A recent agreement struck between "Big Five" accounting firm Deloitte & Touche and the SEC has captured the attention of both the accounting and mutual fund industries. At issue is just how far removed members of an accounting firm chosen to audit specific mutual funds must be to protect objectivity and maintain true independence.

In a March 8th letter addressed to Lynn Turner, chief accountant at the SEC, Deloitte mapped out plans to further distance itself from Fidelity's mutual funds before it becomes a Fidelity fund auditor. Fidelity recently selected Deloitte & Touche to audit 56 of its 243 mutual funds. Since 1990, Deloitte & Touche has served as the independent auditor for both Fidelity Brokerage Services and National Financial Services Corp., a Fidelity subsidiary.

According to the agreement letter, to maintain independence, certain key Deloitte & Touche personnel will be required to shift directly held assets out of the Fidelity funds before the accounting firm begins acting as fund auditor. In addition, the firm will shift the 401(k) and profit sharing plan assets of employees out of Fidelity's mutual funds and into another unnamed mutual fund group if a conflict of interest is perceived.

According to the rules of conduct for independent auditors, members of an auditing team and other employees of the firm may not own an interest in or have other direct ties to the firms to which they provide audit services. There has always been the understanding that if one serves as the independent auditor for an investment company, one may not invest in the funds, said one industry accountant. But the SEC never codified that stipulation. Now, Deloitte & Touche has raised questions for which there are no hard and fast answers, said some accountants.

Deloitte & Touche is seeking guidance from the Independence Standards Board (ISB) of New York on whether its employees' retirement plan investments in Fidelity funds constitute a conflict. Specifically, Deloitte & Touche seeks counsel as to whether an auditor's members are allowed to hold retirement plan assets in other funds within the same fund group or with affiliated firms for which the firm does not serve as auditor.

The ISB is the eight-member standard-setting group jointly established in May of 1997 by the SEC and the American Institute of Certified Public Accountants, the trade group for CPAs. The ISB was formed in response to the increasing challenge of defining auditor independence, as business and professional relationships become more complex. The ISB is responsible for developing independence standards for auditors in all industries. The ISB's board includes four individuals from the accounting world and four individuals from outside the industry, including John Bogle, Vanguard's senior chairman.

In recent months, the SEC has moved the issue of auditor independence to the forefront, having clamped down on public accounting firms that have disobeyed auditor engagement rules. In January of this year, several partners and managers of PricewaterhouseCoopers were accused of owning stock in some 70 companies for which the firm served as auditor. And, earlier this year, the SEC warned KPMG that its intent to publicly offer a 20 percent equity stake in its company could spell trouble if stockholders were also members of firms for which KPMG served as auditor.

Mutual funds offer some unique challenges for auditors, say industry observers. Questions arise over how much distance auditors must maintain when a joint holding company or common parent owns sister fund groups; whether accounting firms should be free to audit and approve the financial statements of the corporate entity as well as its mutual funds; and how much distance must auditors maintain in an industry seeing increasing consolidation, a multitude of strategic business alliances and the proliferation of large one-stop-shopping financial service powerhouses with numerous divisions.

The question also arises whether stricter auditor independence guidelines will mean accounting firms will be more limited as to which mutual funds they choose to offer employees under a 401(k) plan. Also, there is the question of whether fund advisers will find themselves with limited choices of accountants to do their auditing.

At a March 12th meeting, the ISB agreed to expedite the consideration of issues related to the auditing of mutual funds, said Rick Towers ISB's staff technical director.

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