Samuel L. Burke is the former associate chief accountant for the SEC, where he spent three years involved in resolving auditing and independence issues and participating in a variety of rulemaking projects, including the rules strengthening auditor independence that became effective March 31, 2003. Last July, Burke joined PricewaterhouseCoopers as a partner in its national independence office.

CW: It seems like the Big Four have been suffering from the new independence rules, specifically as they pertain to tax practices. In September, six PwC tax attorneys defected to Washington, D.C.-based Shaw Pittman, and in November the firm's tax director in Brussels jumped to Baker & McKenzie.

PwC is not alone here: E&Y's director of M&A tax services recently left for another D.C. firm, and KPMG announced it would stop providing certain legal services due to SOX-related independence issues. What's happening here?

Sam Burke: New rules and regulations generate awareness and often generate change. Recognizing this, I think what we are seeing is the marketplace digesting an enormous amount of regulation with far-reaching impact.

It will be years before we are able to evaluate the effectiveness of The Sarbanes-Oxley Act and the rules that were adopted by the SEC to implement the Act. It is important that this be recognized by those who play a part in the financial reporting process.

Certain non-audit services create inherent conflicts such as bookkeeping or acting as an employee of an audit client. Many firms, including PwC, have disposed of substantial portions of the consulting business. This disposition effectively eliminates the possibility that certain services will be provided to audit clients. Of course, service lines that were not sold may not provide proscribed services such as legal services to audit clients. PwC is committed to its audit process. This commitment existed prior to the SOA when PwC publicly stated its intent to dispose of its consulting business. Even before the enactment of SOX, PricewaterhouseCoopers publicly stated its intent to dispose of its consulting business and, since then, many firms, including PwC, have disposed of substantial portions of their consulting practices.

[Editor's note: PwC was one of the last of the former "Big Five" to dispose of its consulting business. In May of 2000, Ernst & Young sold its consulting practice to Paris-based Cap Gemini; in August of 2000, Andersen severed ties with its consulting unit, which became Accenture and went public in July of 2001; in February of 2001, KPMG spun off its consulting arm, now called Bearing Point, in an initial public offering; and in August of 2002, PwC sold its consulting unit to IBM Global Services after abandoning an IPO. Deloitte Touche Tohmatsu is the only Big Four firm that has not yet spun off its consulting unit, called Deloitte Consulting.]

That disposition effectively eliminated the possibility that many services which could have created a conflict would be provided to our audit clients. While there are still certain other non-audit services that can create conflicts if they are provided to audit clients whose securities are registered with the SEC — such as bookkeeping or acting as an employee or management — PwC is committed to its audit practice and its independence and has implemented policies and procedures so that such conflicts should not arise.

CW: What are your thoughts about non-audit service trend in general?

SB: I have concerns about the pendulum swinging too far.

An effective marketplace requires balance. That balance allows our markets to self-correct and excel. Since joining PwC, I have been impressed with the culture and tone within the organization. There is a recognition that balanced change is needed and the partnership is proactively seeking change.

CW: Can you give us examples?

SB: Shortly after joining the firm, I attended a weeklong meeting together with other newly admitted partners, and virtually the entire management team spent the week with us.

Their message to newly admitted partners was to do the right thing at all times and to stand firm on quality. This message has been reinforced in the firm's "Stand and be Counted" campaign, and at the firm's "Quality Lens" training session, which is a three-day continuing education session attended by virtually all audit partners and managers. Undoubtedly, the firm is headed in the right direction.

CW: What about the industry in general?

SB: The profession is also working hard to repair its reputation. This process will not happen overnight. The profession will need to continue to think proactively and work to re-establish the respect of the public. In the coming months and years, it will be important that the profession work together with the regulators, globally, to ensure that the financial reporting process is operating at the highest possible threshold. This will require the firms and regulators to consider the broader implications of their respective roles in the global markets.

CW: As you know better than most, the new auditor independence rules adopted in January list nine non-audit services that, if provided by an accounting firm, would impair the firm's independence. While other types of tax work were not banned, they do require audit committee pre-approval.

