SEC Chief Accountant Answers FAQs On Sarbanes-Oxley Auditor Independence Rules
August 22, 2003
On August 13, 2003, the U.S. Securities and Exchange Commission (SEC) released guidance from the Office of the Chief Accountant on the application of the SEC's final rules on Auditor Independence (Strengthening the Commission's Requirements Regarding Auditor Independence, Jan. 28, 2003). Title II of the Sarbanes-Oxley Act, entitled "Auditor Independence," required the SEC to adopt final rules under which certain non-audit services would be prohibited, conflict of interest standards will be strengthened and the relationship between the independent auditor and the audit committee will be clarified and enhanced. In response, the final rules, among other things, specify non-audit services that would impair the independence of the auditor; require that a company's audit committee pre-approve all audit and non-audit services provided to the company by the auditor of the company's financial statements; mandates that the auditor furnish certain information directly to the audit committee; and require the rotation of audit partners off engagements and "cooling off" periods before an audit client can hire a member of the audit engagement team from its audit firm.
The guidance from the Chief Accountant's Office is in the form of answers to 35 "frequently asked questions regarding the implementation and interpretation of the rules." These answers are not rules or statements approved by the SEC. However, they are important pronouncements by the relevant SEC office in response to queries -- similar to those received from our client -- on the practical meaning of the final rules' provisions in the following areas:
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audit partner rotation off a client engagement;
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permissible and prohibited non-audit services;
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audit committee pre-approval of non-audit services;
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audit committee communications with auditor;
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fees to auditor categories; and
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cooling off period before audit client hires from audit engagement team.
Pre-Approval of Non-Audit Services Requires Detailed Information
One of the more significant set of answers is in response to questions regarding the audit committee's pre-approval of the independent auditor's provision of tax and other permissible non-audit services. The final rule provides two alternatives related to pre-approval: either pre-approval before the accountant is engaged to provide the services or the engagement is entered into pursuant to "detailed pre-approval policies and procedures established by the audit committee, with the audit committee informed on a timely basis of each service." The pre-approval by policy is considered an alternative to forcing the audit committee to meet and consider each and every tax and other permissible non-audit service to be rendered by the outside auditors, provided the policy is detailed as to the particular service and designed to safeguard the continued independence of the accountant. However, the staff's answers to questions in this area rebuff any suggestion that board members can generally sign off on broad categories of consulting and tax services once a year rather than obtaining and absorbing the details of each service to be performed.
The SEC staff has confirmed to MWE that the answers in the release on the topic of pre-approvals were issued in response to claims they received that some firms were advising companies that pre-approval policies could be designed without furnishing substantive information to the audit committee on the details of the work to be provided. Now, via this release, the SEC staff makes it clear that the audit committee's pre-approval policies cannot provide for broad, categorical approvals (e.g., tax compliance services); that the pre-approval policies must be detailed as to the particular services to be provided; that the audit committee must be informed about each service; that monetary limits cannot be the only basis for the pre-approval policies; and that if the audit committee is presented with a schedule or cover sheet describing services to be pre-approved, "that schedule must be presented with detailed back-up documentation regarding the specific services to be provided."
In our discussion with the staff regarding these answers, they suggested that requests for pre-approval of such items as "tax filings" or "tax return preparation" be accompanied by a detailed description of the type of return and scope of the work. They reiterated a test -- if a member of management has to make a judgment as to whether a proposed service fits within the pre-approval services, then the policy would not be sufficiently detailed. The pre-approval policy "must be designed to ensure that the audit committee knows precisely what services it is being asked to perform."
The emphasis on the need for detailed information may serve to deter pre-approval by policy of services that are difficult to fully describe months before they are rendered. For example, it may be difficult to pre-approve by policy tax planning services which involve strategies that might be considered novel or aggressive because the project details may not be available sufficiently in advance to put the committee in the already difficult position of deciding whether such a project could put the auditing firm in a position of auditing its own work.
Other Highlights
As referenced above, the answers to the frequently asked questions cover a variety of topics, including audit committee communications with the auditors; whether services rendered under certain conditions are considered prohibited or permissible non-audit services; and disclosures of fees paid to outside auditors. The complete release is available here: http://www.sec.gov/info/accountants/ocafaqaudind080703.htm
