Date:    08/17/2000  2:47 PM

Subject: Attention Lynn E. Turner: re File No. S7-13-00

ATTENTION: Lynn E. Turner
     
August 16, 2000
     
Lynn E. Turner
Chief Accountant
United States Securities and Exchange Commission 
Washington, D.C.  20549
     
Dear Mr. Turner:
     
        Thank you for your transmittal of August 11, 2000 regarding the
Commission's recently published rule proposal addressing auditor 
independence issues: "Revision of the Commission's Auditor Independence 
Requirements." I have read through the materials, including the testimony, 
press releases, and speech transcripts with considerable interest-having 
previously read the proposal itself, when it became available on EDGAR. I am 
pleased to provide these comments regarding the rule proposal and related 
issues.
     
        First and foremost, I believe that direct financial interest in all
audit clients should be proscribed for all employees of a professional firm 
providing auditors' services. This is a bonding mechanism by the profession 
to the public which states directly that there is no direct financial 
interest in the auditee. This direct financial interest proscription should 
likewise apply to the employees' household, i.e., those under the same roof. 
This addresses the ownership by the auditor (considered to be the 
professional auditing firm and its employees) and by those who clearly share 
joint investments and outcomes of such investments. Beyond the household, I 
believe that the confidentiality restrictions upon auditors should preclude 
the public concerns regarding other parties' investments, in other than 
enforcement actions associated with breaches of confidentiality and insider 
trading.
     
        As an aside, I believe all arguments about new economies mandating
that capital be acquired through non CPA owners, investments by working 
spouses be permitted, or such holdings in the past being "merely technical" 
violations--not leading to lack of independence in fact--miss the point and 
are vacuous. We are dealing in capital markets that make accessibility to 
capital through diverse instruments easier as opposed to harder, the ability 
to tailor holdings to avoid conflicts is likewise easier in the Internet 
setting than in yesteryear's hard-copy world, and a violation of a bonding 
arrangement cannot be argued to be de minimus based on magnitude. The entire 
point of proscription is that none is permitted. It removes the choice and 
sets aside magnitude as irrelevant. To argue that a pension plan of a spouse 
should not have to bother to avoid holding a particular company's stock if a 
husband or wife works for the auditing firm of the auditor of that company 
is tantamount to saying that the auditor should be able to hold that 
auditee's stock. If the latter is deemed to be unacceptable, so should the 
former. The fact is when professionals choose career paths, there are 
certain commitments undertaken, and for those associated with auditing firms 
and benefiting from the credibility that such firms have built up over time 
from their bonding arrangement of no direct financial interest in auditees, 
all members of the household share in that career choice commitment. To try 
to blame a new economy or a frequency of working spouses as the reason for 
weakening a clear bonding with the public by the profession is again vacuous 
and ill-reasoned.
     
        Second, I believe that the outsourcing of internal auditing to the
firm conducting the external auditing should never have been permitted. I 
simply observe "it's about time" that such a practice is to be proscribed. I 
would suggest entire proscription of outsourcing by the external auditors of 
their firms' auditees' internal auditing.
     
        Third, I would totally reject the Commission's concept of defining
direct financial interest proscription at an individual employee level, 
based on involvement in or affect on an audit engagement. Moreover, the 
concept of having spin-off firms, subsidiaries, or entities of nonauditing 
services bearing the same or related name as the auditing firm should not be 
accepted as solving any promulgation on the independence of auditors. 
Substance versus form should be the focus, and the clearness of the bonding 
signal to the public in exchange for the public covenant implicit in the 
auditor's public accounting franchise, must be emphasized. In other words, 
if one works for firm A and firm A audits client X, then no employee of firm 
A should hold any direct interest in client X, period. The corporate 
structure of associated firms does not alter the direct interest of 
employees of firm A. Note that one of the good results in the recently 
announced arbitration findings involving Arthur Andersen and Andersen 
Consulting was the requirement of a name change by the latter as the total 
separation occurs. Complete divestiture and no name identification with the 
audit firm is the substance of compliance with the direct interest rule by 
all employees of the firm doing the audit.
     
