On December 14, 2004, the PCAOB announced proposed rules to safeguard independence of public accounting firms that audit and review financial statements of public companies. The thrust of these proposed rules addresses threats to the auditor’s independence in two areas: the provision of advice on tax positions that may be abusive, and tax planning services for senior officers of the public company client (those officers who have a financial oversight role). While these rules are subject to comment through February 14, 2005, the scope of the proposals and the accompanying discussion will have a significant impact on the accounting profession irrespective of the final form of those rules. The PCAOB proposals introduce a new subpart (Part 5 — Ethics) of Section 3 (Professional Standards) of the PCAOB rules, and can be summarized as follows:
- A registered public accounting firm will not be independent of an audit client if the firm, or an affiliate of the firm, provides any service or product to an audit client for a contingent fee or a commission, or receives from an audit client, directly or indirectly, a contingent fee or a commission.
- A registered public accounting firm will not be independent of an audit client if the firm, or an affiliate of the firm, provides assistance to the audit client or to certain senior officers of the audit client, in planning, or providing tax advice on, certain types of potentially abusive tax transactions.
- The registered public accounting firm will have to provide information to the audit committee in connection with seeking preapproval of non-prohibited tax services, including the engagement letter and the compensation arrangements (including referral fee or fee-sharing arrangements between the accounting firm and any other person.
- The registered public accounting firm must be independent of its audit client throughout the entire audit and professional engagement period, which commences with the signing of the initial engagement letter, and ends when the audit client notifies the SEC that the client is no longer that accounting firm’s audit client.
The PCAOB proposed these new rules on the basis of a series of public roundtable discussions and the Board’s review of non-audit services being provided by registered public accounting firms. The PCAOB considered a wide range of tax services, including routine tax return preparation, tax planning, executive tax services, international assignment tax services and tax shelter strategies and products. The PCAOB chose to focus on two areas that it saw as creating potential ethical issues for the firms: the provision of advice on tax positions that may be abusive, and tax compliance and planning services for certain senior executives of the audit client. To the extent that other tax services provided by the auditor are consistent with the existing restrictions on tax services, and are subject to the pre-approval by the audit committee of the public client, such tax services would not be prohibited by the new rules.
The theory underlying rules on auditor independence, whether from the SEC, the PCAOB or the AICPA, is that an accountant should not perform services for an audit client if, as a result of the performance of such services, the accountant would not be, or a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the accountant is not, capable of exercising objective and impartial judgment on all issues within the accountant’s engagement. Proposed Rule 3520 sets forth the fundamental ethical obligation of a public accounting firm’s independence, but does not create a new independence requirement. The firm must be independent of its audit client throughout the audit and professional engagement period. The Rule also specifically requires that the accounting firm comply with all applicable rules regarding independence, whether of the SEC, the GAO, the state accounting boards or other authorities with applicable jurisdiction.
Proposed Rule 3521 is adapted from the SEC’s rule on contingent fees, and would treat a registered public accounting firm as not independent if it enters into a contingent fee arrangement with an audit client. The Proposed Rule extends to affiliates of the public accounting firm: the firm’s parents; subsidiaries; pension, retirement, investment or similar plans; and any associated entities of the firm (as determined by the SEC). Like the SEC, the PCAOB has not defined "associated entity," and instead relies on the SEC’s interpretations of "associated entity." In order to avoid running afoul of the evolving interpretations of these terms, an accounting firm with a services agreement connecting it to a separate non-attest practice structure should avoid having such separate non-attest practice have a contingent fee arrangement with the attest firm.
The PCAOB Proposed Rule differs from the SEC prohibition in Rule 2-01(f)(1) of Regulation S-X on contingent fees in several ways. The PCAOB Rule eliminates the SEC exception for fees "in tax matters, if determined based on the results of judicial proceedings or the findings of governmental agencies." Also, the PCAOB rule prohibits contingent fees received "directly or indirectly," and therefore, includes the payment of a contingent fee from any person, even if such person is not related to the audit client in any way. This is intended to prohibit accounting firms from recommending tax shelters or other products to their clients, and receiving payment from the promoter of such tax shelters if the audit client participates in such product.
PCAOB Proposed Rule 3522 effectively prohibits auditors from providing services relating to planning or opining on the tax consequences of transactions that are listed or confidential transactions under U.S. Department of Treasury regulations, or transactions that promote an interpretation of applicable tax laws for which there is inadequate support. These tax-motivated transactions are deemed to pose an unacceptable risk of impairing the auditor’s independence with respect to its audit client. Because the IRS or a governmental agency might challenge the tax implications of such products, the interests of the client and the auditor converge, and the auditor is consequently less independent than it should be.
Under Proposed Rule 3523, a registered public accounting firm would be deemed to have lost its independence from an audit client if the firm, or any affiliate of the firm, during the audit and professional engagement period, provides any tax service to an officer in a financial reporting oversight role at the audit client. Again, performing such tax services would appear to create a mutuality of interest between the auditor and such senior financial officers. Those individuals covered by this Rule would be only those who have direct responsibility for oversight over those who prepare the financial statements and related information. A director whose only role at the issuer is serving on the board would not be covered by Proposed Rule 3523. The prohibitions of Proposed Rule 3523 apply whether the tax services are paid for by the audit client or by the executive officer directly.
Sarbanes-Oxley requires that all non-audit services must be approved by the audit committee of the issuer. Proposed Rule 3524 increases the auditor’s responsibility in seeking audit committee pre-approval by requiring the accounting firm to provide the audit committee with detailed documentation of the scope and nature of the proposed tax services; to discuss with the audit committee the potential effects on the audit firm’s independence; and to document the audit firm’s discussions with the audit committee. The PCAOB Proposed Rule is intended to supplement the SEC rules on pre-approval.
The PCAOB’s new Rules are proposed to become effective on the later of October 20, 2005, or 10 days after the SEC approves the Rules. All transactions completed before such date will be permitted. The October 20, 2005 date is intended to allow tax services in connection with 2004 to be completed, after allowing for all extensions. In the meantime, the PCAOB is accepting comments on the Proposed Rules until February 14, 2005.
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