On June 27, 2000, the U.S. Securities and Exchange Commission (SEC) issued a proposal for a major new rule that, if enacted, would force a restructuring of the accounting profession and radically alter independence requirements for accounting firms that audit SEC registrants. This is the most significant proposition on auditor independence since the current federal securities laws were first enacted in the 1930s, and, with the Big Five firms and the SEC sparring over the proposed changes in hearing rooms and on the nation's leading editorial pages, the issue certainly has not lacked for attention.

But are the independent firms who audit nonpublic companies paying attention? They should be, because even accounting firms that do not audit SEC registrants could be seriously impacted as the effects of the proposed new rule trickle—if not cascade—down through the profession. After all, restrictions placed on the operations of large, multinational firms could ultimately be placed on the operations of smaller, more localized firms.

If enacted, the SEC rules would be viewed as the new model by state legislators and state boards of accountancy, as well as by federal bank regulators and the Department of Labor (DoL) in establishing "independence" rules that apply in their respective areas—such as ERISA accounting in the case of the DoL. These new proposed SEC rules could influence the regulatory approach to auditor independence outside the United States, as well.

A limit on service offerings

The most significant aspect of the proposed rules are those provisions that would dramatically curtail the ability of accounting firms to provide services other than audit and tax services to SEC audit clients. This is particularly important as firms of all sizes are expanding their service offerings in order to survive and thrive in this rapidly changing and highly competitive economy and in order to provide convenient "one-stop shopping" to their clients.

Specifically, firms would be prohibited from providing the following 10 enumerated categories of nonaudit services, some of which have not previously been prohibited by the SEC:

1. Bookkeeping or other services related to the audit client's accounting records or financial statements
2. Financial information systems design and implementation, including the design or implementation of a hardware or software system used to generate information that is "significant" (i.e., reasonably likely to be material) to the audit client's financial statements taken as a whole
3. Appraisal or valuation services, fairness opinions, or contribution-in-kind reports
4. Actuarial services
5. Internal audit outsourcing
6. Management functions
7. Human resources, including the recruiting, hiring or designing of compensation packages for officers, directors or managers of the audit client or any of its affiliates
8. Brokerdealer, investment advisor or investment banking services
9. Legal services
10. Expert services, including the rendering or supporting of an expert opinion for an audit client, or an affiliate of the audit client, in a legal, administrative or regulatory filing or proceeding

Moreover, the SEC proposes to reserve the right to prohibit other services, applying both broad "catch-all" provisions and the "appearance" standard, by which an accountant will not be recognized as independent if the accountant is not "or would not be perceived by reasonable investors to be, capable of exercising objective and impartial judgment. . . ." Thus, the SEC could come back at a later date and prohibit accounting firms from providing tax-related services to their audit clients.

Because of the resulting uncertainties as to what is or is not permitted, accounting firms of all sizes may decide to avoid certain service lines altogether, even if not expressly prohibited by the proposed rules. Furthermore, through a grossly overbroad definition of "affiliate," the SEC would cripple the ability of accounting firms to operate in the new economy through investments in, or alliances with, nonclients (including associations of firms).

The independence bogeyman

Are the exclusionary rules warranted? The prevailing feeling within the profession is that examples of audits that have been tainted by the auditor's other professional relationships with the client are as rare as sightings of Bigfoot or the Yeti.

As AICPA President and CEO Barry Melancon recently testified before the POB's Panel on Audit Effectiveness: "Over the years, various studies have been performed regarding nonaudit services and no empirical evidence exists to suggest that providing nonaudit services impairs or causes an ineffective audit or concluded that an exclusionary rule on nonaudit services is necessary. This is consistent with the profession's findings." This is also consistent with the findings of the O'Malley Panel and with the SEC's own findings.

In fact, Melancon continued, a firm's ability to provide multiple services to a single client might have the opposite effect of improving an accountant's overall work: "We believe that, with the appropriate safeguards in place, the provision of many nonaudit services may enhance the audit by broadening the firm's understanding of a company's business, operating environment and other factors that lead to a more effective audit. This more effective audit clearly is in the public interest." In fact, the O'Malley Panel found that in 25% of the cases where both audit and nonaudit services were provided to a client, the quality of the audit was enhanced by the nonaudit services.

A call to arms

Warding off regulatory burdens that unfairly restrict the growth opportunities of local, independent firms is in the best interest of PCPS members. The SEC's public comment period is open until September 25, 2000, and we urge all members who have not already done so to review the proposed rules and give the benefit of your comments to the SEC and to your local Senators, Congressmen and Chambers of Commerce. The proposed rule is available in the Federal Register (65 Fed. Reg. 43,148 (2000)) or on the SEC's Web site (http://www.sec.gov/rules/proposed/34-42994.htm).

To assist members, we have reviewed the rule proposal carefully, identified a number of key concerns and laid them out in a paper entitled "Highlights of the SEC's Proposed Rule Governing Auditor Independence." Please feel free to use this resource to support your efforts when contacting the SEC and others. We have also compiled a "Where To Write" sheet to assist you in directing your comments. For copies of both documents, please call 1-800–CPA–FIRM or e-mail pcps@aicpa.org.

If you wish any additional information or further analysis on any aspect of the rule proposal, please contact Al Anderson, our Senior Vice President—Technical Services (212–596–6144) aanderson@aicpa.org; Rich Miller, our General Counsel (212–596–6245) rmiller@aicpa.org; or Tom Higginbotham, our Vice President—Congressional and Political Affairs (202–434–9205) thigginbotham@aicpa.org.