e.g. benefit plans required to file Form 11-K). Does the definition of audit committee sufficiently describe who should serve in this capacity where such situations exist? If not, what additional guidance would be appropriate?

• Our proposed rules exempt unit investment trusts and asset-backed issuers from the rule requiring the audit committee to approve auditing and non-auditing services. Should unit investment trusts and asset-backed issuers be subject to these requirements? If so, given that unit investment trusts and asset-backed issuers are not actively managed, who should be responsible for approving the auditing and non-auditing services? Are there other, similar entities that should be exempt from the pre-approval requirements?

• Are the existing definitions in Regulation S-X and Rule 2-01 of Regulation S-X of audit client, issuer, and subsidiary sufficiently clear?

  No comment to above all questions

§ 210.2-07 Communication with Audit Committees

G. Communication with Audit Committees

[Questions for public comments]

• In light of the requirements for the CEO and CFO to certify information in the company's periodic filings,⁸⁷ should the auditor be required to communicate information on critical accounting policies and practices and alternative accounting treatments to management as well as to the audit committee?

  No comment.

1. Critical Accounting Policies and Practices

[Questions for public comments]

• Should the auditor be required to provide additional information to the audit committee regarding the company's critical accounting policies?  

• When should the communication take place?  

• Should the auditor be required to provide the communication in writing?  

• Is it appropriate that investment companies would be subject to the rules regarding critical accounting policies?

  No comment to above all questions

2. Alternative Accounting Treatments

[Questions for public comments]

• Is the discussion of which accounting policies require communication with the audit committee sufficiently clear?  

• Should additional matters be required to be communicated to the audit committee? If so, which matters?  

• Is it appropriate that investment companies would be subject to the proposed rules regarding alternative accounting treatments?

  No comment to above all questions

3. Timing of Communications

[Questions for public comments]

• Should the timing of these communications be required to occur before any audit report is filed with the Commission or at some other time?  

• Should these communications regarding critical accounting policies be required to be in writing? If so, why?  

• Should we include specific instructions within the proposed rule regarding the nature of communications of critical accounting policies? If so, what instructions should be provided and why?  

• Do these required communications fulfill existing GAAS requirements? If not, why?  

• Should these communications regarding alternative accounting treatments be required to be in writing? If so, why?  

• Do these required communications fulfill the statutory requirements? If not, why?  

• Should the minimum requirements for discussion of alternative accounting treatments be expanded or reduced? If so, how?  

• Should the list of recommended other communications be expanded or reduced? If so, what specific items should be added and why?  

• Should the list of recommended other communications be required to be communicated to the audit committee? Why or why not?  

• Are the appropriate entities included under the term "issuer" appropriate? If not, what entities should be included or excluded?  

• Is it appropriate that investment companies are required to make these communications to their audit committees? Why or why not?  

• This proposed rule would apply to "issuers." Should the Commission consider applying this rule to a broader population such as "audit clients" as defined in 2-01(f)(6) of Regulation S-X? Why or why not?

  No comment to above all questions

§ 240.14a-101 Schedule 14A. Information required in proxy statement.

H. Expanded Disclosure

2. Audit Committee Actions

[Questions for public comments]

• Is the proxy statement the appropriate location for this disclosure? If not, why?  

• Should we permit incorporation by reference into the company's annual report?  

• Would expansion of the proxy disclosure of professional fees paid to the independent auditor from three categories to four provide more useful information to investors?  

• Are the new categories of disclosure appropriate? Are they well defined, or should they be more accurately defined? Should there be additional (or fewer) categories?  

• Is disclosure of two years of fees appropriate? Should the proposed additional fee disclosures be expanded to three years or remain at one year?  

• What, if any, additional information about professional fees would be useful to investors?  

• For a registrant not subject to the proxy disclosure rules, such as foreign private issuers, should we require that the same disclosures be placed in annual reports?  

• Is there any additional disclosure concerning the activities of audit committees that would be beneficial to investors?  

• Should companies be required to provide the information in their quarterly reports? Should it be required that the information be included in other filings such as Form 10-Q or 10-QSB?  

• Should registered investment companies be required to provide the information in their semi-annual report to shareholders on proposed Form N-CSR?

