SEC Proposes Innovative Auditor Independence Rules

The Securities and Exchange Commission has agreed to propose for comment significant changes to current practices and requirements for auditor independence. Some proposals contain innovative solutions that go beyond the mandates of the Sarbanes-Oxley Act. Comments from accounting firms will be especially critical on these rule proposals.

Discussions at the Commission's November 19th meeting indicate the following changes will be included in the rule proposals:

  • Prohibitions on non-audit services. Auditors will be prohibited from providing non-audit services when the services result in the auditor auditing his or her own work, performing management functions, or acting as an advocate for the audit client. The intention is not to prohibit properly approved "bread and butter" tax services. Only expert tax services that result in the firm acting as an advocate for the audit client will be prohibited.

  • Mandatory rotation of audit partners. Accounting firms will be required to rotate certain partners on the audit engagement team. These partners will be prohibited from providing audit services to an audit client for more than five consecutive years and from returning to audit services with the same issuer within five years. The current requirement set by AICPA's SEC practice section is for rotation after seven years with a two-year cooling off period. A new distinction will be introduced to provide different requirements for auditors involved in "accounting" versus those involved in "financial reporting oversight."

  • Mandatory forensic audits. Although not required by the Sarbanes-Oxley Act, the rule proposals will ask for comments on a potential requirement for annual forensic audits by a firm other than the audit firm. SEC Chairman Harvey Pitt suggested these audits might encourage increased competition among accounting firms, and they could help address the concerns about accounting firms running out of specialized talent. The forensic auditor's role would include an assessment of the competency of the financial auditor. The assessment could provide a basis for the SEC or the Public Company Accounting Oversight Board to grant an exemption from the rotation requirements.

  • Prohibitions on certain incentive plans. A partner will not be considered independent, if he or she receives compensation for selling non-audit services. This proposal is not required by the Sarbanes-Oxley Act.
  • Fee disclosures in annual reports. Disclosures will be required in the client's annual report about the services provided by, and fees paid by the issuer to, the auditor of the issuer's financial statements. The fee information will need to cover two years and be broken down into audits, tax preparation and all other fees.

Although the Sarbanes-Oxley Act requires certain reforms to be in place by January 26, 2003, the SEC has some flexibility with regard to those that go beyond the requirements of the Act. It will request comments on appropriate transitions to these new requirements.

-Rosemary Schlank


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