Document ID: SEC-2006-0539-0001
Agency: sec
Document Type: Notice
Title: Public Company Accounting Oversight Board: Independence, tax services, and contingent fees; ethics and independence rules
Posted Date: 2006-04-25T04:00Z

[Federal Register: April 25, 2006 (Volume 71, Number 79)]
[Notices]               
[Page 23971-23974]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr25ap06-128]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53677; File No. PCAOB-2006-01]

 
Public Company Accounting Oversight Board; Order Approving 
Proposed Ethics and Independence Rules Concerning Independence, Tax 
Services, and Contingent Fees and Notice of Filing and Order Granting 
Accelerated Approval of the Amendment Delaying Implementation of 
Certain of These Rules

April 19, 2006.

I. Introduction

    On July 26, 2005,\1\ the Public Company Accounting Oversight Board 
(the ``Board'' or the ``PCAOB'') adopted proposed Ethics and 
Independence Rules Concerning Independence, Tax Services and Contingent 
Fees,\2\ (herein, ``the proposed rules'') pursuant to the Sarbanes-
Oxley Act of 2002 (the ``Act'') \3\ and Section 19(b) of the Securities 
Exchange Act of 1934 (the ``Exchange Act'').\4\ The proposed rules 
include general rules with respect to ethics and independence, restrict 
certain types of tax services a registered public accounting firm may 
provide to its audit clients, and prohibit contingent fee arrangements 
for any services a registered public accounting firm provides to its 
audit clients, in order to maintain its independence. On November 22, 
2005, the Board adopted certain technical amendments to Rule 3502, 
including its title, and Rule 3522.\5\
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    \1\ On August 2, 2005, the PCAOB submitted its proposed rules to 
the Commission for approval.
    \2\ PCAOB Release No. 2005-014.
    \3\ 15 U.S.C. 7202 et seq.
    \4\ 15 U.S.C. 78s(b).
    \5\ PCAOB Release No. 2005-020. On November 23, 2005, the PCAOB 
submitted the technical amendments to the Commission for approval.
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    Notice of the proposed rules, including the November 22, 2005 
technical amendments, was published in the Federal Register on March 7, 
2006,\6\ and the Securities and Exchange Commission (``Commission'') 
received eight comment letters. For the reasons discussed below, the 
Commission is granting approval of the proposed rules.
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    \6\ Release No. 34-53427; File No. PCAOB-2006-01.
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    On March 28, 2006, the PCAOB adopted an additional statement, 
delaying the implementation schedule for Rules 3523 and 3524 of the 
proposed rules,\7\ and submitted that amendment to the filing to the 
Commission. The Commission finds there is good cause to approve this 
amendment prior to the thirtieth day after publication in the Federal 
Register and, for the reasons discussed below, the Commission is 
approving the amendment.
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    \7\ PCAOB Release No. 2006-001.
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II. Description

    The Act established the PCAOB to oversee the audits of public 
companies and related matters, to protect investors, and to further the 
public interest in the preparation of informative, accurate and 
independent audit reports.\8\ Section 103(a) of the Act directs the 
PCAOB to establish auditing and related attestation standards, quality 
control standards, and ethics standards to be used by registered public 
accounting firms in the preparation and issuance of audit reports as 
required by the Act or the rules of the Commission.
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    \8\ Section 101(a) of the Act.
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Overall Framework (Rules 3501 and 3502)

    Proposed Rules 3501 and 3502 will create an overall framework 
within the PCAOB's ethics rules. Proposed Rule 3501 sets forth the 
requirement for the accounting firm to be independent of its audit 
client throughout the audit and professional engagement period as a 
fundamental ethical obligation of the auditor. This requirement for the 
auditor to be independent encompasses the obligation to satisfy the 
independence criteria set out in the rules and the standards of the 
PCAOB, but also an obligation to satisfy all other independence 
criteria applicable to the engagement, including the independence 
criteria set out in the rules and regulations of the Commission.
    Proposed Rule 3502 establishes a standard of ethical conduct for 
persons associated with registered public accounting firms, indicating 
that these persons shall not take or omit to take an action knowing, or 
recklessly not knowing, that the act or omission would directly and 
substantially contribute to a violation by the accounting firm of the 
Act, the rules of the Board, or provisions of the securities laws. 
These two proposed rules would be effective 10 days after the date of 
this order.

