Securities and Exchange Commission
Washington, D.C. 20549
Office of the Chief Accountant
January 22, 1999
Sherwin P. Simmons, Chair
Commission on Multidisciplinary Practice
American Bar Association
541 North Fairbanks Court
Chicago, Illinois 60611-3314
Dear Mr. Simmons:
In response to your letter to Chairman Levitt and my further discussions with Paul Gonson, this letter provides the views of the Office of the Chief Accountant ("OCA") regarding the impairment of auditor independence that is created when a firm provides both auditing and legal services to an entity required to file with the Securities and Exchange Commission ("SEC" or "Commission") financial statements that have been examined by an independent accountant. This letter has not been reviewed by the Commission. In addition, this letter does not purport to express any legal position on issues being considered by the Commission on Multidisciplinary Practice.
The United States Supreme Court, in United States v. Arthur Young, 465 US 805 (1984), indicated that the purpose of independent audits under the federal securities laws is to enhance the credibility of financial information and, in turn, the securities markets. To accomplish this purpose successfully, investors must be confident that auditors will place investors' interests above all else, including the interests of the client and the accounting firm. In explaining the need for auditors to place investors' interests over those of the client, the Court noted, "If investors were to view the auditor as an advocate for the corporate client, the value of the audit function itself might well be lost." 485 US at 819 n. 15.
This obligation to place investors first gives auditors a special role under the law. This role demands that the auditing profession be more than just another business selling just another product or service. Auditors are the only professionals that an entity must engage before it may sell securities in the United States, and the only professionals charged by law to act independently from management.
In contrasting the role of the attorney with that of the independent accountant, the US Supreme Court stated,
"... the private attorney's role [is] the client's confidential adviser and advocate, a loyal representative whose duty it is to present the client's case in the most favorable light. An independent certified public accountant performs a different role. By certifying the public reports that collectively depict a corporation's financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation's creditors and stockholders, as well as to the investing public. This 'public watchdog' function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust" (emphasis in original). 465 US at 817-818.
The Commission's auditor independence regulations specifically state that the roles of auditors and attorneys under the federal securities laws are incompatible. Rule 2-01(c) of Regulation S-X, 17 CFR 210.2-01(c), states that in determining whether an accountant is independent of a particular person, the Commission "will give appropriate consideration to all relevant circumstances, including evidence bearing on all relationships between the accountant and that person or any affiliate thereof, and will not confine itself to the relationships existing in connection with the filing of reports with the Commission." The Commission further stated in an interpretive release, which has been incorporated into its Codification of Financial Reporting Policies ("Codification"), that one of the relationships that must be considered in making independence determinations is the relationship created by rendering legal services. The Commission stated,
"Certain concurrent occupations of accountants engaged in the practice of public accounting involve relationships with clients which may jeopardize the accountant's objectivity and, therefore, his independence. In general, this situation arises because the relationships and activities customarily associated with this occupation are not compatible with the auditor's appearance of complete objectivity or because the primary objectives of such occupations are fundamentally different from those of a public accountant....
"A legal counsel enters into a personal relationship with a client and is primarily concerned with the personal rights and interests of such client. An independent accountant is precluded from such a relationship under the Securities Acts because the role is inconsistent with the appearance of independence required of accountants in reporting to public investors" (emphasis added). Codification §§ 602.02.e.i and e.ii.
Accordingly, OCA would consider a firm’s independence from an SEC registrant to be impaired if that firm also provides legal advice to the registrant or its affiliates. When necessary, the Commission has taken appropriate action to enforce this provision. See, e.g., In the Matter of Samuel George Greenspan, Accounting and Auditing Enforcement Release Nos. 312 (August 26, 1991) and 298 (May 23, 1991).
The differing roles of attorneys and accountants was highlighted last year during congressional consideration of H.R 2676, the "Internal Revenue Service Restructuring and Reform Act of 1998." This Act, among other things, extends the attorney-client privilege of confidentiality to tax advice that is furnished to a taxpayer by any individual who is authorized to practice before the IRS. The privilege, however, may be asserted only in noncriminal tax proceedings before the IRS or in poceedings in federal courts in which the IRS is a party. The bill is carefully crafted so that when the tax adviser is an accountant the privilege may not be asserted in any proceeding challenging an SEC registrant's or auditor's compliance with the federal securities laws, the Commission's rules and regulations, or professional accounting, auditing, or independence standards. In this regard, the Conference Report on H.R. 2676 states,
"The privilege may not be asserted to prevent the disclosure of information to any regulatory body other than the IRS. The ability of any other regulatory body, including the Securities and Exchange Commission (SEC), to gain or compel information is unchanged by this provision. No privilege may be asserted under this provision by a taxpayer in dealings with such other regulatory bodies in an administrative or court proceeding." Cong. Rec. H5169 (daily ed. June 24, 1998).
The narrow confines of the confidentiality privilege in H.R 2676 reflect and preserve the obligations of independent accountants to place the needs of investors ahead of those of the accountant's clients.
Finally, as you may be aware, the Commission recently recognized the establishment of the Independence Standards Board ("ISB") and indicated that, consistent with its continuing policy of looking to the private sector for leadership in establishing and improving accounting principles and auditing standards, the Commission intends to look to the ISB for leadership in establishing and improving auditor independence regulations applicable to the audits of the financial statements of Commission registrants. Financial Reporting Release No. 50 (February 18, 1998). In a letter dated January 7, 1999, I asked the ISB to consider placing the topic of legal advisory services on its agenda and suggested that the ISB consult with your Commission. At my request, Mr. Gonson sent you a copy of that letter. It is my hope that, working together, you will reach a fair and workable solution to this issue.
Lynn E. Turner
cc: Paul Gonson
Harvey Goldschmid, SEC General Counsel
William Allen, Chair, Independence Standards Board