Watered-down rule might still wet small CPAs

For small accounting firms, the waiting game begins.

Securities regulators on Wednesday adopted a rule to strengthen auditor independence that has virtually no effect on small accounting shops. But some are wondering how long the rule’s provisions will take to reach them – a possibility if state regulators follow suit.

The Securities and Exchange Commission approved the controversial measure, called the auditor independence rule, in a unanimous vote after reaching an 11th-hour compromise with major accounting firms.

The rule aims to prevent conflicts of interest that could compromise the integrity of companies’ financial statements (InvestmentNews, Oct. 2).

The rule affects only firms that audit public companies, which tend to be the largest in the accounting industry. But state boards of accountancy, which set regulations for firms of all sizes in their states, could follow the SEC’s lead.

Trickle-down effect

“Whether it will trickle down is hard to say,” says Christine Bogard, audit partner at Abramson Pendergast & Co. in Bellevue, Wash., who also serves on that state’s Board of Accountancy’s quality assurance review committee.

“I don’t know whether states will want to make things more difficult for small businesses than it already is,” Ms. Bogard says.

At the meeting last Wednesday, SEC Commissioner Laura Unger asked the staff whether the rule satisfied concerns aired during public hearings about whether states would adopt similar provisions.

“State regulators are very independent, and they’ve not always adopted our [rules],” Lynn Turner, chief accountant of the SEC, told Ms. Unger. “They’ll look at this but will go through their own process.”

The original version of the auditor independence rule, which was proposed in June, was even more controversial than the one adopted Wednesday. It contained a provision that would have banned virtually all non-audit services a firm could sell to an audit client.

The agency received more than 3,000 letters – second only to the response to the controversial Regulation FD – and heard more than 100 witnesses during 30-plus hours of testimony before arriving at the watered-down version of the rule.

To the chagrin of the accounting industry, the SEC appeared to be rushing the rule through the public hearing process to get it approved before SEC Chairman Arthur Levitt leaves next year.

Until last Tuesday, accounting industry insiders were not even sure whether the rule would reflect the original proposal or would include compromises on the biggest points of contention.

The final rule has yet to be released. But according to a summary presented at the hearing, the rule will, among other provisions:

* Restrict investments in audit clients mostly to those who work on the audit or can influence it.

* Allow firms to provide consulting services to audit clients provided certain requirements are met.

* Allow firms to perform up to 40% of an audit client’s internal audit work.

If state boards adopted similar provisions, Ms. Bogard’s biggest concern would be that 40% cap, even though the SEC’s rule includes an exception for public companies with less than $200 million in assets.

“Most of our clients are of such size that they don’t have an internal audit function,” Ms. Bogard says. “If that [provision] reaches us, yes, that could have an impact.”

Gary Shamis, a partner with Cleveland accounting firm Saltz Shamis & Goldfarb, says that if state boards were to use the SEC rule as a benchmark and keep the cap at $200 million, it would be a non-issue. Most small firms handle clients with fewer assets.

Mr. Shamis originally raised the issue of state boards following the SEC’s lead at an SEC public hearing in September. “I talked to three of the members of the Ohio Board of Accountancy … to inquire how these rule changes at the federal level will influence their requirements on independence,” he testified.

“I was sufficiently convinced [in] my discussion with the Ohio board members that a change at the SEC level has a very good chance of affecting the rules that govern my firm’s independence.” He is now “thrilled” with the minimized effect of the rule.

Over the past decade, accounting firms have begun offering other services to clients such as management consulting. The SEC’s goal is to assure investors that financial statements are free of impropriety due to a firm’s relationships with its audit clients.