Let’s Get Ready to Rumble

SEC to vote Wednesday on auditor independence rule.
David KatzNovember 13, 2000

It’s time for the main event.

Following six months of preliminary verbal brawling about auditor independence, the Securities and Exchange Commission will vote this Wednesday on the SEC’s proposed rule on auditor independence, which has undergone tinkering by the commission’s staff since it was introduced last June.

On the eve of the vote, it seems that the SEC may have put some padding in its gloves and will put in place a softer rule than the one that roiled the accounting business when it was launched. Commissioner Arthur Levitt has been making conciliatory sounds in the direction of small accountants, at least, and the commission seems on the whole to be moving away from some of the original restrictions.

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“After four days of public hearings, almost 3,000 comment letters, and months of discussions with those in the accounting profession, the time has come for the Commission to act,” The SEC’s Levitt stated in announcing the SEC vote on adoption of the rule at a Nov. 15, 10 a.m. open meeting in Washington, D.C.

At issue is whether auditors can remain independent while selling consulting and other services to the same clients. The vote will occur at a tenuous time for the consulting business of the Big 5 public accounting firms, coming as it will on the heels of reports of Hewlett Packard’s abandonment of plans to buy the consulting business of PricewaterhouseCoopers and KPMG’s likely delay of an initial public offering of its consultancy arm.

Whether the sudden cooling of interest in the accounting industry’s consulting business has anything to do with the SEC’s proposal or is a mere product of stock-market forces remains to be seen.

For the accounting profession, however, there are big bucks at stake in the SEC’s forthcoming action. In 1999, the Big 5 amassed $15 billion in U.S. revenues for management advice and similar services, according to figures cited by the SEC. Revenues for these service lines represent half of the total revenue for the firms—quite a boost from the 13 percent they amounted to in 1981.

An impressive list of luminaries, including former Fed Chairman Paul A. Volcker, has weighed in on the subject of auditor independence. And CFOs have not been silent.

At the fall hearings on the rule, for instance, Gary M. Pfeiffer, CFO of E.I. DuPont DeNemours and Judy Lewent, senior vice president and CFO of Merck & Co. pushed for auditor- independence guidelines, rather than rules.

Pfeiffer said he thinks “the complexity of business models that large companies operate in around the world and across dozens and dozens of different businesses and industries is best measured and metered by guidelines and principles….”

Lewent called the complexity and detail of the proposed 109-page rule “a daunting thing.” She also worried about how the rule would curb corporations’ ability to adjust to fast changes in the business environment.

Whether—and in what ways—the SEC might soften the shots of the rule proposal it approved on June 27 is anybody’s guess. But some softening of the rule—which would, among many other things, bar public auditing firms from taking on a client’s internal auditing functions and financial computer systems’ design and implementation work—seems likely.

For the full text of the rule, click here

In fact, in the much-contested “scope of services” area, the SEC had backed away from an outright ban on non-audit services provided by auditors to their clients, even before it had approved the proposed rule. (Besides non- audit services, the rule focuses on two other areas: investing by auditors or their family members in audit clients and employment relationships between auditors and clients.)

“We have tentatively concluded, pending public comment, that the better approach is to permit some significant non-audit services, though several factors weigh in favor of a blanketed ban,” the SEC said in its executive summary of the proposed rule. (Advice on internal accounting controls and risk management are two services that don’t impair auditor independence, according to the SEC.)

One argument in favor of a total ban on non- audit services is that barring only some services won’t address the growing overall financial interdependence of auditors and clients, the SEC reasoned. And some kinds of services might not fall squarely into the banned or allowed categories.

Still, the fact that the SEC ultimately decided to pick and choose among banned services rather than ban them outright is a positive sign from the accounting profession’s point of view. And since public comment has weighed almost exclusively toward easing and simplifying the proposed rules, a kinder, gentler rule seems likely to emerge on Wednesday.

Barring Non-Audit Services

Besides internal audit outsourcing and computer services, there are eight other areas of service that would be barred under the original rules:

  • Bookkeeping related to the client’s accounting records or financial statements.
  • Services involved with valuing the client’s assets or liabilities.
  • Actuarial services.
  • Performing management functions for a client.
  • Providing human resources services, such as recruitment or employee testing.
  • Serving as a broker-dealer, promoter, underwriter, or analyst of a client’s securities.
  • Providing legal services.
  • Giving expert opinions in legal, administrative, or regulatory filings.

Accountants are hoping the list will shrink to as few as two items. could not confirm press reports that Big 5 firms have won compromises from the SEC that include a shorter list of regulatory requirements.

One sign that a gentler rule may be at hand is Levitt’s recent love song to smaller public accounting practitioners. Levitt said in a recent speech, for instance, that he’s “spent a great deal of time talking with the country’s small public accountants, listening to their stories, discussing their day to day challenges, addressing specifically their concerns for the future.”

After each meeting, Levitt says, he came away “not only with a sense of deeper understanding, but with a sense of utter amazement. The obstacles and challenges that many of them face each day are weathered with an abiding commitment to their work and the communities they serve,” he said.

Easing Up on the Little Guys

All that listening by the chairman may result in a rule that’s easy on smaller practitioners.

That’s at least the hope of Gary S. Shamis, managing partner of SS&G Financial Services in Cleveland, and one of the non-Big 5 practitioners Levitt singled out for special praise. In an interview with, Shamis called the Wednesday vote “the main event” in the auditor independence battle.

He thinks it would be a great help to his firm if the final rule contains a de minimis provision excluding accountants working for, say, clients with $100 million to $200 million in revenues from the strictures of the rule.

Yet even if the rule were focused only on the Big 5, and in a way that disrupted their businesses, he said, that could also hurt smaller firms in their recruiting efforts. Nineteen of the 20 partners in his firm come from the large firms, said Shamis, who previously worked at Touche Ross before it became part of Deloitte & Touche.

While his firm has no public clients, and is thus not directly regulated by the SEC, Shamis says he’s still worried about the rule because of the “trickle-down effect” it may create among state accountancy boards, which he thinks might widely adopt it.

At a September SEC hearing, Shamis testified that he talked to three members of the Ohio Board of Accountancy about how the federal rule would influence their requirements on auditor independence. “I was sufficiently convinced from my discussion with the Ohio board members that a change at the SEC level has a very good chance of affecting the rules that govern my firm’s independence,” he testified.

“I don’t think the SEC looked at the magnitude of what the change was” in what they were proposing, Shamis says. “I don’t think it crossed their mind that these rules would establish a benchmark for our industry.”

As it exists now, the rule would “change the way we do business” and have “profound negative effects,” he said, noting that 76 percent of the firm’s clients “buy some sort of value-added services.” In terms of fees, 25 percent of his firm’s business comes from auditing, 25 percent from consulting and the rest from tax consultation, he said.

“If these new SEC rules become applicable to my firm, we will have to dismantle our firm. We will reduce our work force by approximately 50 percent by selling off business lines and/or terminating employees. The financial results of imploding our firm will be devastating to me and my partners,” he testified.

“Long term commitments for rental space will be in place, but not needed. Client relationships will be terminated and significant investments made into developing and acquiring additional consulting services will be lost,” he said.

Shamis says that what he’s hoping will happen is the adoption by the SEC of “something reasonable that we could live with and what the Big 5 could live with.”

“With all the posturing,” however, he said, “that’s a long shot.”

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