For the PCAOB, It’s “Independence Day”

New rule changes are designed to define terms and reduce conflicts of interest among auditors.
Alan RappeportApril 22, 2008

The Public Company Accounting Oversight Board voted unanimously for two proposals aimed at better defining auditor independence and reducing the possibility of conflicts of interest.

Introduced last July, the first proposal would replace an interim independence standard that helps define what independence is. Meanwhile, the other proposal approved on Tuesday creates standards for working on the personal income taxes of a client company’s CFO. The changes would provide auditors with clearer direction on how to demonstrate to a client’s audit committee that the audit firm is independent.

The PCAOB’s ruling must be approved by the Securities and Exchange Commission before taking effect.

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“The process has resulted in an improvement in both the tax services rule and in the rules governing communications with audit committees about independence matters,” said PCAOB board member Daniel L. Goelzer.

Under the current rule, ISB No. 1, Independence Discussions with Audit Committees, auditors send a letter to each client’s audit committee once a year disclosing any relationships that could have a bearing on the firm’s independent status — and hence, revealing any bias — related to the client. In addition, auditors must openly discuss their independence with the audit committee to assure board members that the firm is indeed a non-biased body. Subsequent guidance released by the Independence Standards Board in 2000 explained how the same rule applies to secondary auditors.

That rule will be replaced by Rule 3526, Communication with Audit Committees Concerning Independence. It would require registered public accounting firms to tell an issuer’s audit committee about any relationships between the firm or its affiliates. Any issuer or person in a financial reporting oversight role that might appear to bear on the firm’s independence would also have to disclose. Such disclosures would be required both before the firm accepts a new relationship with a company and annually for continuing engagements.

“This is common sense,” Goelzer said. “The new rule will make sure that audit committees have the relevant independence information in front of them when they select the auditor, not after they have already made the decision and the work has begun.”

PCAOB Chairman Mark Olson said that the board received encouraging and supportive comments on the proposal, and that the rule will help audit committees make better informed decisions when hiring their auditors. “I am supportive of the modifications that the rule will make to ISB No. 1, as they will enhance information provided to audit committees that may bear on the firms’ independence before they select their auditors,” he said. “I also believe that real value will be derived from the requirement that accounting firms discuss the potential effects of these relationships on the firms’ independence with the audit committees.”

The PCAOB also approved a change to the rule governing whether an auditor’s independence status is jeopardized if the firm works on the personal tax returns of a client company’s CFO. The rule’s original proposal did not address whether an auditor’s independence is compromised if the firm helped an executive with the preparation of personal taxes the same year it became the company’s auditor (assuming the firm stopped providing tax work for the executive by the time the engagement period began).

Rule 3523, Tax Services for Persons in Financial Reporting Oversight Rules, prevents external auditors from providing tax services during the audit and professional engagement period to client-company finance chiefs and their family members. The amendment excludes from the rule tax services provided during the audit period prior to the professional engagement period.

If approved by the SEC, Rule 3526 will take effect on Sept. 30, one month after approval. Rule 3523 would be effective immediately upon SEC approval.

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