AS DELIVERED ON 12/17/98


                AUDITOR INDEPENDENCE - THE ISSUES

   [Remarks of Richard H. Walker, SEC Director of
Enforcement, at the Symposium on "The CPA and Independence,"
sponsored by the New York State Society of CPA's and The CPA 
Journal, on December 17, 1998]


     Good morning.  Today marks the second occasion I've had
over the last two weeks to address members of the accounting
profession.  Last week, at an AICPA conference in Washington, I
told members of the profession of my great concern over an
alarming increase in financial fraud - an increase not just
in the incidence of financial fraud, but in the magnitude of
such fraud and its occurrence in companies where I would not have
expected to see it occur.  I explored with the group some of
the factors that may have contributed to this phenomenon - the
pressures on company management to meet analysts' expectations,
compensation practices that provide lucrative rewards for
achieving financial results, and judicial and legislative
developments that have reduced the profession's exposure to
liability.

     I left for today's symposium another subject that the
SEC believes to be of critical importance for the protection of
our capital markets:  the independence of auditors in both fact
and appearance.  Of course, my remarks today reflect my own
views and not necessarily the views of the Commission or other 
members of the staff.

     Sixty-five years ago, in the depths of the greatest
financial dislocation that ever hit this country, Congress
passed the federal securities laws.  The key objective that
Congress had in mind was to put in place a regulatory system 
that would restore and build investor confidence.  Congress 
knew that only by focusing on investor confidence could it 
pull the markets out of the depths and bring the nation back 
to prosperity.

     The past 65 years have shown that Congress was right.
The system Congress created in those dark times has today made
our economy the envy of the world.  It has put the United States
in first place in what is now a global competition for capital.
It has also made our system a model that other nations are
quick to copy.

     What is it that lies at the heart of the investor
confidence we have built up?  The answer is simple.  It is the 
fact that when investors bet their money in our markets, they can
reasonably count on a company's numbers being good.  This is
true in large measure because of the role that independent
auditors play.  Where there is a problem, independent auditors 
report it. Where a company is in serious trouble, independent 
auditors appropriately qualify their opinion.

     Investors know that they can trust our auditors because
they are -- and of equal importance -- they APPEAR to be
independent. It's not enough that audit quality is maintained 
and that the numbers are right.  It's also necessary that public
investors -- the users of financial reports -- perceive that 
the numbers are right.  The importance of the independence 
requirement was well summarized by the U.S. Supreme Court 
about 14 years ago when it said, "Public faith in the reliability 
of a corporation's financial statements depends upon the public 
perception of the outside auditor as an independent professional. 
... If investors were to view the auditor as an advocate for 
the corporate client, the value of the audit function itself 
might well be lost."
[United States v. Arthur Young & Co., 465 U.S. 805, 819 n.
15 (1984)]

     The SEC has a duty, imposed on the agency by statute,
to assure that the auditors who opine on the financial
statements of public companies are independent.  For example, 
Section 13 of the Securities Exchange Act requires public 
companies to file annual reports "certified ... by independent 
public accountants." Regulation S-X requires that accountants be 
independent, and Commission decisions clearly state that independence 
in both fact and appearance is required.  Regulation S-X also requires
accountants to comply with GAAS, which brings the profession's
own independence requirements within the ambit of the Commission's 
regulatory framework.

     These independence requirements are particularly
important today.  Individual investors are presently fueling 
our bull market by investing a healthy portion of their individually
managed retirement and 401(k) accounts in securities.  This
huge increase in investment activity, so critical for our
national prosperity, intensifies the need for good financial
reporting. As analysts told the ISB last year, if they perceive an
independence problem, they simply "walk-away from the
stock."

     At the same time that independence requirements are
becoming increasingly important, the auditing profession is 
facing a changing landscape that is requiring the profession to 
face complex and difficult issues.  Two of these changes have
particular relevance for auditor independence:  First, there
has been a dramatic escalation in competition to obtain and hold
onto auditing business.  And second, auditors now often find
themselves part of huge national (even multinational)
organizations that offer a literal supermarket of nonaudit
services and present greater opportunities for potential
conflicts of interest.  Let me discuss each of these
phenomena in turn.

