Step Away From The Auditor

Thinking of getting to know your "independent" auditor better? Don't push it, says the SEC.
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This story appears in the May 2001 issue of Entrepreneur. Subscribe »

Auditors are fiscal watchdogs for businesses-but sometimes, says the federal government, auditors appear a little too cozy with those they're trained to scrutinize. As a result, the Securities and Exchange Commission (SEC) recently made some changes to make sure auditors remain independent. If you use an auditor to certify your financial statements, don't ignore the SEC's new rules, which place restrictions on the type of services auditors can perform for publicly traded companies. The changes, which became effective in February, will affect an estimated 2,200 small companies.

SEC chairman Arthur Levitt, a leader in the campaign to revise the rules, argued that auditors can't be independent watchdogs if they're business advisors to the companies they audit. For many large accounting firms, auditing services now provide a smaller portion of their revenues, while consulting services have grown steadily.

Levitt says the changes were also needed to protect investors. In a speech before the American Institute of Certified Public Accountants (AICPA), the industry's trade association, he pointed out that auditors may be tempted to go easy on their clients when it comes to judgment calls and look the other way when businesses use accounting tricks to save on taxes.

In Committee

While there are many different parts to the rules, one of the most significant sections deals with audit committees, notes Jim Hamilton, senior securities law analyst with CCH Inc., a tax and business law information provider in Riverwoods, Illinois. An overwhelming majority of U.S. companies have their own audit committees, and the SEC sees those committees as the primary link between the company's board of directors and its outside auditors. Under the new SEC rules, the audit committee is expected to be more vigilant in overseeing and monitoring the financial reporting process.

For example, the business must disclose if its audit committee considered whether the nonaudit services performed for it maintain the principal accountant's independence. The rules also require a company's proxy statement to include a report of its audit committee, stating whether the provision of nonaudit services is compatible with maintaining that independence. The rules identify nine nonaudit services deemed inconsistent with an auditor's independence, including appraisal services, actuarial services, broker-dealer services, legal services and management functions. Seven of the nine services are already restricted by the AICPA, SEC or SEC Practice Section. In addition, the SEC says internal audit committees should think about whether it's necessary to adopt policies concerning hiring the company's auditing firm to perform nonaudit services.

While Levitt pushed to restrict IT consulting services that accounting firms provide their clients, the SEC agreed to a compromise in the end. Under the change, accounting firms can continue to offer IT consulting services to their audit clients, provided certain criteria are met. For example, companies must disclose in their annual proxies the total amount they paid to auditors for IT services. In addition, the audited companies have to control their IT systems. Accounting firms would be allowed to perform up to 40 percent of clients' internal audit work. Smaller companies with assets under $200 million can perform more than 40 percent, but they must comply with other conditions. As far as enforcement goes, the SEC is putting a good deal of stock in the ability of companies' audit committees to make sure auditors remain independent. So you should expect "very good compliance," says Hamilton. "The rules are sure to improve auditor independence and the appearance of [it]."

Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 14 years.

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