A Pathology of the Independence Standards Board's Conceptual Framework Project

ISB to cease operations after making major contributions to the resolution of difficult and longstanding auditor independence issues. (AICPA 2001b) With that headline, the Independence Standards Board (ISB or Board) announced that it was closing its doors. Why did the Board dissolve before officially adopting its largely completed conceptual framework? What does the Board's demise mean for the future of independence rule making? This commentary is a pathology--which the dictionary defines as "the scientific study of the nature of disease, its causes, processes, development, and consequences" (1) -- of the ISB's conceptual framework project, which ultimately affected the Board's ability to survive. FORMATION AND OPERATION OF THE ISB The Securities and Exchange Commission (SEC) is responsible for developing rules to ensure the independence of auditors of public entities. The SEC, the American Institute of Certified Public Accountants (AICPA), and the largest auditing firms agreed in June 1997 to form an. independent, private body to establish independence standards applicable to the auditors of SEC registrants (SEC 1998, Sec. II). Funded by the accounting profession, that body--the ISB--consisted of four well-known and highly respected public members, one of whom was elected chair, and four members from the accounting profession--three CEOs from the Big 5 and the CEO of the AICPA. The SEC's Chief Accountant, or his/her designee, had observer status at Board meetings. An Executive Director and a small staff coordinated the Board's operations (which began in October 1997), helped inform the public about the ISB's activities, and ensured regular communications with the SEC, the AICPA, and regulators and standard setters outside the U.S. (2) In addition to issuing three independence standards, the Board started a project to develop a framework to serve as a conceptual foundation for its future work. The ISB retained us as project directors and appointed a task force composed of auditors, audit committee members, academics, state board of accountancy representatives, analysts and other financial statement users, corporate executives, representatives from international standard setters, the AICPA chair, and the SEC observer. The Board also retained a business ethicist to assist in the project, and a group of three Board members monitored the framework project. To stimulate public debate about conceptual issues, in February 2000 the Board issued Discussion Memorandum (DM) 00-1, A Conceptual Framework for Auditor Independence (ISB 2000a). After considering the comments received during the exposure period from individuals and groups in the academic, auditing, standard-setting, and investor communities, the Board directed the staff and consultants, assisted by the project task force, to develop an Exposure Draft (ED) of a proposed Statement of Independence Concepts. That ED was issued in November 2000 (ISB 2000b). Based on additional public comments and further assistance from project task force members, the Board's oversight task force, and others, the staff and consultants revised the ED and prepared a final draft of a conceptual framework for the Board's review. (3) CONTROVERSIAL ISSUES IN THE FRAMEWORK PROJECT The most significant debates among the parties involved in the framework's development concerned the role of independence in appearance and the appropriateness of a threats and safeguards approach. The nature of those debates provides important insights into the future of auditor independence regulation. Independence in Appearance The appearance of independence has long been part of auditors' ethical standards. (4) Nevertheless, how to incorporate investors' and other financial statement users' perceptions into a conceptual framework for independence was extremely controversial. (5) There was little disagreement among the project's participants that improving financial statement credibility and enhancing user confidence are important outcomes of an audit and an auditor who appears to be independent contributes to those outcomes. …