In an attempt to modernize the rules concerning auditor independence, the Securities and Exchange Commission (SEC) adopted amendments (Release No. 34-43602, November 21, 2000) that include new rules requiring the following additional disclosures in proxy statements filed after February 5, 2001:
- Under the caption "Audit Fees," the aggregate fees billed for the most recent fiscal year for professional services rendered for the audit of the registrant's annual financial statements and review of financial statements included in registrant's Forms 10-Q or 10-QSB;
- Under the caption "Financial Information Systems Design and Implementation Fees," the aggregate fees billed for the most recent fiscal year for financial information systems design and implementation services performed by the company's principal accountants;
- Under the caption "All Other Fees," the aggregate fees billed for all other non-audit services performed by the auditor and
- Whether the audit committee has considered whether the provision of non-audit services described in number two and three above is "compatible with maintaining the principal accountant's independence."
The SEC believes these new rules are needed to preempt potential conflicts of interest arising from the rapid transformation of the accounting industry. In their release, the SEC found that as the accounting firms continue to merge, they expand their services and as a result become multi-disciplinary service organizations and enter into new types of business relationships with clients. The firms are then capable of offering new types of services to their audit clients, such as financial or administrative services, and the line between independence and interdependence can then become unclear. According to the release, " . . . an unchecked expansion of non-audit relationships between auditors and their audit clients could affect both an auditor's objectivity and investor confidence in financial statements."
The SEC maintains that these newly required disclosures also advance important policy goals, including protecting securities investors. The SEC sees this as the key policy goal, noting that investors rely on financial statements prepared by public companies and other issuers who are required by federal securities laws to be audited by independent auditors. As stated in the release, an investor's confidence in public securities is shaken if the investor does not believe that an auditor is independent of a company. Additionally, the SEC believes that the auditor independence requirements will foster higher quality audits by minimizing external forces that may influence an auditor's judgment.
Under these new rules, the registrant's audit committee now shoulders the burden of assessing when an auditor is independent. The SEC, however, recognizes that an audit committee's decisions on independence issues arising from non-audit services are considered business judgments. Yet, due to the increasing complexity of the relationship between the registrant and its accounting firms, the difficulty for many audit committees may be determining when a service is independent or not. In their release, the SEC provides an independence standard, describing an auditor as not being independent when, 1) it is known that the auditor does not actually have an objective and unbiased state of mind or 2) a reasonable investor, with knowledge of all relevant facts and circumstances, would conclude that the auditor is not capable of exercising objective and impartial judgment.
The SEC release also recommended certain factors that audit committees should consider when making these types of business judgments about non-audit services. Specifically, the SEC endorses guidelines drafted by the Panel on Audit Effectiveness (the "Panel"). The Panel suggests that audit committees look to the following factors:
- Whether the service facilitates the performance of the audit, improves the client's financial reporting process or is otherwise in the public interest;
- Whether the service is being performed principally for the audit committee;
- The effects of the service, if any, on audit effectiveness or on the quality and timeliness of the entity's financial reporting process;
- Whether the service would be performed by specialists (e.g., technology specialists) who ordinarily also provide recurring audit support;
- Whether the service would be performed by audit personnel and, if so, whether it will enhance their knowledge of the entity's business and operations;
- Whether the role of those performing the service (e.g., a role where neutrality, impartiality and auditor skepticism are likely to be subverted) would be inconsistent with the auditor's role;
- Whether the audit firm's personnel would be assuming a management role or creating a mutuality of interest with management;
- Whether the auditors, in effect, would be auditing their own numbers;
- Whether the project must be started and completed quickly;
- Whether the audit firm has unique expertise in the service and
- The size of the fee(s) for the non-audit service(s).
In addition to the audit committee's new hardship of resolving auditor independence issues, the responsibilities normally belonging to external auditors now shifts to audit committees, which may result in greater difficulty in recruiting directors to serve on audit committees.