• Registered investment companies are required to provide disclosure of audit fees billed for the registrant only, but are required to disclose other types of fees in the aggregate for the registrant, its investment adviser, and certain other parties.¹⁰⁶ Is this appropriate, or should we also require disclosure of audit fees on an aggregate basis? In the alternative, should we require disclosure of audit-related fees or any other fees for the registrant only and not on an aggregate basis?  

• If we adopt such a requirement, should we require or permit registrants to recalculate and report fees already disclosed for more than two years so that all fee information is consistently reported and available?

  No comment to above all questions

I. Transition Period

• Would a period of time beyond the adoption date of the final rules be necessary or appropriate for compliance with the final rules by smaller companies or companies with whose securities currently are not listed or quoted? If so, which rules should we consider a delayed effective date?  

• How should an effective date be determined with respect to each amendment?  

• Are there special considerations that we should take into account in providing a transition period for foreign private issuers?

  No comment to above all questions

III. General Request for Comments

• We invite any interested person wishing to submit written comments on the proposals or any matters that may impact the proposals, to do so. We specifically request comments from investors, issuers, and accounting firms.  

• We solicit comment on each component of the proposals.  

• Would the proposals related to audit committees and partner compensation help alleviate the pressure that clients may place on engagement partners or accounting firms to acquiesce to the clients' views on accounting issues? What are some of the other scenarios where such pressures might exist?

  No comment to above all questions

B. Disclosures of Audit and Non-audit Services

6. Proposed Form N-CSR

Pursuant to 44 U.S.C. 3506(c)(2)(B), we solicit comments to: (1) evaluate whether the proposed collections of information are necessary for the proper performance of the functions of the agency, including whether the information will have practical utility; (2) evaluate the accuracy of the Commission's estimates of the burden of the proposed collections of information; (3) determine whether there are ways to enhance the quality, utility, and clarity of the information to be collected; and (4) evaluate whether there are ways to minimize the burden of the collections of information on those who are to respond, including through the use of automated collection techniques or other forms of information technology.

No comment.

V. Cost - Benefit Analysis

We request comments on all aspects of this cost-benefit analysis, including the identification of any additional costs or benefits. We encourage cementers to identify and supply relevant data concerning the costs or benefits of the proposed amendments.

No comment.

D. Request for Comments

As noted above, we request comments on all aspects of this cost-benefit analysis, including the identification of any additional costs or benefits. We encourage commenters to identify and supply relevant data concerning the costs or benefits of the proposed amendments. We request comments, including supporting data, on the magnitude of the costs and benefits mentioned in this section.

• Are there any other costs or benefits that we have not identified? For example, would the additional duties on audit committees increase the cost of maintaining those committees? Would the amount of compensation demanded by audit committee members increase? Would there be a shortage of potential audit committee members that would lead to higher costs related to finding and retaining such members? Would the cost of officer/director liability insurance increase? Please describe any such costs and provide relevant data.  

• Are there additional costs related to the proposed disclosures? If there are, please identify them and provide supporting data.  

• We request comments on the reasonableness of the burden hour, cost estimates, and underlying assumptions related to the proposed disclosures.  

• Will the prohibition of certain non-audit services impose greater costs on companies? If so, what will those costs be and how significant will those costs be?  

• How much cost will issuers incur from not being able to retain their preferred providers of non-audit service, when that preferred provider happens to also be their auditor?  

• What will be the impact, if any, on audit fees from the proposal to prohibit certain non-audit services?  

• Are there any economies of scope that will be lost due to implementation of the auditor independence rules?  

• Are there any economies of scale that will be lost due to implementation of the auditor independence rules?

  No comment to above all questions

VI. Consideration of Impact on the Economy, Burden on Competition, and Promotion of Efficiency, Competition, and Capital Formation

• Given that only larger clients have more than two partners as part of the audit process, would this provision impose higher costs on mid-tier firms?

• We request comment on the anti-competitive effects of the proposals.  

• The possible effects of our rule proposals on efficiency, competition, and capital formation are difficult to quantify. We request comment on these matters in connection with our proposed rules.

  No comment to above all questions

VII. Initial Regulatory Flexibility Act Analysis

We request comment on the number of accounting firms with revenue under $6 million.

No comment to above all questions

###