[Federal Register Volume 66, Number 141 (Monday, July 23, 2001)]
[Rules and Regulations]
[Pages 38149-38152]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-18261]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210 and 211

[Release Nos. 33-7993; 34-44557; IC-25066; FR-50A]


Commission Policy Statement on the Establishment and Improvement 
of Standards Related to Auditor Independence

AGENCY: Securities and Exchange Commission.

[[Page 38150]]


ACTION: Policy statement.

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SUMMARY: The Securities and Exchange Commission (``SEC'' or 
``Commission'') today amended Financial Reporting Release No. 50 (``FRR 
50'') to state that it will no longer look to the Independence 
Standards Board (``ISB'' or ``Board'') for leadership in establishing 
and improving auditor independence standards applicable to auditors of 
the financial statements of Commission registrants. The deliberations 
and conclusions of the ISB contributed significantly to the development 
of the Commission's new auditor independence regulations and disclosure 
requirements, which were adopted in November 2000. In light of the 
Commission's new auditor independence rules, the Commission believes 
that many of the issues that led to the creation of the ISB have been 
resolved, and that going forward the best method to assure the 
independence of auditors is for the Commission and its staff to enforce 
and interpret its new rules. In addition, the Commission notes the 
recent increase in public participation on the American Institute of 
Certified Public Accountants' (``AICPA'') Professional Ethics Executive 
Committee (``PEEC'') and encourages greater public membership on PEEC. 
The Commission staff, when appropriate, may work with the PEEC on 
discrete auditor independence issues. Standards previously adopted by 
the ISB and interpretations previously issued by the ISB will continue 
to be authoritative to the extent they do not conflict with the 
Commission's rules and interpretations. In making this amendment to FRR 
50, the Commission reaffirms that maintaining the independence of 
auditors is crucial to the credibility of financial reporting and, in 
turn, the capital formation process.

EFFECTIVE DATE: August 22, 2001.

FOR FURTHER INFORMATION CONTACT: John M. Morrissey, Deputy Chief 
Accountant, or Samuel L. Burke, Associate Chief Accountant, Office of 
the Chief Accountant, at (202) 942-4400, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 20549-1103.

SUPPLEMENTARY INFORMATION:

I. Background

    The Federal securities laws reflect the importance of independent 
audits in protecting investors by requiring, or permitting the 
Commission to require, that financial statements filed with the 
Commission by public companies, investment companies, broker/dealers, 
public utilities, investment advisers, and others, be certified (or 
audited) by independent public accountants,\1\ and by granting the 
Commission the authority to define the term ``independent.'' \2\
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    \1\ For example, items 25 and 26 of Schedule A to the Securities 
Act of 1933 (the ``1933 Act''), 15 U.S.C. 77aa(25) and (26), and 
17(e) of the Securities Exchange Act of 1934 (the ``Exchange Act''), 
15 U.S.C. 78q, expressly require that financial statements be 
audited by independent public or certified accountants. Sections 
12(b)(1)(J) and (K) and 13(a)(2) of the Exchange Act, 15 U.S.C. 78l 
and 78m, 5(b)(H) and (I), 10(a)(1)(G), and 14 of the Public Utility 
Holding Company Act of 1935, 15 U.S.C. 79e(b), 79j, and 79n, 8(b)(5) 
and 30(e) of the Investment Company Act of 1940, 15 U.S.C. 80a-8 and 
80a-29, and 203(c)(1)(D) of the Investment Advisers Act of 1940, 15 
U.S.C. 80b-3(c)(1), authorize the Commission to require the filing 
of financial statements that have been audited by independent 
accountants. In accordance with these provisions, the Commission has 
required that independent accountants audit certain financial 
statements. See, e.g., Article 3 of Regulation S-X, 17 CFR 210.3-01 
et seq.
    \2\ Section 19(a) of the 1933 Act, 15 U.S.C. 77s(a), 3(b) of the 
Exchange Act, 15 U.S.C. 78c(b), Sec. 20(a) of the Public Utility 
Holding Company Act of 1935, 15 U.S.C. 79t(a), and 38(a) of the 
Investment Company Act of 1940, 15 U.S.C. 80a-37(a), grant the 
Commission the authority to define accounting, technical, and trade 
terms used in each Act.
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    Since the Commission's creation in 1934, it consistently has 
emphasized the need for auditors to remain independent. The 
Commission's requirements are set forth in Rule 2-01 of Regulation S-X 
\3\ and in the interpretations, guidelines and examples that are 
collected in Section 600 of the Codification of Financial Reporting 
Policies (``Codification'') entitled ``Matters Relating to Independent 
Accountants.'' \4\ The Commission also makes publicly available the 
staff's written responses to requests for informal advice on its 
independence requirements.\5\
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    \3\ 17 CFR 210.2-01 (2000).
    \4\ Financial Reporting Codification, Section 600, ``Matters 
Relating to Independent Accountants,'' reprinted in SEC Accounting 
Rules (CCH) para. 3,851, at 3,781.
    \5\ See FRR 33 (November 25, 1988) and FRR 4 (October 14, 1982). 
See also, Office of the Chief Accountant, ``Application of Revised 
Rules on Auditor Independence--Frequently Asked Questions'' (January 
16, 2001), which is available on the Commission's web site: 
www.sec.gov.
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    For approximately 60 years, the Commission developed and maintained 
its own auditor independence requirements.\6\ In 1997, after several 
months of discussions with representatives of the accounting 
profession, the Commission determined that it would look to the ISB, a 
private sector body composed equally of members from the accounting 
profession and from the public, to take a leadership role in 
establishing and maintaining auditor independence standards. In FRR 
50,\7\ issued February 18, 1998, the Commission announced its 
endorsement of the ISB. In doing so, however, the Commission stated 
that it was not abdicating its authority to modify or supplement ISB 
standards, to bring enforcement actions, or to take such other action 
as it may deem appropriate. In addition, FRR 50 noted that before any 
ISB standard or interpretation that conflicted with an SEC rule or 
interpretation could take effect, the SEC would have to amend its 
regulations to remove the conflict. Because of the experimental nature 
of the ISB, the Commission also stated in FRR 50 that it would review 
the operations of the ISB as necessary or appropriate and evaluate, 
within five years, whether the framework of the ISB was serving the 
public interest and protecting investors.\8\
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    \6\ See generally, Office of the Chief Accountant, ``Staff 
Report on Auditor Independence'' (March 1994).
    \7\ Release Nos. 33-7507, 34-39676, IC-23029, FR-50 (February 
18, 1998).
    \8\ Id.
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    During its tenure, the ISB deliberated and provided guidance on 
several important auditor independence issues, including the need for 
communications on auditor independence issues among auditors, 
management, and audit committees,\9\ and the impact on an auditor's 
independence of investments in mutual funds \10\ and the retention by 
an audit client of a professional who formerly worked for the 
accounting firm.\11\ The ISB members brought extensive and diverse 
business and professional experiences to the Board, and their 
discussions of these and other issues contributed significantly to the 
formulation of the Commission's new rules.\12\
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    \9\ Independence Standards Board, Independence Standard No. 1, 
``Independence Discussions with Audit Committees'' (January 1999) 
(``ISB No. 1'').
    \10\ Independence Standards Board, Independence Standard No. 2, 
``Certain Independence Implications of Audits of Mutual Funds and 
Related Entities'' (December 1999) (``ISB No. 2'').
    \11\ Independence Standards Board, Independence Standard No. 3, 
``Employment with Audit Clients'' (July 2000) (``ISB No. 3'').
    \12\ See generally ``Revision of the Commission's Auditor 
Independence Requirements,'' Release Nos. 33-7919; 34-43602; 35-
27279; IC-24744; IA-1911; FR-56 (Nov. 21, 2000).
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    In late 1999, the ISB members faced significant issues regarding 
the evolving alternative business structures being used by accounting 
firms and the nature and scope of non-audit services that the firms 
could perform for an audit client before they would be deemed to lack 
auditor independence. The public members of the ISB recognized that 
these were significant public policy issues that required input from a 
wider

[[Page 38151]]

and more diverse audience than the ISB had been able to attract. These 
members, therefore, asked the Commission to assume this project.
    The public ISB members' vision of the public interest in these 
issues was indeed correct. The Commission's rulemaking project 
generated approximately 3,000 comment letters and four days of public 
hearings in which the Commission heard directly the testimony of about 
100 investors, accountants, lawyers, audit committee members, 
regulators, professional associations, and other witnesses.\13\
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    \13\ The Commission's proposing and adopting releases, comment 
letters submitted electronically, and copies of the testimony at the 
Commission's public hearings are available at the Commission's web 
site: www.sec.gov.
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    Although the Commission's rulemaking completely revised the 
Commission's auditor independence regulation, significant portions of 
the rule were built upon the foundation of the ISB's deliberations, 
draft documents, and standards. Upon completion of the Commission's 
rulemaking, it had addressed the vast majority of issues that had led 
to the creation of the ISB.
    Following the Commission's rulemaking, the AICPA has begun a 
project to amend the ethics and independence rules established by its 
PEEC \14\ to conform in several respects to the Commission's new 
rules.\15\ Reducing the discrepancies between the Commission's and the 
profession's auditor independence regulations should reduce the 
confusion associated with having diverse standards and encourage 
compliance.
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    \14\ Among other things, PEEC develops the AICPA's standards of 
ethics and independence, promotes understanding and voluntary 
compliance with such standards, establishes and presents charges of 
violations of the standards to the Joint Trial Board for 
disciplinary action, and works to improve the profession's 
enforcement procedures.
    \15\ See AICPA, ``Omnibus AICPA Proposal of Professional Ethics 
Division Interpretations and Rulings'' (April 16, 2001).
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    The AICPA Board of Directors and membership also voted to have 
public members (as opposed to members from the profession) comprise 
twenty-five percent of the PEEC membership, and to study whether 
additional public membership would be appropriate. The Commission 
believes that increased public participation on PEEC is essential to 
the credibility of the AICPA's independence and disciplinary processes 
and is hopeful that the AICPA Board will decide to further increase 
public participation on PEEC to achieve equivalent public and private 
representation.\16\
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    \16\ Other countries have mandated public participation on such 
committees. For example, in the United Kingdom the Department of 
Trade and Industry, with the support of the accounting profession, 
has instituted a new regulatory framework for the accountancy 
profession that includes a new Ethics Standards Board. Under that 
framework, at least sixty percent of the Ethics Standards Board is 
to be independent from the profession--that is, not themselves 
subject to the disciplinary procedures of the accountancy bodies. 
Further, members of the profession have indicated their support for 
increased public participation on the PEEC. See Arthur Andersen 
press release dated November 15, 2000, ``* * * With respect to the 
profession's self-regulation, we believe that public participation 
is positive and beneficial. We support efforts to continue to expand 
such public participation. To that end, we will work hard to achieve 
equivalent public and profession participation on the AICPA's 
Profession Ethics Executive Committee.'' See Deloitte & Touche 
statement dated November 15, 2000, ``* * * We believe that the 
recent addition by the AICPA of public members to the PEEC is an 
appropriate and positive step toward enhancement of the profession's 
governance process. We support continued review of the benefits of 
further expanding public membership in the profession's Ethics 
Committee.'' See Joint statement issued by the AICPA, Arthur 
Andersen, LLP, Deloitte & Touche, LLP and KPMG, LLP, ``* * * We 
believe that substantially increased public participation on the 
PEEC would be both appropriate and beneficial * * *''.
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II. Amendment of Financial Reporting Release No. 50

