Audit Rules Proposed On Banned Services For Public Cos.

Accounting firms got their first look last week at proposed new rules that would govern how accountants can serve their public company audit clients—no contingent fees, no tax shelters for audit clients, and no personal tax services for officers with financial oversight responsibility.

The Public Company Accounting Oversight Board issued its proposed ethics rules following months of debate and study, identifying those three circumstances as impairing an auditor’s independence. The board is accepting comments on the proposed rules before handing them up to the Securities and Exchange Commission for its review and approval.

The rules would bar accountants from providing tax services to audit clients on a contingent-fee basis, and would prohibit an audit firm from offering personal tax services to officers who oversee financial reporting.

However, the ban on contingent fees should not come as a surprise; earlier this year, the fees—which enable an auditor to take a cut of whatever savings the client was able to realize as a result of the tax advice—became a target of the SEC. In June, SEC Chief Accountant Don Nicolaisen ordered accounting firms to disclose all contingency-based tax fees to company audit committees.

"Banning contingent fee arrangements is not new, acknowledged PCAOB member Daniel Goelzer. "The SEC has already barred them." PCAOB Chairman William McDonough added that, "I believe it is right to align our rules with the rules of the SEC.

The rules also would prohibit accountants from providing their audit clients with tax services “based on an aggressive interpretation of applicable tax laws and regulations.” The Internal Revenue Service, U.S. Justice Department and Congress all have raised concerns about aggressive tax strategies that have been marketed by accounting firms.

SUMMARY

Below is a summary of key provisions of the PCAOB proposal, as taken from the Board's proposing release:

Independence

The proposed rules list several circumstances in which the provision of tax services impairs an auditor's independence, including:

1. If the auditor enters into contingent fee arrangements with audit clients;

2. If the auditor provides certain services on a transaction that is based on an "aggressive interpretation of applicable tax laws and regulations";

3. If the auditor provides tax services to officers in a financial reporting oversight role of an audit client.

Pre-Approval

The proposal strengthens the auditor's responsibilities related to audit committee pre-approval of tax services by requiring the firm to discuss certain information with the committee, including "the potential effects of the services on the firm's independence."

Not Prohibited

The proposal mentions some tax services that are not prohibited, including routine tax return preparation and tax compliance, general tax planning and advice, international assignment tax services, and employee personal tax services.

Download Complete Version Of The PCAOB Proposal (50 Pages)

In addition, the proposal strengthens an auditor's responsibilities related to audit committee pre-approval of tax services. It does so by requiring auditors to discuss—and subsequently document—certain information with the committee, including "the potential effects of the services on the firm's independence." PCAOB member Bill Gradison noted that there may be other similar standards on the horizon. "I have in mind communications with audit committees which may be on the Board’s agenda next year," he said.

The Board specifically described other tax services that would not be affected by the new rules, including routine tax return preparation and tax compliance, general tax planning and advice, international assignment tax services, and employee personal tax services.

As proposed, the rules represent “a pretty pragmatic approach, consistent with the direction that the accounting firms are taking,” said Robert Bunting, chairman of the American Institute of Certified Public Accountants. “The profession has already reacted to two of the major issues—aggressive tax planning and services to senior executives. This is not inconsistent with what is becoming best practice in the profession.”

The Council of Institutional Investors said it viewed the new rules as a significant step in the right direction, but falling short of assuring auditor independence. “They still leave some gray areas that need to be worked out,” said Elliot Schwartz, director of research for the CII. “We would like to see a total ban on tax services to audit clients, so that it’s clear and there’s no opening for interpretation.”

McDonough said a total ban on tax services to audit clients is unwarranted. “Overall, I think we have set forth a narrowly tailored set of rules designed to address specific problems,” he said. “We could have approached the topic with a broader brush, by prohibiting tax services entirely. I do not think that is necessary, nor do I think it would have been appropriate.”

Lou Thompson, president of the National Investor Relations Institute, agrees that the PCAOB’s approach is adequate. “There’s a rationale for having the basic tax work done by the firm that knows the company best,” he said.

Bunting said accounting firms are most concerned with assuring they can retain the tax compliance and planning services that they have provided to their audit clients for generations. He predicted comments from the accounting profession likely will express evergreen concerns about the burden the new rules place on smaller operations. He also predicted the accounting profession would mount a protest in the future if the PCAOB rules should show signs of cascading into the private sector.

PCAOB member Daniel Goelzer said in his view, accounting firms will not be harmed by the new rules. “The lines the staff has proposed would not have untoward effects on either accounting firm economics or on the ability of firms to retain top-flight tax expertise,” he said.