by Ken Rankin
Washington - New rules proposed by the Securities and Exchange Commission to tighten federal regulation of accountants could drive up the cost of corporate audits and weaken competition among accounting firms, top SEC officials acknowledged.
Smaller accounting firms could be especially disadvantaged by a provision requiring the rotation of senior audit team members, SEC associate chief accountant Samuel L. Burke warned during a recent public meeting at which the agency agreed to solicit public comment on the proposed rule changes.
The rules, advanced to implement this year’s Sarbanes-Oxley accounting reform law, are designed to restore public confidence in corporate financial reporting by setting higher standards of independence for outside auditors.
In addition to requiring audit teams to rotate personnel at least every five years, the proposals call for new restrictions on the provision of non-audit services to audit clients; a ban on compensation arrangements that reward accountants for soliciting consulting business from audit clients; and new requirements that auditors retain their workpapers, correspondence, and other documents prepared or received in connection with the audit for at least five years. (For more details, see the audit reform sidebar on p. 60).
Under the timetable set by the new law, the SEC is required to issue final versions of the new rules no later than Jan. 26, 2003.
Although the five SEC commissioners voted unanimously to move forward with the rules developed by agency staffers, more than a few concerns were raised about how the new requirements will impact financial reporting and the accounting industry.
Focusing squarely on the fallout from the proposed auditor rotation rules, SEC commissioner Cynthia Glassman warned that forcing accounting firms to change audit partners every five years could crimp competition among accounting firms and drive up the cost of audits for public companies.
In response to questioning by agency commissioner Roel Campos, Burke said that mandatory rotation would have a "profound" impact on smaller CPA firms, especially those with only one or two partners.
Although the new rule proposal will permit staggered rotation of members of an audit team to preserve some continuity, departing SEC chairman Harvey Pitt raised concerns at the forum that corporations requiring highly specialized auditors may also be disadvantaged under the rule change.
Arguing that the SEC should aim to preserve "auditor competence" as well as "auditor independence," Pitt suggested softening the rotation requirements to allow clients to keep their outside audit team in place for longer than five years if they agree to undergo a "forensic audit" by a third-party accounting firm.
Forensic audits - currently used only for rare cases in which auditor misconduct is suspected - could foster competence among auditors, but their use may prove to be too costly for many companies, Pitt conceded.
Pitt, who resigned his post in November but agreed to remain at the SEC until a replacement is appointed, also suggested that the proposed rule be amended to include a provision obliging accounting firms to ensure that the audit is performed competently, even after a rotation. He also suggested that the rotation provisions be expanded to include accounting firms that audit investment advisors and broker/dealers.
Concerns were also raised during the meeting about the impact of the proposed audit record-keeping requirements.
For his part, Pitt warned that the provision requiring five-year retention of certain audit documents might cause confusion since other audit papers are required to be kept for seven years. A single seven-year requirement for all such audit materials might foster better compliance, he suggested.
Campos, meanwhile, questioned the effectiveness of the record retention requirements. Auditors seeking to avoid future disclosure of disagreements during the audit process might simply refrain from putting those disagreements in writing, he suggested.
To address this potential problem, Campos said that the new Public Company Accounting Oversight Board may want to adopt rules of its own requiring that disagreements among auditors be "jotted down."
Despite these concerns, members of the commission praised acting chief accountant Jackson Day and other SEC staffers for developing the complex new audit rules under the rigid deadline set by the Sarbanes-Oxley Act. The rules were expected to be published for public comment by early December, and top SEC officials called on the accounting profession to support the changes.
Citing the industry’s past opposition to the kind of reforms contained in the proposal, commissioner Paul Atkins called it a "great disappointment" that the accounting profession didn’t move in this direction voluntarily years ago - a not-so-veiled slam at the American Institute of CPAs.
Campos called on the nation’s accountants to "embrace these proposals," and to work with the SEC to implement them by the Jan. 26 deadline.
For their part, AICPA officials said in a statement that they remain "fully committed to working with the SEC" to implement Sarbanes-Oxley, but were non-committal on the details of the proposed rules changes.
"Today is the accounting profession’s first exposure to the proposed rules," the AICPA said following the SEC commissioners’ vote. "When they become available, we will review the proposed rules in detail and will be an active participant in the public comment process."
