SEC limits auditor-client ties

In the wake of accounting scandals at Enron, WorldCom and Tyco, the Securities and Exchange Commission adopted rules Wednesday to define what services auditing firms will be allowed to provide to their clients.

As part of the biggest spate of rule making in recent SEC history, SEC commissioners approved staff recommendations designed to specify exactly what kinds of non-audit services auditing firms would be allowed to perform for their clients. Recent accounting scandals convinced Congress that auditing firms that sell lucrative consulting services to their auditing clients are less likely to be aggressive watchdogs when monitoring that client's books.

The Sarbanes-Oxley Act, passed with virtually no opposition last summer, established a new accounting oversight board and called on the SEC to adopt specific rules regarding auditor independence. The new rules will force accounting firms to adopt these policies:

The top two accounting partners working on a particular client's audit will be required to rotate off the business after a period of five years. Those two will then have to wait at least five more years until returning to that client's audit. Other senior partners will be required to rotate after seven years. None of these auditors will be allowed to join the client and oversee the auditing firm's work until after a one-year “cooling off” period. Certain small accounting firms would be exempted.

No audit partner can be compensated based on the amount of non-auditing services he or she is able to cross-sell to a client. Prior to the collapse of Enron, accounting firm Arthur Andersen had rewarded lead auditor David Duncan based on how much non-auditing business he brought into the accounting firm from Enron.

Auditing firms will be required to disclose how much money they made from auditing and non-auditing services provided to a client. Under an SEC rule adopted in 2000, auditing firms are already required to disclose what they earn from audit and non-audit services.

The new rules will allow auditing firms to provide certain tax services, pending approval from the audit committee of the client's board of directors. But under no conditions can auditing firms serve as advocates for their tax advice in legal proceedings.

Accounting firms will be prohibited from offering the following services to audit clients: design and installation of financial information systems; appraisal services and fairness opinions; actuarial services; internal audit services that have been outsourced by the client; management and human resource functions; investment banking services; legal advice; other expert services unrelated to the audit.

The new rule also requires the board of directors' audit committee to sign off on all audit and non-audit services that a company's auditor will provide.

In addition to auditor-independence rules, the SEC also adopted a rule requiring that accounting firms hold on to all work papers, e-mails and other correspondence generated in connection with an audit for at least seven years. This is the so-called “David Duncan rule,” written in reaction to the disclosure that Duncan and colleagues at Andersen destroyed Enron work papers in the weeks leading up to an SEC subpoena in 2001.

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