Contingent Fees (Rule 3521)

    Proposed Rule 3521 would treat registered public accounting firms 
as not independent if they enter into contingent fee arrangements, 
directly or indirectly, with audit clients.\9\ While the PCAOB's 
definition of contingent fees was adapted from the Commission's 
definition, there are two distinct differences. The principal 
difference is the elimination of the exception in Rule 2-01(c)(5) of 
Regulation S-X for fees ``in tax matters, if determined based on the 
results of judicial proceedings or the findings of government 
agencies.'' The PCAOB found this provision had been misinterpreted and 
could permit fees that jeopardized the independence of auditors. In 
addition, the proposed rule would expressly indicate that the 
contingent fees cannot be received ``directly or indirectly'' from the 
audit client. We do not object to the language that has been included 
in the PCAOB's proposed rule. The proposed rule would not be applied to 
contingent fee arrangements that were paid in their entirety, converted 
to fixed fee arrangements, or otherwise unwound before 60 days after 
the date of this order.
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    \9\ The proposed definition of ``contingent fee'' includes any 
fee established for the sale of a product or the performance of any 
service pursuant to an arrangement in which no fee will be charged 
unless a specified finding or result is attained, or in which the 
amount of the fee is otherwise dependent upon the finding or result 
of such product or service. However, a fee is not a contingent fee 
if the amount is fixed by courts or other public authorities and not 
dependent upon a finding or result.
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Tax Transactions (Rule 3522)

    Proposed Rule 3522 would prohibit auditors from providing any non-
audit services to its audit clients related to the marketing, planning 
or opining in favor of the tax treatment of transactions that are 
confidential transactions under the Internal Revenue Service's 
regulations or transactions that would be considered aggressive tax 
position transactions.\10\ As such, this proposed rule adds to the list 
of services an audit firm is prohibited from providing its audit 
clients in order to maintain its independence. While the Board 
considered a wide-range of tax services, they ultimately determined 
that these particular types of tax services

[[Page 23972]]

(confidential transactions or aggressive tax transactions) represented 
a class of tax-motivated transactions that presented an unacceptable 
risk of impairing an auditor's independence. The proposed rule would 
not be applied to tax services that were completed by the accounting 
firm by 60 days after the Commission approves the rules.
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    \10\ The PCAOB has defined aggressive tax positions as those 
that are initially recommended, directly or indirectly, by the 
auditor and a significant purpose of which is tax avoidance, unless 
the proposed tax treatment is at least more likely than not to be 
allowable under applicable tax laws.
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Tax Services for Persons in a Financial Reporting Oversight Role (Rule 
3523)

    Proposed Rule 3523 adds to the list of services an audit firm is 
prohibited from providing its audit clients in order to maintain its 
independence by prohibiting audit firms from providing any tax service 
to any person who fills a financial reporting oversight role at an 
audit client,\11\ or an immediate family member of such individual, 
unless such person is in that role solely because he or she is a member 
of the board of directors or similar management governing body. The 
proposed rule includes those individuals who are in a financial 
reporting oversight role at an affiliate of the entity being audited 
unless that affiliate is either not material to the consolidated entity 
or the affiliate's financial statements are audited by another auditor. 
Based on the March 28, 2006 amendment, this proposed rule would not be 
applied to tax services being provided pursuant to an engagement in 
process at the time the Commission approves the rules, provided that 
such services are completed on or before October 31, 2006.\12\
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    \11\ The PCAOB's definition of a ``financial reporting oversight 
role'' matches the Commission's definition of the same term.
    \12\ The proposed rule also provides a transition period for 
those individuals that are hired or promoted into a financial 
reporting oversight role; this transition period allows for the tax 
services in process to be completed within 180 days after the hiring 
or promotion.
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Auditor's Responsibility in Connection With Audit Committee Pre-
Approval of Tax Services (Rule 3524)