        As I have read past discussions of independence violations and the
proposed response, I become concerned about the "signal" being sent to new 
professionals. Consider the scenario of two professional firms' employees, 
one of whom broke the rules, participated in a stock market which had 
substantial returns in recent times, and now has been "caught," relative to 
a second professional who honored the rules of his profession. To suggest 
that professionals did not know they were in violation should be impossible 
to accept for those entrusted with auditing public corporations: after all, 
direct financial interest is very easy to define and understand. To treat 
the setting as simply an occasion for improving the firm's controls in the 
future with no real penalty to those doing the transgression would seem to 
reward the 'wrong-doer,' much as amnesty programs have done in the past. In 
my judgment, those who blatantly broke a clearly set forth direct financial 
interest proscription are not individuals who should be considered able to 
carry the public trust forward. Yet, not only are the punitive consequences 
unapparent for this group, but the current proposals seem to suggest a "mea 
culpa" by regulators that suggest-if you want the rules changed, break them 
on a sufficiently large scale that we have to change them. I see no reason 
to alter the direct investment proscription rules. The proposals to focus on 
individuals rather than firms, degree of involvement rather than firm 
employment, and amount of affect rather than recognizing the sharing in firm 
viability and profits implicit in being an employee and/or partner, are 
inviting gamesmanship, blurring very clear signals, and rewarding past bad 
acts.
     
        Fourth, the SEC should decide what really must be proscribed (e.g.,
outsourcing of internal auditing to that firm acting as external auditor) 
and what is not to be proscribed as a separate matter from disclosure. If an 
activity is deemed conflicting with independence, then it is the activity 
that should be explicitly proscribed. I believe the source of the problem 
goes back to the hotly debated question of commissions and contingent fees. 
If we all agree that being paid contingent on the result creates, by design, 
an interest in the outcome, then that cannot be tolerated in any forum, be 
it mergers and acquisitions, litigation settings, tax services, or other 
so-called joint alliances with auditees. The question of focus must be the 
objectivity of the service performed and the clear distinctiveness of 
remuneration for such service from the results of the accounting, auditing, 
tax, or dispute setting. The auditing firm should not become a seller or 
intermediary where a fraction of a sale to an auditee reverts to the 
auditing firm. Note that this calls into question recent developments at the 
AICPA, the referrals being promoted by a variety of companies through CPA 
firms, and similar issues. The point is that the CPA's name should not be 
"for sale" but rather should be a "reputation signal" of objective, quality, 
reliable, professional services.
     
        Fifth, the magnitude of the remuneration or its percentage
relationship to auditing fees should not be used in setting independence 
guidelines or even implied to signal some issue concerning independence or 
objectivity. Anyone familiar with professional services understands that 
auditing fees by their nature tend to be recurring over time and often 
similar in magnitude, whereas many consulting fees are episodic. Indeed, the 
average corporation is reported to refinance its large debt sources only 
once in seven years. The notion that some have suggested that if a service 
is requested that exceeds some artificial threshold of an audit fee, it 
ought to be proscribed is in my opinion without any justification. Is one 
suggesting that auditors have less independence for large clients than small 
clients since the former pay higher auditing fees? Are small clients not to 
be privy to related accounting and auditing services merely because their 
audit fees are small? Think through the arguments with care, and the 
non-sequitur nature of the debates becomes apparent.
     
        Sixth, dramatically opposed arguments have been offered by the same
voices: (1) we have more qualified professionals and produce better audits 
because of other services provided, yet (2) we have "split" these staffs 
through firewalls or spin-off arrangements and that ensures their lack of 
conflict. These two diametrically opposed positions unveil the essence of 
the real issue. Conflict should be directly addressed in the form of 
proscribing direct financial interest and specific proscribed services, and 
then the professional staff in a single firm should not only be subject to a 
consistent set of independence standards but should likewise share 
information on engagement services performed for a single client and benefit 
from that synergy. I believe that professionals who have an opportunity to 
participate in accounting, management consulting, turn-around experiences, 
tax settings, and dispute resolution are more prepared to be effective 
professionals, including when they are placed in auditing settings. However, 
the important point is independence and objectivity hallmarks, as well as 
the "tone at the top" of the professional services firm. The message cannot 
be one of salesmanship first or service to clients' management as being 
foremost. Instead, the message must be Certified Public Accountant, 
objective competent professional, and here are the results of our services. 
Remember, research indicates that a top-valued attribute of CPA firms that 
has been reported as triggering both choice and retention decisions has been 
that auditing firm's backbone and independence. How many times have you 
heard a CEO state, "I expect the CPA to help keep me out of trouble..." A 
cheerleader can be found in many quarters, but a trusted advisor that helps 
you gain a reputation in the market for credible reporting and performance 
is neither plentiful nor undervalued. In a sense the entire attention of the 
SEC and the profession to the questions at hand is a sign of real past 
success. The reason auditees approach professional accounting firms is not 
generally to "influence their audit" but rather to access professionals 
whose experience, competence, and objectivity would seem to be positive 
traits in addressing the other needs of the company. The SEC should walk 
very carefully in determining how to draw the line on proscriptions and 
service limits. 
     