     Approximately 15 or 20 years ago, auditors -- like
lawyers and other professionals -- began actively competing for
clients. This competition among auditors over the last decade 
or two has naturally included price competition, which in turn 
has led to dwindling profit margins for audit activity, and 
some would say to cost-cutting and a decrease in the amount 
of resources that auditors will spend on an audit.  All of 
this leaves auditors in a situation where other auditors are 
hungry to take away their business, where clients receiving 
approaches from competing firms are aware of this fact and 
are placing ever greater demands on their auditors, and where 
auditors are, at the same time, ever more limited in the 
amount of time and effort they can spend on a particular audit.
  
    In this environment, what pressure does an auditor feel
when a client, for any reason, is unhappy with an auditor's
judgment on a matter?  What pressure does the auditor feel 
when it is a
major client whose departure will make a real dent in the
auditor's practice?  The answer, some would suggest, is
obvious. And the pressure is made worse by the "lose-your-client-lose-
your-job" philosophy that may be found in some quarters of the
profession.  In these firms, partners without clients can be
labeled "nonproductive" and fired, while rainmakers are
always prized.

     Now add to this mix the other big environmental change
in the auditing profession.  In order to deal both with very
thin profit margins in auditing and with litigation risk from
auditing activities, firms have increasingly turned to providing
clients with far more profitable nonaudit services.  This has 
been a true metamorphosis for accounting firms, and particularly 
for the big firms, which some estimate now get 30 to 40 percent 
of their revenues from consulting and under 40 percent from
accounting and auditing.  Some of these firms have come to offer 
virtual one-stop-shopping for all a client's business consulting 
needs.

     This brave new world of highly-competitive, full-service,
accounting-slash-consulting, and the potential conflicts and
pressures it creates for auditors, raise concerns about both
the actual quality of financial reporting and about the level of
investor confidence in this new environment.  These concerns
are based not just on speculation but on what we're seeing in
our investigations and other contacts with the profession.

     For example, in one situation, we are told of pressure
by a client on the client's auditor to help improve the client's
financial performance.  The auditor's firm also provides
lucrative consulting services to the client and is anxious
to provide even more.  Although the dialogue between the client
and the auditor is free of any overt threats, the clear subtext
of the message from the client is:  "You help me out with the
numbers, and I'll help you out with the business."  Implicit
in the message is:  "If you don't help me out, you will see the
business go elsewhere."

     In another case, we are confronted with a large
financial restatement, purportedly occasioned by imperfections in a
company's computer system used to collect financial data.
The company's auditors, who failed to detect the problem during
the audit, also served as consultants to the company with
respect to the computer system.

     In yet another case, we see several partners in one
office of an accounting firm buying and selling the securities of
large corporations that are audit clients of that office and other
offices of the firm.  The result, of course, is a classic
violation of the most fundamental independence rules.  The
firm does not require its partners to affirmatively disclose
their securities holdings, so that they can be computer-matched
against a list of the firm's clients.  All the partners need do is
sign an annual form assuring the firm that they don't own stock
in clients.  The next question, of course, is how should the
SEC respond to this situation.  Should we tell the major
corporate clients and investors that the financials are now deemed
unaudited?  Require the firm to resign as auditors for these
major clients?  Try to cordon the relief just to clients of
the office in question?  Proceed with an enforcement action?
     In still other cases, we see firms setting up all
manner of purportedly separate entities -- affiliates, allies, spin-
offs, whatever - specifically created to engage in businesses that
auditors cannot themselves engage in.  Some of these new
entities may be owned directly or indirectly by the accounting firm,
while other such entities may be owned by third parties (or even
publicly held) with certain affiliations or ties to the
accounting firm.  While some of these arrangements between
accounting firms and other entities can pass muster under
the independence rules, others cannot.  Auditors obviously
cannot expect to do through a controlled or closely related entity
what they cannot do directly and still maintain their
independence.