    Proposed Rule 3524 would require the auditor seeking pre-approval 
to perform tax services to provide the audit committee written 
documentation of the scope of the proposed tax service and the fee 
structure for the engagement, discuss with the audit committee the 
potential effects on the firm's independence of performance of the 
services, and document the firm's discussion with the audit committee.
    The Board amended the proposed effective date for this rule as part 
of its March 28, 2006 statement. As amended, the proposed rule would 
not be applied to any tax service pre-approval occurring before 60 days 
after the Commission approves the rules. Additionally, due to 
considerations of potentially existing audit committee procedures and 
schedules for pre-approving all audit and non-audit services, in cases 
where the registrant pre-approves non-audit services via policies and 
procedures, the rule will not apply to any tax service that has started 
within one year after the Commission approves the rules. The Board 
provided this longer transition so that most tax services considered 
within an annual audit committee review process that occurred prior to 
Commission approval could proceed without the need for additional pre-
approval.

III. Discussion

    The Commission's comment period on the proposed rules ended on 
April 3, 2006, and the Commission received eight comment letters. The 
majority of comment letters came from accounting firms,\13\ although 
one professional organization,\14\ one registrant \15\ and one 
individual also responded. In general, the respondents expressed 
support for the proposed rules, though a number of the commenters 
requested either revisions or additional clarifying guidance from 
either the Commission or the PCAOB, as discussed in more detail below.
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    \13\ Deloitte & Touche LLP, Ernst & Young LLP, KPMG, McGladrey & 
Pullen, and PricewaterhouseCoopers.
    \14\ American Institute of Certified Public Accountants.
    \15\ Capital Group Companies.
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Response to Specific Request for Comment on Proposed Rule 3522

    In its public release of the proposed rules for comment, the 
Commission asked respondents to comment on proposed Rule 3522, 
specifically as to whether it was clear from the Board's discussion 
that a subsequent listing of a transaction, while not in and of itself 
impairing the auditor's independence prior to the listing of the 
transaction, may impact independence from the date of listing forward. 
Further, the Commission questioned whether additional guidance was 
necessary regarding the consideration of an auditor's independence when 
a transaction planned or opined on by the auditor subsequently becomes 
listed.
    The accounting firms and the AICPA responded to this question. Some 
commenters \16\ indicated that if the audit committee and the firm, in 
good faith, reached a conclusion that the proposed transaction was 
allowable at the time the tax services were provided, the subsequent 
listing of the transaction should not impair the auditor's 
independence, as long as the firm is not in a position of defending its 
original advice. The PCAOB received similar comments during its 
exposure of the rule and responded by stating that it agreed with 
commenters that a per se rule that a subsequent listing of a 
transaction impaired an auditor's independence in either the period of 
the transaction or subsequent to the listing was not appropriate. The 
PCAOB stated that firms should be cautious in participating in 
transactions that could become listed, and that subsequent to the 
listing the firm and the audit committee should consider the potential 
impact of defending the transaction on the auditor's independence.
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    \16\ KPMG, E&Y, AICPA, PWC.
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    Commenters \17\ on the Commission's Notice requested guidance on 
the subsequent consideration of independence upon the listing of the 
transaction and made a number of suggestions. Suggestions on this 
included: Clarifying that a subsequent listing of a transaction has no 
retroactive impact on independence and does not per se impair 
independence going forward, clarifying that the subsequent 
determination as to the impact on auditor independence should rest 
primarily with the audit committee, and clarifying that an audit 
committee's good faith determination in determining if the subsequent 
listing impairs independence should be considered conclusive. We agree 
that listing of a transaction does not result in a per se violation of 
an auditor's independence in either the period in which the transaction 
occurred or in subsequent periods. Based on the large percentage of 
commenters who felt that additional guidance is necessary regarding the 
subsequent determination of independence upon the listing of a 
transaction, we encourage the PCAOB to provide such guidance within a 
reasonable period of time after the approval of the proposed rules.
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    \17\ D&T, PWC, McGladrey.
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Rule 3523

