Columbia Law Professor Offers Auditor/SEC Compromise

"The contemporary auditing firm has moved from providing a single service at relatively modest cost to becoming a multi-faceted vendor of business advisory services," according to Professor John C. Coffee, Jr. of the Columbia Law School who testified today in the auditor independence hearings before the Securities and Exchange Commission. "The Commission has correspondingly more reason to be concerned about the increased incentives to acquiesce in accounting irregularities that accompany the growth in non-audit services as a percentage of the total revenues of auditing firms."

Along with this changing role of the services provided by the auditing firm, recent changes in litigation reform have reduced the threat of legal liabilities facing auditing firms. As a result, it is conceivable that the potential for reduced independence has increased.

Furthermore, as auditing firms realize more revenue from non-traditional audit services, there is increased pressure on the partners of the firm to make such revenue-generating services available to clients. According to Coffee, "Once the auditing firm sees the potential of increasing its revenues from the audit client by a multiple of its current billings, then it is in the rational self-interest of the auditing firm to convert the partner or partners in charge of this client into effectively a vendor of advisory services and to compensate such partners in proportion to their success at cross-selling those services."

Rather than completely restrict the services that auditing firms are able to provide their auditing clients, Coffee suggests the alternative of placing a ceiling on the services that may be offered. If firms providing auditing services to a client are not able to offer non-audit services that exceed the fees for those auditing services, the expectation of non-audit revenue from the client would be reduced, and the auditor would have less incentive to be corrupted.

To prohibit certain non-audit services altogether, such as those on the SEC's hit list (which include bookkeeping, appraisal and valuation services, human resources consulting, and others), would be to prohibit services that do not necessary involve clear conflicts. Coffee points out that tax services, which have long been provided by accounting firms, are not on the prohibited list, but that the possibility exists that "a tax position recommended by (or even a tax shelter marketed by) the auditor's firm may have materially distorted the client's reported results."

Coffee suggests a procedure whereby all non-audit services, including tax services, be combined and subject to a fee ceiling equal to or less than (a percentage to be determined as a result of these rulings) auditing services revenues. The firm intent on providing a client with non-audit services that produce revenues in excess of audit revenues could limit its services for that client to the non-audit services. "Such a role would keep the auditing role paramount (at least for auditing clients) and would prevent auditing services from otherwise deteriorating into the loss leader by which a multi-service business advisory firm attracted and held its clients.

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