FEDERAL COMMUNICATIONS COMMISSION

WASHINGTON, D.C. 20554

# IN REPLY REFER TO: 1600E

RAO Letter 28

DA 99-2674

Adopted: December 1, 1999

Released: December 1, 1999

**Responsible Accounting Officer:**

Re: Auditor Independence and Objectivity

## I. Introduction

The Commission relies on outside auditors to verify carrier compliance
with a variety of Commission rules. For this to be effective, the
Commission needs to be confident that the auditors are acting
independently and that the opinions expressed by the auditors are
objective and unbiased. This Responsible Accounting Officer (RAO) letter
discusses the importance of independence and objectivity in the
performance of audit work required by the Commission and adopts, as
modified for Commission purposes, *Standard No. 1* of the Independence
Standards Board[^1], which requires auditors to disclose and discuss
potential independence problems.

## II. Background

In the *Joint Cost Order*, adopted in 1988, the Commission required
large local exchange carriers to obtain independent audits to verify
that their systems for allocating costs between regulated and
nonregulated activities accurately reflected the procedures set forth in
their cost allocation manuals and application of the Commission's
rules.[^2] The Commission expressed concern in the *Joint Cost Order*
that independence problems might arise, but the Commission declined to
choose the independent auditors for the carriers, instead relying on the
auditors' standards of professional conduct to mitigate its
concerns.[^3] The Commission stated that it would review the auditors'
work and "take appropriate corrective action if \[it had\] reason to
believe that a particular firm has not performed its task in an
objective and competent manner."[^4] Since that initial requirement was
adopted in 1988, the Commission has added many other instances in which
independent audits are relied upon to assure compliance with its rules.
[^5]

Auditors are governed by standards of professional conduct that require
them to remain objective toward and independent of the audited company.
Those standards emphasize independence and objectivity in both fact and
appearance, reflecting the practical view that, even if independent in
fact, auditors should avoid even the appearance of bias so that those
who rely on the results of their audits can be confident in their work.

Consulting and advocacy by accounting firms has increased substantially
in recent years.[^6] In many instances, carriers use the same accounting
firms to advocate positions on issues before the Commission that they
engage to perform independent audits. Advocacy or support on behalf of a
carrier concerning issues before the Commission, particularly with
respect to auditing or accounting matters, could raise concerns and
questions about the independence and objectivity of the auditors.

## III. Discussion

To address the independence implications for the new consulting and
advocacy services provided by auditors, the Securities and Exchange
Commission and the American Institute of Certified Public Accountants
recently established the Independence Standards Board (ISB). The initial
standard of the ISB, *Standard No. 1---Independence Discussions with
Audit Committees,* requires the following:

> At least annually, independent auditors shall:

a)  disclose to the audit committee (or the board of directors if there
    > is no audit committee), in writing, all relationships between the
    > auditor and its related entities and the company and its related
    > entities that in the auditor's professional judgment may
    > reasonably be thought to bear on independence;

b)  confirm in writing that in its professional judgment it is
    > independent of the company within the meaning of the Securities
    > Acts; and

c)  discuss the auditor's independence with the audit committee.

We believe that *Standard No. 1* can be adapted to address in part the
Commission's concern about auditor independence. The Commission's
concern that audits be performed with independence and objectivity
mirror the concern of audit committees that are responsible for engaging
independent auditors for corporations. Therefore we establish the
following standard based on ISB's *Standard No. 1*. For independent
audits performed pursuant to Part 32 and Sections 64.901 *et seq*. of
the Commission's rules[^7], the auditor shall at least annually:

a)  disclose to the Accounting Safeguards Division (ASD) of the Common
    Carrier Bureau in writing all relationships between the auditor and
    its related entities and the carrier and its related entities that
    in the auditor's professional judgment may reasonably be thought to
    bear on independence;

b)  confirm in writing to ASD that in its professional judgment it is
    independent of the carrier; and

c)  discuss the auditor's independence with ASD.

Creation of the Independence Standards Board is an encouraging sign of
the profession's desire to preserve the independence and objectivity of
auditors. Although adoption of *Standard No. 1* alone may not be enough
to satisfy the Commission's concerns, it should lead to a frank and open
dialogue that will benefit both the Commission and the auditors.

Because items in this RAO letter pertain to the collection of
information, Office of Management and Budget (OMB) approval of the
proposed collection is required by the Paperwork Reduction Act of
1995.[^8] Under the Paperwork Reduction Act, members of the public are
not required to respond to a collection of information sponsored by the
Federal government, and the government may not conduct or sponsor a
collection, unless the information collection contains a currently valid
OMB control number. Accordingly, independent auditors will not be
required to comply with this RAO until OMB has given such approval. ASD
will notify the public when OMB has approved the proposed information
collection.

This letter is issued pursuant to authority delegated under Section
0.291 of the Commission\'s rules, 47 C.F.R. § 0.291. Applications for
review under Section 1.115 of the Commission\'s rules, 47 C.F.R. §
1.115, must be filed within 30 days of the date of this letter. *See* 47
C.F.R. § 1.4(b)(2).

If you have any questions please contact Hugh Boyle at 418-0820.

> Sincerely,
>
> Kenneth P. Moran, Chief
>
> Accounting Safeguards Division
>
> Common Carrier Bureau

[^1]: *See* [Independence Discussions with Audit
    Committees]{.smallcaps}*, Independence Standards Board Standard No.
    1* (Independence Standards Bd. 1999)(*Standard No. 1*).

[^2]: ^?^ *See* Separation of Costs of Regulated Telephone Service from
    Costs of Nonregulated Activities, *Report and Order*, CC Docket No.
    86-111, 2 FCC Rcd 1298, 1330-31, ¶¶ 254-56 (1987) (*Joint Cost
    Order*), *recon.*, 2 FCC Rcd 6283 (1987), *further recon.*, 3 FCC
    Rcd 6701 (1988), *aff\'d sub nom.* *Southwestern Bell Corp. v. FCC,*
    896 F.2d 1378 (D.C. Cir. 1990). The audit requirement is codified at
    47 C.F.R. § 64.904(a).

[^3]: *Id*. at 1332, ¶ 270.

[^4]: *Id*. at 1333, ¶ 274.

[^5]: The areas in which the Commission relies on independent auditors
    include the following: 1) carrier compliance with our cost
    allocation and affiliate transactions rules, *see* 47 C.F.R.
    64.904(a); 2) Universal Service Administrative Company's Schools &
    Libraries Division and Rural Health Care Division to help ensure
    against fraud, waste, and abuse, *see* Changes to the Board of
    Directors of the National Exchange Carrier Association, Inc., *et
    al.*, *Report and Order* in CC Docket No. 97-21, *Second Order on
    Reconsideration* in CC Docket No. 96-45, 12 FCC Rcd 18400, 18439-40,
    ¶¶ 75-76 (1997); 3) section 272 biennial audits, *see* 47 U.S.C. §
    272(d)(1); and 4) merger reviews to test compliance with conditions
    such as improved access to unbundling for CLECs, *see, e.g.*,
    Applications of Ameritech Corp. Transferor, and SBC Communications
    Inc., Transferee, *Memorandum Opinion and Order*, FCC 99-279, ¶¶
    410-12 (rel. Oct. 8, 1999).

[^6]: *See, e.g.*, Barry C. Melancon, *A New Initiative for
    Accreditations*, [Journal of Accountancy]{.smallcaps}, Feb. 1999, at
    4.

[^7]: These engagements include audits, attest examinations, agreed-upon
    procedures engagements, and any other engagement required of
    independent auditors.

[^8]: ^?^ *See* 44 U.S.C. § 3507 (1995).