    A number of commenters raised concerns in relation to the PCAOB's 
application of the principle of ``individuals in a financial reporting 
oversight role'' to its proposed Rule 3523. The PCAOB has proposed a 
definition of the term ``financial reporting oversight role'' that 
matches the way in which the Commission has defined the term in our 
independence rules. However, while the defined term is identical to the 
Commission's

[[Page 23973]]

definition, the proposed application of that term differs from the 
Commission's application. In the Commission's independence rules 
pertaining to employment relationships, there are restrictions on the 
time frame in which a former professional employee of an audit firm can 
fill a ``financial reporting oversight role'' at an issuer-client, or 
significant subsidiary of that issuer, without negatively impacting the 
independence of the audit firm. In contrast, the PCAOB's proposed rule 
prohibits the audit firm from providing tax services to a person in a 
financial reporting oversight role at the audit client or material 
affiliate of the audit client, with some exceptions (i.e., individuals 
who serve as directors are not included).
    Commenters \18\ expressed concerns that the PCAOB's proposed rule 
extends the definition of ``financial reporting oversight role'' to a 
broader group of individuals than the Commission's independence rule, 
and that application of the rule to such a broad group will make 
monitoring compliance burdensome. This issue was not raised in the 
PCAOB's comment period because the reference to individuals at material 
affiliates was added by the PCAOB in response to comments seeking 
clarification regarding whether the rule applied to immaterial 
subsidiaries. The PCAOB added language to the rule to make clear that 
it did not apply to immaterial subsidiaries. However, based on 
commenters' requests for further clarification, we encourage the PCAOB 
to issue additional guidance.
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    \18\ AICPA, D&T, E&Y, KPMG, PWC.
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Additional Comments

    The AICPA and one accounting firm commented how the standard for 
liability in the rule compares to the standard for liability under 
Section 21C of the Exchange Act. The AICPA also questions whether the 
PCAOB's standard setting authority encompassed the adoption of rules 
related to the responsibility of associated persons not to knowingly or 
recklessly contribute to an accounting firm's violation of rules or 
applicable law. We believe that the rule is within the scope of the 
PCAOB's authority, particularly its authority to establish ethical 
standards.
    A number of commenters made requests for additional implementation 
guidance from the PCAOB upon the approval of the rules. Commenters 
raised questions regarding certain language in proposed Rule 3522 
pertaining to the confidentiality restrictions in the rule and the use 
of the term ``planning'' in the rule text. Based on these comments, we 
recommend the PCAOB provide additional implementation guidance on these 
topics.

