Both SEC and IRS have had an interest in the tax services, particularly tax shelter services, that accounting firms provide taxpayers. In terms of SEC, according to the Sarbanes-Oxley Act of 2002, before an SEC registrant company’s auditor can provide non-audit services such as tax services to the company, the company’s audit committee must approve them. Effective May 6, 2003, SEC adopted rules required by the act to strengthen conflict of interest standards and clarify the relationship between the independent auditor and the audit committee. In adopting these rules, SEC said it was enhancing the independence of accountants that audited financial statements and prepared related reports to be filed with SEC. It also said that accounting firms could provide tax services to their audit clients, subject to each client’s audit committee pre- approval, without impairing their independence. However, accountants would impair their independence if they represented audit clients before a tax or district court or a federal court of claims. Further, according to the rules, audit committees should carefully scrutinize an accountant’s involvement in a transaction if the accountant initially recommended the transaction, the transaction’s sole business purpose might be tax avoidance, and its tax treatment might not be supported in the Internal Revenue Code and related regulations. The Sarbanes-Oxley Act established the Public Company Accounting Oversight Board (PCAOB) and authorized it to establish standards and rules for auditor independence. In exercising its responsibilities under the act, PCAOB determined it was appropriate to consider the impact on auditor independence of providing tax services to audit clients. In July 2004, it convened a roundtable discussion on the effect of tax services provided by auditors on auditor independence. Participants at the roundtable, including representatives of accounting firms, public companies, investors, and regulators, discussed many different topics, with suggestions including more PCAOB guidance to audit committees and a rule barring auditors from providing at least some tax services to audit clients. On December 14, 2004, PCAOB proposed new ethics and independence rules, with comments due by February 14, 2005, and an effective date of no earlier than October 20, 2005. The proposed rules would treat an accounting firm registered with PCAOB as not independent in certain instances for purposes of doing a financial statement audit and for other purposes. For example, the firm would be considered not independent if it provided services related to planning or giving an opinion on the tax treatment of a listed (described later) or confidential transaction under Department of the Treasury regulations. Similarly, the firm would be considered not independent if it provided these services for a transaction that was based on an aggressive interpretation of the applicable tax laws and regulations. Such a transaction is one that satisfies three criteria: it was initially recommended by a tax advisor; it has tax avoidance as a significant purpose; and it “is not at least more likely than not to be allowed under; applicable tax laws.” The proposal would also treat the firm as not independent if the firm provided tax services to officers who oversee an audit client’s financial reporting. It would not prohibit the audit firm from providing the audit client with routine tax return preparation and tax compliance, general tax planning and advice, international assignment tax services, and employee personal tax services. In addition, the proposal would expand on current SEC pre-approval requirements to require an auditor seeking audit committee pre-approval of tax services to give the committee certain information, discuss with the committee the services’ potential effects on the firm’s independence, and document the discussion’s substance. Treasury regulations address IRS’s oversight of tax shelters. Under the regulations, there are six categories of transactions for which investors must report, or disclose, the transactions into which they have entered, and promoters must maintain lists of investors who have entered into the transactions. At IRS, the Office of Tax Shelter Analysis (OTSA) maintains a database containing information on tax shelter investors and promoters, including accounting firms. Created in February 2000 to centralize and coordinate IRS’s response to abusive tax shelter activity nationwide, OTSA includes in its database the amount of potential federal tax loss estimated by the taxpayer or IRS to result from both listed and nonlisted transactions. These losses, which also represent benefits to the taxpayer, may or may not be disallowed by IRS upon further review of each transaction. IRS considers listed transactions, which must be reported on tax returns sent to IRS, to be abusive. The Joint Committee on Taxation has described listed transactions as having a tax avoidance purpose, with the tax benefits subject to disallowance under existing law. For a transaction to be listed, IRS must issue a notice, regulation, or other form of published guidance informing taxpayers of the details of the transaction. In October 2004, IRS had 30 types of listed transactions, a number that had grown more quickly in recent