Auditor Independence: A BIT MORE ROPE.

• Author: Rockness, Joanne

This past year may well be remembered as a year of some of the biggest changes in public accounting since the 1933 and 1934 Securities Acts. Umbrella professional service organizations have grown out of traditional CPA firms. CPA firms have been acquired by traditional professional and financial service organizations. American Express, Century Business Systems, and H&R Block are now among the largest CPA firms.

The Big Five have evolved into multidisciplinary professional service providers with consulting and other non-audit services accounting for 70 percent of revenues. Allegations abound that audit fees are often set unprofitably low to establish client relationships and then sell other services. The result? A serious question of auditor independence and new SEC regulation.

The Securities and Exchange Commission's (SEC) commitment to auditor independence is not new, but its June 2000 proposal made independence the hottest and perhaps the most controversial topic of the year. Chairman Arthur Levitt asserts that independence is "the core of the accounting profession ... the space to think, to speak, and to act on the truth. And truth is the lifeblood of investor confidence." The auditors' role is to act in the interests of shareholders and the public, not in the interest of management. With today's financial markets bringing enormous pressure on management to meet or exceed analysts' expectations, reports of earnings management (sometimes even fraud) appear to be at an all-time high. The SEC asserts that the audit role must be strong and reliable to assure the integrity of management, the fairness of financial statements and ultimately the integrity of the financial markets, and it believes auditor independence in both fact and appearance to be essential. The November 2000 SEC rul ing both moderates and finalizes the commission's independence stance.

Why is the SEC focused on independence regulation now? One answer appears to come from the proliferation of internal audit outsourcing services. Internal audit outsourcing, one of the fastest-growing services in the Big Five, may be the proverbial straw that broke the camel's back.

In 1996, the American Institute of Certified Public Accountants (AICPA) Ethics Committee revised rules to allow AICPA members to perform extended audit services, including internal audit outsourcing services for audit clients, as long as a member of the firm does not act or appear to act in a capacity equivalent to a member of client management or an employee. Much of corporate America embraced this as a very attractive alternative to staffing the internal audit department, a department for which it is notoriously difficult to hire and retain competent, experienced employees.

In its June 2000 proposal, the SEC asserted that performing an internal audit function results in the audit firm assuming a management function, thereby causing external auditor reliance on a system that the same firm has designed and/or maintains (i.e., auditing its own work). How external auditors performing additional work as internal auditors can be viewed as independent is a mystery to many, but the November regulation reflects a compromise position.

Accounting firms' expanding scope of services is the other primary area apparently prompting SEC concern. While CPA firms have performed non-audit services for audit clients for the past 50 to 100 years, recent growth in this area has been dramatic. In 1999, fees for...