     We see the flip side of this issue in the recent
interest by certain large public companies - financial services firms -
in acquiring accounting firms.  These companies want to add to
their menu of client services, and in so doing, to compete with
established professional firms.  These ventures can take the
form of complex so-called "alternative practice structures,"
where a public company buys a firm's nonaudit business, hires the
firm's partners as employees, and leaves the audit practice in a
separate partnership of the firm's original partners.  There
is here the natural concern that the public company may exert
control over the audit partners, who are also the company's
employees.  And in yet another variation on the theme, we
are now seeing proposals to merge legal and accounting professional
firms.  The American Bar Association is presently
considering proposals for combined accounting and legal firms.

     The possible number of different kinds of combinations
between accountants and other business service providers is
endless.  But faced with these possibilities, how do we sort
out the independence issues?  What do we say (i) when lawyers in
one part of a firm are ethically bound to advocate a client's
interests zealously and to hold information obtained from
the client in the strictest confidence; (ii) while accountants
in another part of the firm are ethically bound to exercise
skepticism in dealing with the client's management and must
show primary allegiance to the public by disclosing damaging
confidential information about the client; (iii) while
consultants in another part of the firm are giving the
client management advice, the results of which may be reviewed
during the audit; and (iv) while others in the firm are trying to
sell expensive new goods and services to the client?

     As arrangements with clients become more and more
complex, we question whether so-called "firewalls" can have any
realistic possibility of managing all these conflicts.  Even with
model firewalls, what is the  reasonable investor to make of an
audit opinion that expresses a view on the results of the
accounting firm's management consulting?  What is the reasonable
investor to think when the audited financials contain an opinion 
from the accounting firm's law partners on the likely outcome of
major litigation?  Again, will these reasonable investors - like
the analysts we heard from last year - simply "walk away from
the stock"?  And even if firewalls could actually be effective
in dealing with these conflicts - which we would suggest they
cannot - these firewalls would then effectively destroy the
information sharing and service enhancements that are put forward 
as the justification for allowing a single firm to offer all these
services in the first place.

     As we move forward in the new auditing environment, I
can assure you that when the SEC sees an independence violation
affecting a public company, we will be prepared to take
action. This may involve discussion and negotiation to avoid the
problems, where possible.  Where not possible, our response
may involve enforcement activity.  In October of this year, the
SEC amended its Rule 102(e), dealing with discipline of
professionals who practice before the Commission.  The amendments 
specify that accountants can be held liable for "improper professional
conduct" in situations where they have violated their own
professional standards, including standards relating to
auditor independence, either: (1) through repeated negligence, or
(2) through a single instance of "highly unreasonable conduct"
in circumstances where the accountant should know that
"heightened scrutiny" is warranted.

     In adopting this standard of highly unreasonable
conduct in circumstances requiring heightened scrutiny, the 
Commission made clear that auditor independence was one of the 
particular circumstances it had in mind.  The Commission's October
release containing the Rule 102(e) amendment states as follows:
"Because of the importance of an accountant's independence to the
integrity of the financial reporting system, the Commission
has concluded that circumstances that raise questions about an
accountant's independence always merit heightened scrutiny.
Therefore, if an accountant acts highly unreasonably with
respect to an independence issue, that accountant has engaged in
`improper professional conduct.'"

     The SEC's October 1998 release also stated that the
Commission's law enforcement proceedings against accountants
will not be limited to cases involving at least "highly
unreasonable conduct."  Rather, where an accountant has engaged 
in even a single act of negligent conduct, the Commission remains
prepared to use its cease-and-desist remedy, a separate type of
proceeding explicitly provided for by Congress in Section 21C of 
the Securities Exchange Act.

     While we are prepared to enforce the auditing
profession's independence requirements when they impact public 
companies, we would much rather deal with independence issues 
upstream, before they become problems.  In this vein, we are 
encouraged by the profession's recent focus on independence.  
Our hosts this morning, the CPA Journal and the New York State 
Society of Certified Public Accountants, in particular, have 
taken a leading role in providing a forum for discussion of 
different views on independence requirements and how to maintain 
them in a changing profession.  This kind of informed discussion 
by leaders of the profession will facilitate responsible solutions 
to these issues.

     We especially look forward to hearing from Bill Allen,
our next speaker this morning, and his colleagues on the
Independence Standards Board as they carry their efforts forward 
in the coming months.  As you know, the SEC worked with the AICPA to
create the ISB last year to be a vehicle for the profession to consider
these important issues and to propose a new codification of
the profession's independence rules.