IV. Accelerated Approval of Amendment No. 1; Solicitation of Comments

    The Board's March 28, 2006 amendment to the implementation schedule 
for certain of the proposed rules (the ``March 28, 2006 amendment'') 
would delay the effective date for Rules 3523 and 3524.
    Rule 3523 originally had an effective date of the later of June 30, 
2006 or 10 days after the date that the Commission approved the rules. 
The PCAOB acknowledged in its adoption of the rule that the proposed 
rule would lead to some registered firms terminating recurring 
engagements to provide tax services and may require certain members of 
public companies' senior management to find other tax preparers. In 
order to allow for as smooth a transition as possible, the PCAOB 
decided to amend the effective date such that Rule 3523 would not apply 
to tax services that are being provided pursuant to an engagement in 
process at the time the Commission approves the rules, provided that 
such services are completed on or before the later of October 31, 2006 
or 10 days after the date of this order.
    Rule 3524 requires certain disclosure, discussion, and 
documentation when a registered firm seeks audit committee pre-approval 
to provide a public company audit client tax services that are not 
otherwise prohibited by Commission or PCAOB rules. Acknowledging that 
some companies choose to use pre-approval policies and procedures to 
approve certain tax services, the original proposed rules provided two 
different effective dates: 60 days after the date that the Commission 
approves the rules or, in the case of an issuer that pre-approves non-
audit services by policies and procedures, the rule would not apply to 
any tax service provided by March 31, 2006. Considering the time period 
since the rules' adoption, the PCAOB decided to amend the effective 
date with respect to tax services provided to audit clients whose audit 
committees pre-approve tax services pursuant to policies and 
procedures. As a result, under the proposed amendment, Rule 3524 would 
not apply to any such tax service that is begun within one year after 
the date of this order. This transition period should allow most tax 
services considered in an annual audit committee review process that 
occurred prior to Commission approval to proceed without the need for a 
firm to seek new pre-approval.
    We find good cause to approve the March 28, 2006 amendment prior to 
the thirtieth day after the date of publication of notice of filing the 
March 28, 2006 amendment in the Federal Register. The original proposed 
rules, as noted above, were published in the Federal Register. We 
believe that the March 28, 2006 amendment, by delaying the effective 
date for certain of the proposed rules, addresses some of the concerns 
raised by commenters regarding the time period in which auditors would 
have to comply with the new rules. The March 28, 2006 amendment does 
not modify the scope and purpose of the rules as originally proposed 
but simply extends compliance dates commensurate with the original 
filing date. Finally, we also find that it is in the public interest to 
approve the rules as soon as possible to assist accounting firms in 
making arrangements to efficiently implement the proposed rules.
    Accordingly, we believe good cause exists, consistent with Sections 
107 and 109 of the Act, and Section 19(b) of the Exchange Act, to 
approve the March 28, 2006 amendment to the proposed rules on an 
accelerated basis.
    Interested persons are invited to submit written data, views, and 
arguments concerning the March 28, 2006 amendment, including whether 
the amendment is consistent with the Act and the securities laws or is 
necessary or appropriate in the public interest or for the protection 
of investors. Comments may be submitted by any of the following 
methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/pcaob.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Number PCAOB-2006-01 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File No. PCAOB-2006-01. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov).

[[Page 23974]]

Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule that are filed with the 
Commission, and all written communications relating to the proposed 
rule between the Commission and any person, other than those that may 
be withheld from the public in accordance with the provisions of 5 
U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Section, 100 F Street, NE., Washington, 
DC 20549. Copies of such filing also will be available for inspection 
and copying at the principal office of PCAOB. All comments received 
will be posted without change; we do not edit personal identifying 
information from submissions. You should submit only information that 
you wish to make available publicly. All submissions should be 
submitted on or before May 25, 2006.

V. Conclusion

    On the basis of the foregoing, the Commission finds that proposed 
rules, including the March 28, 2006 amendment, are consistent with the 
requirements of the Act and the securities laws and are necessary and 
appropriate in the public interest and for the protection of investors. 
However, to facilitate implementation of the proposed rules, the 
Commission expects the PCAOB will issue additional implementation 
guidance as requested by a number of the commenters.
    It is therefore ordered, pursuant to Section 107 of the Act and 
Section 19(b)(2) of the Exchange Act, that the Proposed Ethics and 
Independence Rules Concerning Independence, Tax Services, and 
Contingent Fees (File No. PCAOB-2006-01), as amended, be and hereby are 
approved.

    By the Commission.
Nancy M. Morris,
Secretary.
 [FR Doc. E6-6125 Filed 4-24-06; 8:45 am]

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