    After careful consideration, the Commission amends section II of 
FRR 50 in that the Commission no longer will look to the ISB to provide 
leadership in establishing, improving, or maintaining auditor 
independence standards applicable to the auditors of Commission 
registrants, and will not consider ISB principles, standards, 
interpretations, and practices established or issued after the date of 
this amendment as having substantial authoritative support for the 
resolution of auditor independence issues.
    The Commission's new rules address many of the issues that led to 
the creation of the ISB. The ISB's remaining agenda may not be 
sufficient either to attract to the ISB the same exceptionally high 
caliber of individuals as those who served on the Board for the past 
four years or to justify the cost to the profession of maintaining the 
ISB. In light of the AICPA's increase in public representation on the 
PEEC and the AICPA's continuing study of whether additional public 
membership on PEEC would be appropriate, the Commission believes that, 
going forward and where appropriate, working with the PEEC on discrete 
issues provides an appropriate means to include the private sector in 
the process of maintaining and improving auditor independence 
requirements.

III. Continuing Authority of ISB Standards and Interpretations

    The Commission will continue to consider ISB Standard Nos. 1, 2, 
and 3, and ISB Interpretations 00-1, 00-2, and 99-1, to have 
substantial authoritative support for the resolution of auditor 
independence issues.\17\ In FRR 50, the Commission encouraged 
registrants and auditors to ask the ISB staff for assistance in 
interpreting the existing auditor independence regulations. FRR 50 
stated, however, that, unless or until ratified by the ISB, positions 
issued by the ISB staff would not be considered to be authoritative 
with respect to anyone other than the particular party requesting the 
interpretation.\18\ Accordingly, the Commission will continue to view 
positions issued by the ISB staff to a particular party before the 
effective date of this amendment to be authoritative, but only as to 
the party that requested the interpretation. Of course, compliance with 
ISB pronouncements does not relieve registrants and accounting firms 
from also having to comply with the Commission's auditor independence 
requirements.
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    \17\ See also ``Revision of the Commission's Auditor 
Independence Requirements'' Release. Nos. 33-7919; 34-43602; 35-
27279; IC-24744; IA-1911; FR-56 (Nov. 21, 2000) at n. 168 
(discussing the Commission's interpretation of ISB Standard No. 1).
    \18\ FRR 50 at n.11.
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IV. Regulatory Requirements

    This general policy statement is not an agency rule requiring 
notice of proposed rulemaking, opportunities for public participation, 
or prior publication under the provisions of the Administrative 
Procedure Act (``APA'').\19\ Similarly, the provisions of the 
Regulatory Flexibility Act,\20\ which apply only when notice and 
comment are required by the APA or another statute, are not applicable. 
For the reasons explained above the Commission believes that this 
statement of policy is in the public interest, considering the 
protection of investors and the promotion of efficiency, competition, 
and capital formation and provides a sound basis for the Commission to 
make significant contributions to meeting the needs of investors and 
capital markets.
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    \19\ 5 U.S.C. 553.
    \20\ 5 U.S.C. 601-602.
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V. Codification Update

    The ``Codification of Financial Reporting Policies'' announced in 
Financial Reporting Release No. 1 (April 15, 1982) is amended as 
follows:
    Delete the current text in Section 601.04, which appears under the 
caption ``Statement of Policy on the Establishment and Improvement of 
Standards Related to Auditor Independence,'' and replace it with the

[[Page 38152]]

text in sections I, II, and III of this release.
    The Codification is a separate publication of the Commission. It 
will not be published in the Federal Register/Code of Federal 
Regulations.


    Dated: July 17, 2001.

    By the Commission.

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-18261 Filed 7-20-01; 8:45 am]
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