In a sense, a restoration of the pre-contingent fee/commission era is 
sought, restoring the concept of objectivity of services and removing the 
sales aspect that might blur technical substance from being accorded 
appropriate weight. This is best accomplished by removing the 
contingent/sharing/commission framework from all services provided by a 
public accounting firm to the auditee. Similarly, work within the public 
accounting firms to ensure a structure that rewards objective competency and 
independent performance, to achieve the appropriate tone at the top. It 
should be in the interest of each of those firms not to create an incentive 
system that by design would be described as creating conflicts with its 
auditors' independent relationship to auditees. Yet, this is an area where 
joint efforts of self-regulation and regulation can be combined with the 
firms' management to proscribe the practices that are the real culprit. We 
all understand that performance evaluation systems tend to drive 
performance. They can be designed to be compatible with the independence of 
auditors.
     
        Seventh, care is needed in the disclosure area. Remember the
conflicting considerations. When the auditing standards prescribed 
disclaimers for lack of independence, the point was emphasized that the 
reason for lack of independence was not to be reported, because it was 
feared the user might second-guess the decision and discount the reason for 
the lack of independence and choose to rely on the financial statements. 
Instead, it was recognized that the auditor was responsible for determining 
his or her lack of independence under the standards and then reporting the 
result of that decision. Somewhat similarly, the "plain English" push in the 
international standards and other forums, as well as the information 
overload arguments, all challenge whether excessive details inform or 
camouflage. On the other hand, efficient markets have often argued that as 
long as the information is disclosed, the market participants can reflect it 
and resource allocation is improved. I believe the disclosure idea of other 
services provided may well be an avoidance of important decisions regarding 
proscriptions, modes of payment and compensation, and firm-wide standards, 
rather than informative value added. For you to tell me that the auditing 
firm performed a service in one year that was ten times the audit fee, in my 
judgment, gives me no information on independence. If that service was 
objectively provided in an area in which the auditor had expertise and there 
was synergy in learning about that area of operations when evaluating the 
overall risk of the audit setting, I would not only believe the service was 
a positive signal but also a value-added signal. Indeed, one could consider 
the positive quality signal as follows: a one-time need arose which was a 
large-scale project and the auditing firm competed in the market place and 
was selected, with the governance structure's full consideration of 
independence considerations, and that auditee still believed the task could 
best be performed by its auditors. I believe the complement to proscription 
of services is governance. If disclosure is to occur, then it should be done 
as information on expenditure patterns rather than emphasized as necessarily 
relevant in any way to the independence question. As a researcher who 
benefits from public information being accessible in order to do systematic 
study of various empirical phenomena, I should probably embrace additional 
disclosure as an opportunity to explore some of the assertions made in the 
standard-setting and regulatory processes. Yet, I have to hasten to point 
out a cost-benefit context and an implicit suggestion that information 
rather than data is being sought. If it is information on independence being 
sought, then I fail to see the causal link of dollar amounts or proportions.
     
        Note that prior to your communication, I drafted a commentary which
I have been informed is forthcoming in Accounting Today (probably the next 
issue). While some of my points herein relate to that article, rather than 
repeat its content herein, I would simply direct your attention to the 
source.
     
        If you have any questions about these comments or those that appear
in my article, don't hesitate to contact me. I hope these perspectives will 
be of use in your deliberations.
     
                                        Sincerely,
     
                                Wanda A. Wallace, Ph.D., CPA, CMA, CIA