Considering the increased legal exposure of directors — combined with increased shareholder activism — many assumed that directors and committees would not be interested in testing the boundaries of "permissible" services.

That doesn't seem to be the case. As early as February companies like Sun, Vermont Teddy Bear, Inktomi and others were already approving tax and other services from their auditors, and in the past few weeks, similar approvals were disclosed by several other large companies.

SB: SOX and the rules adopted by the SEC importantly changed the reporting relationship between auditors and their clients, making it clear that the auditors work for the audit committee as representatives of the investors.

This change in relationship, coupled with the transparency created through periodic filings, provides investors with information from which they can make their individual investment decisions. This improved transparency includes disclosure in a company's periodic annual reports of the audit committee involvement in engaging the auditor as well as descriptions of the services that are being provided by the auditor along with summary fee information.

This information will now be available for two years and will be required of all companies that file annual reports rather than just those that file proxy statements. This disclosure is significant because matters of importance vary from investor to investor.

Presuming the companies mentioned were early adopters of the pre-approval requirements in February, I would say that is exactly what the provisions were intended to do. The SEC's rules, which implement SOX, are very clear as to the requirements for audit committee pre-approval.

My views on the matter have not changed since I left the SEC. I am, however, able to better understand how the rules are being applied to varied circumstances and the difficulties that arise from time to time. From the outset, I viewed this change in relationship with the audit committee as one of the most important provisions required by SOX. The discussions and interactions that are taking place are, in my view, exactly what the rules were intended to facilitate.

From my vantage point, audit committees and their advisors are taking the new requirements very seriously. Every audit committee is different as are the expectations and tolerance levels of each committee. To characterize an audit committee's decision to hire its auditor to provide a permissible service such as tax services as "testing the boundaries of permissible services" is based on a presumption that the audit committee is not acting in the shareholders' best interests. This is simply not the case.

In the end, absent a regulatory prohibition, audit committees and boards need to be able to make decisions about services to be provided by a company's auditors that are in the best of interest of the investors that they represent. That means in many instances complying with the regulatory requirements to which they are subject.

CW: The GAO released a study a few weeks ago that stated mandatory audit firm rotation "may not be the most efficient way to strengthen auditor independence and improve audit quality." The study also stated that mandatory auditor rotation may cause a "loss of institutional knowledge of the public company's previous auditor of record," will add financial costs to public companies, and would cause smaller firms to be "unable to compete or absorb the increased costs."

On that topic, you told The Chicago Tribune last year that your "gut reaction is that there will be a profound impact on smaller [accounting] firms."

Is that still the case? More than 600 accounting firms have been approved by the PCAOB, and the "non-Big Four" are actually winning more engagements than the Big Four.

SB: I continue to believe that smaller businesses, including accounting firms, will and are being affected by the new regulatory requirements. The SEC has recognized the importance of this community to the financial reporting process and has made appropriate accommodations where possible. For example, the SEC provided an alternative application of the rules related to partner rotation which allows many small firms to continue with their public company practice.

The number of firms registering with the PCAOB is higher than I might have estimated a year ago. This development is a positive one. In my opinion, more competition is better for the capital markets. The number of firms registering further demonstrates how the profession is embracing change.

Understanding the reason that a company changed auditors is important when evaluating the gains and losses. Risk profiles have changed and some firms are being more selective in their client acceptance and retention decisions. Some companies are weighing the cost vs. benefit of engaging a larger firm. There may be individual service issues such as geographic coverage or resident expertise. Accounting firms across the county and around the world are able to respond to these types of issues in varying degrees. Today, however, there continues to be, as noted by the GAO, relatively few firms that have the ability to conduct an audit of a global organization.

Trends in going private transactions as well as market entries from abroad and by way of initial public offerings will provide some useful insights as to the impact of the legislation on small business. This is one of those areas that will take some time to evaluate.

 

This column should not be regarded as legal advice. It is for general information and discussion only, and is not a full analysis of the matters presented.

 

Topics