The recommendations that are before the Board today bring us to the end of a long and winding road that began on December 14, 2004. On that day, the Board proposed a rule to prohibit auditors from providing personal tax services to senior officers who oversee financial reporting at a public company audit client.
The idea behind that rule, which has now been in effect since mid-2006, remains sound. Auditing a public company and simultaneously assisting its officers with their personal taxes is incompatible with both the fact and the appearance of independence. It also carries a potential that the auditor will be caught in the middle, if the interests of the audit client and the interests of the officers in minimizing their taxes diverge. Rule 3523 prohibits mixing auditing and executive tax services, and nothing the Board is considering today erodes that principle.
However, we have also learned a few things during our three and a half year journey. One is that, in framing independence rules, care has to be taken to avoid creating unnecessary obstacles to competition.
In its original form, Rule 3523 prevented an audit committee from engaging a new firm to perform the company’s audit if that firm had provided tax services for a company financial reporting executive during the early part of the fiscal year to be audited – even though the personal tax work ended before the firm became the financial statement auditor. The amendment to Rule 3523 that we are considering would solve that problem by deleting the words “audit and” from the existing rule. As a result, personal tax services will be required to end when the audit engagement begins, but not before. This change would not compromise the original objective of Rule 3523, and I support it.
While we have spent much time and effort on this rather technical issue, resolving it brought to light a second, more substantive, anomaly in the Board’s existing rules. The current independence rules, which the Board inherited when it adopted the interim standards in 2003, require the auditor to inform the audit committee annually about matters that might bear on the auditor’s independence. Surprisingly, however, nothing in those rules says that such a communication should take place before the audit committee decides to hire the auditor.
Rule 3526 will address that issue by requiring that, prior to accepting an initial audit engagement pursuant to PCAOB standards, the would-be auditor must inform the audit committee of any present or past relationships with the public company, or with its financial reporting executives, that may reasonably be seen as bearing on independence. This is common sense. 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.
Rule 3526 is broader than Rule 3523 in that Rule 3526 extends to any relationship that might reasonably be seen as bearing on independence. However, the two rules dovetail. Rule 3526 will assure that audit committees are informed in cases where a potential new audit firm has performed personal taxes services for financial reporting executives of that type so that fact can be weighed in deciding whether to engage the firm.
In short, while we have been at this task for a long time, I think we have finally ended up at the right place. 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.
I’d like to thank the commenters that helped us to explore the ramifications of these two distinct recommendations and also thank our Office of Chief Auditor – especially Bella Rivshin – as well as our Office of General Counsel for your work on this long-running project.