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The rules for accountants and lawyers passed by the Securities & Exchange Commission on Jan. 22 and 23 are widely dismissed as weak compromises. But that's sloppy analysis. In fact, the SEC's final regulations go well beyond the requirements of the Sarbanes-Oxley corporate reform act, and they put a tough new regime on auditors and corporate counsel (see BW Online, 1/30/03, "The SEC: Victim of the Press"). Let's take a look at the issues the SEC tackled:
Auditor rotation: To prevent auditors from becoming too chummy with their clients, Sarbanes-Oxley imposes a mandatory rotation for the top two partners on an audit team after five years. Read literally, the law says these two partners must take one year off after five years with a client. The SEC's final rule goes much further: It says the top two partners must take five years off. And it extends the rotation idea to a host of junior partners who weren't even mentioned in Sarbanes-Oxley.
The SEC's "cave in"? When it first drafted the rules, it suggested that junior partners should be subject to the same five-on, five-off schedule as the top two. Accounting firms said that was too harsh, especially since lower-level accountants don't have real clout to bias an audit. The SEC agreed that firms would have a hard time rotating all partners in smaller offices. So it said junior partners could spend seven years with one client, then must take at least two years off.
Audit fees: In 2000, the SEC ordered companies to start reporting what they pay their accountants for auditing and consulting services. The goal: Let investors know when auditors might be tempted to give in to management to protect lucrative consulting contracts. The fee figures were widely aired when Enron reported that it paid Arthur Andersen LLP more for consulting ($27 million) than for auditing ($25 million).
Accountants complained that the 2000 rule defined "audit fees" too narrowly, leaving out many essential services that only an auditor can perform, like filing audit-based documents with regulators. After reviewing the issue, the SEC agreed, voting to allow companies to include more accounting costs in the audit fee.
That was a step backward: The SEC should have favored more detailed disclosure, not less. But does it matter? "We've barred the auditors from doing almost all consulting -- so the fee question is behind us," says a senior, reform-minded, SEC official. "That fight is finished. It's the last war."
Tax shelters: In Sarbanes-Oxley, Congress specifically allowed auditors to provide tax services for their clients, provided that the client's board audit committee approved in advance. When the SEC drafted its consulting rules, it asked for comments on whether aggressive tax planning -- such as selling tax shelters to a client -- compromised an auditor's independence.
That was widely interpreted as a bid to ban auditors from advising clients on tax shelters. But SEC officials say they never intended such a ban. The final rule requires audit committees to subject aggressive tax strategies to strict scrutiny, and that's a tougher standard than anything in force today or proposed in Sarbanes-Oxley.
Lawyers' conduct: Sarbanes-Oxley requires corporate lawyers to report evidence of fraud or malfeasance. The law says lawyers must "report up" to the general counsel or CEO, and if those officers fail to act, to the board. The SEC's draft rules added a new and controversial wrinkle -- a requirement to "report out." That is, if the board didn't act on a lawyer's concerns, the lawyer would have to quit and report his departure to the SEC, a process known as "noisy withdrawal."
It may be a good idea, but noisy withdrawal goes against centuries of attorney-client privilege, in which lawyers are required to protect clients' confidences. With less than three months to consider the plan, the SEC decided it needed more time to study noisy withdrawal. It still passed the "reporting up" rules required by Sarbanes-Oxley and toughened the rules for when a lawyer must blow the whistle. While the SEC agreed unanimously on the postponement, commissioners who favor the "noisy withdrawal" plan are certain to keep the issue alive.
Copyright 2003, by The McGraw-Hill Companies Inc. All rights reserved.
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