years than earlier. Nonlisted transactions generally are transactions reportable to IRS that may have some characteristics of abusive shelters but are not, and may never be, listed. At times, IRS questions whether some nonlisted transactions should be moved into the category of listed transactions. To address our first two objectives—relating to Fortune 500 companies, officers, and directors obtaining tax shelter services from their company auditors--we matched data from two sources—S&P and IRS. We acquired specific S&P data elements for the 497 companies on the April 2003 Fortune 500 list that, according to S&P, either were publicly owned or had to file with SEC for another reason, such as having publicly-traded debt. The data elements included the company’s employer identification number, the names of company officers and directors, and the name of the company’s auditor for each year from 1998 through 2003. The number of Fortune 500 companies for which we actually received S&P data varied; for instance, we received names of directors and officers for 471 companies and employer identification numbers for 492. As shown in table 1, the officers for 441 of the 471 companies were those listed in the company’s proxy statement section on most highly compensated officers, as filed with SEC for either 2000 or 2002. We used the years 2000 and 2002 because those were years when the federal government was significantly enhancing its presence to counter tax shelter activity that might have been going on for years. Because S&P did not have similar top officer information for the other companies in the Fortune 500, or 2000 or 2002 director information for any of them, it gave us the names reflecting current officers and directors as of March 2004—the date we obtained the data. Obviously, some of the March 2004 officers for 30 companies and the March 2004 directors for all 471 might have been different from those working in 2000 or 2002, which was closer to the time when most of the tax benefits related to the shelters were taken. Consequently, our analysis of the March 2004 information omits any officers and directors who left the relevant companies after 2002. We matched the S&P data to tax shelter information in IRS’s OTSA database as of May 28, 2004. IRS’s database included information disclosed to or discovered by IRS on companies, individuals, and other taxpayers who used tax shelters. It also included information on as many as three entities, including accounting firms, which IRS said promoted the shelter to the investor. We considered both listed and nonlisted transactions in the database because from an auditor independence standpoint, in both cases the promoters were involved with transactions that IRS or taxpayers believed needed to be reported to the federal government. To determine to what extent the 497 companies obtained tax shelter services, we matched the employer identification numbers in the S&P and IRS databases. When we found a match, we checked the promoter information in the IRS database against the audit firm information in the S&P database to see if the same accounting firm was listed as a promoter for a particular transaction and as the company’s auditor for one or more years that the shelter benefited the company. Although we do not know for sure that a company obtained tax shelter and auditing services from an accounting firm at exactly the same time, we considered it a match when at least one of the tax years for which the company received a tax benefit matched a fiscal year from 1998 through 2003 for which the accounting firm was the company’s auditor. We did this because IRS did not have information on exactly when taxpayers obtained tax shelter services, and 1998 was the year before the Department of the Treasury reported that the proliferation of corporate tax shelters was unacceptable. We analyzed information from other years to provide context. We also matched the names of company officers and directors in the S&P data to the names of the tax shelter investors in the IRS database. Whenever we found a match, we tried to verify if the same person was actually involved, as opposed to two people with the same first and last names. If the person appeared to be the same (for example, had the same middle initial), we matched the promoter name for that individual and, similar to what was just described, the tax benefit dates in the IRS database to the auditing firm of the individual’s company for 1998 through 2003 in the S&P data. Our matching methodology did not allow us to detect instances in which a spouse or other relative of the officer or director was the tax shelter investor or instances in which the investing entity was a partnership or other unit formed by the officer or director. As part of our work, we tested the reliability of IRS’s database and the data we received from S&P. For the IRS database, we reviewed related documentation, interviewed knowledgeable officials, and did electronic testing. For the information received from S&P, we reviewed S&P information on its controls over the data and verified sample data to publicly available documents obtained from SEC’s Web site or elsewhere. For both types of data, we found that the required data elements were sufficiently reliable for the purposes of our work.