     At this stage, it is too early to predict where the
ISB, the SEC and the profession will ultimately go on independence.
Some may advocate fine tuning existing rules on independence,
basically taking the position that the current system works.
Others may propose more radical alternatives, some trusting
more to individual firms and auditors, and others advocating even
greater safeguards to meet new challenges.  We may even see
proposals for more organic changes, such as a separation of
auditing practice into stand-alone firms that are public or
quasi-public in character, with the remainder of the accounting
profession then free to offer the full range of business
services, with all of the benefits that these services can
bring to clients.  But while we don't know where the profession
will ultimately come out on all of this, we already are seeing
the process beginning and the ideas flowing.

     Just last month, the ISB proposed a creative new way to
incorporate a formal consideration of independence issues
into every audit.  Under this proposed standard, auditors would
be required to sit down with their client's audit committee
during the course of the audit "to discuss the auditor's
independence." The auditor would also have to provide written 
disclosure of all relationships between the auditor and the client
"that may be reasonably thought to bear on independence."  This 
proposal closely resembles a portion of a remedial provision that we
suggested in pending litigation last summer, and we think that
rolling this requirement out to the profession as a whole is
a great way to promote a considered look at independence
issues in each and every audit.  We believe that during these annual
conversations, auditors should be required both to describe
in detail their consulting services and other ties to the
client over the past year, as well as the cost of the consulting
services, and  to explain to the client why the auditors
believe their consulting work and fees do not affect their
independence as auditors.

     Separately, we are very interested in recent proposals
by the ISB and others that there be a prohibition for some
reasonable period against an auditor accepting employment
with an audit client.  Employment following close on the heels of an
audit opinion creates the potential for actual independence
problems, and in many cases creates the appearance of a quid-
pro-quo that diminishes the credibility of financial reporting
and hurts investor confidence.

     On another recent topic of ISB discussion -- expansion
of the use of materiality concepts in assessing auditor
independence -- I must sound a note of alarm.  Some have proposed that
even direct interests in audit clients should be subject to a
materiality test.  I question whether applying a materiality
test so broadly in the independence area would create too much
uncertainty and too much of a temptation for some firms to
ride the edge of what is allowed for materiality.  There is also
some concern that a broad materiality excuse could embolden
clients to demand more of auditors.  In short, I believe that an
expanded materiality analysis is plainly not a road we should take
when our concern is auditor independence, though perhaps there
should be some allowance for consideration of materiality in
determining the remedy for cases involving inadvertent independence
violations.

     And whatever place materiality may have in independence
analysis - such as the present use of materiality to assess
indirect interests in audit clients - I would stress that
the focus should include both the qualitative and quantitative
aspects of materiality.  Where materiality is appropriately
considered at all, it cannot be limited to mathematical
analysis. Rather, it depends on an evaluation of all relevant 
facts and circumstances.

     Most important of all, as you consider all of these
ideas, and many others in these exciting times for auditor
independence, we at the SEC would urge you to consider each 
proposal from the investors' point of view, as well as from 
the auditors' point of view.

     In drawing to a close this morning, I will go back to
the SEC's October 1998 release amending its Rule 102(e) that I
mentioned a few moments ago.  In that release, the
Commission stressed the obvious importance of accountants to the
investing public.  But the Commission went on to make the point that
"[b]ecause the Commission has limited resources, it cannot
closely scrutinize every financial statement.  Consequently,
the Commission must rely on the competence and independence of
the auditors who certify, and the accountants who prepare,
financial statements."  In short, you are the SEC's and public
investors' eyes and ears behind the scenes in every public corporation.
We could not think of doing without you.  We thank you for your
great work in the past that has made our securities markets
what they are today, and we thank you for your recent initiatives
-such as this morning's forum - to focus on preserving
principles of independence in a changing professional environment.  
We look forward to hearing your profession's response to the needs
of the times and to working with you to satisfy these needs and
continue the protection you have given investors over the years.

     Again, thank you for the opportunity to meet with you
this morning, and I'll now turn the podium over to Bill Allen.