Washington - Proposed Securities and Exchange Commission rules prohibiting independent auditors from providing other types of consulting services to their audit clients should be adopted, two mutual fund industry executives told the SEC last week.
John H. Biggs, chairman, president, and CEO of TIAA-CREF, said he supported the SEC's proposal but called for a simpler yet harsher rule prohibiting independent auditors from performing other types of consulting services. John C. Bogle, founder and former CEO of the Vanguard Group, and currently an independent member of the Independence Standards Board, also supported a version of what Biggs called a, "simple rule." The potential problem of accounting firms' independence suffering at the hands of multi-million dollar consulting fees "speaks for itself," he said.
Biggs and Bogle testified at the SEC's July 26 hearing on its proposed rules on independent auditors. Bogle said he was, "not at all clear" that rule-making is necessary regarding investments by auditors in audit clients, family and employment relationships between auditors and clients, or appraisal and valuation services. Instead, standards recently suggested by the Independent Standards Boards should be adequate, Bogle said.
The proposed rules would allow a family member of an independent auditor of a mutual fund to invest in a 401(k) plan that offered that mutual fund. Biggs said he endorsed the, "relaxation and narrowing of the rules" against family member investment in audit clients. The SEC rule proposal would liberalize these restrictions. Currently, there is a blanket prohibition against family members investing in audit clients.
The SEC rule proposals also address auditor independence in three other significant ways. They would identify certain non-audit services that, if provided to an audit client, would impair an auditor's independence. The proposals would not extend to services provided to non-audit clients.
A limited exception would also be provided to accounting firms for inadvertent independence violations if the firm has quality controls in place and the violation is corrected promptly. And, companies would have to disclose in their annual proxy statements certain information about non-audit services provided by their auditors during the last fiscal year.
"The bottom line for mutual funds is that the public is confident that the audits are truly independent," said John Collins, a spokesperson for the Investment Company Institute, in a interview following the hearing. "The consumer protection issue is far more important to mutual funds than whether family members of independent auditors can invest in 401(k) plans."
Biggs appeared to support this view. TIAA-CREF uses the "simple rule" that the accounting firm providing its independent audit in preparation of its financial statements cannot provide other consulting services, he said. This rule works well, he said.
Biggs said he would like to know that the companies in which TIAA-CREF invests follow the same standard.
After his testimony, Biggs said he was not swayed by the accounting industry's arguments that such a rule would harm their business.
"In five years, the accounting profession will adapt" to such a rule, and "would not be adversely affected financially," he said.
"A genuine threat" to independence "emerged from the non-audit management services" offered by traditional accounting firms, Biggs said in his testimony. Management consultants in accounting firms are "reluctant to see their economic surplus taken by their audit partners," he said. This "inherent conflict" cannot persist, he said. Bogle echoed Biggs' sentiments in his testimony.
There is no empirical data - a "smoking gun" - to prove that providing management consulting services to audit clients leads to conflicts, but common sense would dictate that the conflict exists, said Bogle.
"If an accounting firm has a $100 million consulting contract with a $2 million audit fee eked out at the end of it, the problem" is readily apparent, said Bogle.
"You don't need a smoking gun," said SEC Chairman Arthur Levitt, apparently agreeing with Bogle. Bogle also said that requiring public companies to disclose that their independent auditors provided other services was not enough to deal with this issue. Levitt had suggested earlier in the day that the final rule may only require disclosure.
The Big Five accounting firms, which do not want to spin off their auditing divisions, oppose the SEC's proposals.
In addition, 21 Republican members of Congress sent Levitt a July 20 letter saying that the commission is trying to quickly promulgate these rules before the presidential election in November.
"The proposal seems hurried, and the process appears designed to avoid meaningful participation by the public, by Congress, and by the new Administration," the congressmen wrote. The letter was signed by Reps. W.J. "Billy" Tauzin (R-La.), Richard K. Armey (R-Tex.), Bob Goodlatte (R-Va.), Vito Fossella (R-N.Y.) and others. A 75-day comment period on the rule proposal will expire Sept. 25.
Neil Hare is an attorney in Washington, D.C., and content director of USLaw.com.
