SEC Cracking Down on Contingency Fee, Independence

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The U.S. Securities and Exchange Commission, acting to preserve auditor independence, is making sure the nation's largest accounting firms are getting the message that accepting contingency fees for doing tax work for the companies they audit is not allowed.

SEC Chief Accountant Donald Nicolaisen held a private meeting last week with the seven largest firms and the American Institute of Certified Public Accountants where he reinforced the SEC's position on the contingency fee issue. He ordered the firms to disclose any arrangements that may violate the rules to the company audit committees that oversee their work.

He went a step further by telling the firms they may face SEC enforcement investigations into the acceptance of contingency fees from companies they also audit, Bloomberg reported. The fees are paid to firms based on a percentage of tax savings the accounting firms help companies to achieve.

"Auditor independence is critical," Nicolaisen said in a statement disclosing the meeting. "Billing arrangements that are contingent are inappropriate and I would expect any such practice to cease."

Nicolaisen's warning underscores the SEC's stepped up efforts to preserve auditor independence in the wake of accounting scandals at Enron Corp. and WorldCom Inc. In April, an SEC judge barred Ernst & Young LLP from accepting new public company audit clients for six months after finding the nation's third largest accounting firm violated these very rules.

Nicolaisen also made it clear that firms should not follow AICPA guidance on this matter because it is incorrect. Bloomberg reported that the AICPA advised accounting firms they could accept the fees if a client's tax returns are reviewed by a government agency, including the Internal Revenue Service.

"The fact that a government agency might challenge the amount of the client's tax savings and thereby alter the final amount of the fee paid to the firm heightens, not lessens, the mutuality of interest between the firm and client," Nicolaisen wrote.

In January 2003, the SEC passed rules prohibiting accounting firms from performing a number of consulting services for audit clients, Bloomberg reported, adding that the rules let firms provide tax advice to audit clients as long as it is pre-approved by the audit committee. Firms can enter into contingency fee agreements with non-audit clients for tax work.

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