Big Four slam SEC rules on audit record-keeping: Firms warn regulations may imperil auditor's role

The independent auditor’s role as a corporate “devil’s advocate” could be severely undermined by proposed new Securities and Exchange Commission rules that impose broad new record keeping requirements for auditors, accounting industry leaders warned.

The SEC’s proposed regulations implement a key requirement of last year’s Sarbanes-Oxley audit reform law that was intended to prevent a repeat of the shredding of audit papers by accountants from former Big Five firm Andersen during the Enron debacle.

But the major accounting firms that would be subject to those new requirements contend that the commission has gone overboard in requiring accountants to retain for five years all “workpapers and other documents that form the basis of the audit.” That would be required, as well as other memoranda, correspondence, documents or e-mails “created, sent or received in connection with the audit or review” of a client’s financial statements.

Read literally, the SEC’s language “would require the auditor to retain virtually every scrap of paper received or created during an audit,” representatives of Big Four firm Ernst & Young told the commission.

Deloitte & Touche agreed, and added that the “ambiguities and imprecision of language in the proposed rule could be interpreted as essentially requiring that auditors retain all documents necessary to allow a third party to re-perform the audit.”

Forcing accountants to retain this amount of documentation “would place an overwhelming burden on the auditor” and shift the focus away from “effective auditing to the collection and preservation of documents,” Deloitte & Touche warned.

Other accounting firms raised concerns that such a broad and ambiguous record retention mandate – backed with stiff criminal penalties for violators – would have a chilling effect on the willingness of audit teams to put their preliminary audit findings in writing.

Unless the rule is modified, “we believe that a very real risk exists … that auditors will rely more on oral rather than written communication in the conduct of an audit,” KPMG told the SEC.

Since “oral communication generally involves less extensive analysis and is subject to greater misinterpretation than written communication,” the unintended consequences of the SEC’s proposal “would be a less interactive and thoughtful audit process,” KPMG argued.

Officials at the American Institute of CPAs went further, and maintained that a broad interpretation of the language requiring auditors to retain “work papers and other documents” could discourage essential dialogue among audit team members during the preliminary stages of the review.

The audit process requires that “engagement team members continually pose and challenge hypotheses,” and auditors “will frequently document a variety of issues in writing” that never appear in the auditor’s final report, they said.

As an example, AICPA president Barry Melancon noted that “junior auditors frequently draft preliminary positions on complex accounting transactions” that are ultimately left on the cutting room floor.

These preliminary memorand help to frame issues and contribute to the development of lower-level audit personnel, but they should not be retained if their conclusions differ from the final auditor’s position, he said.

Major accounting firms also raised concerns about the costs of the new federal audit record retention requirements. Although the SEC estimated the extra staff time necessary to safeguard paper and electronic records at one hour per client, industry officials said that the true costs are likely to be far higher.

“The breadth of the proposed rule would increase the already voluminous number of documents retained by auditors,” said D&T. “Audit firms will have to invest substantial sums in upgrading electronic storage,” and will also need to undertake a costly redesign of “their information technology infrastructures to accommodate the vast amounts of information that would need to be retained and accessed.”

KPMG agreed, warning that “most auditing firms will require some modification to existing systems, processes and procedures relative to record retention in order to comply with the provisions of a final rule.”

To facilitate the changeover, the firm urged the SEC not to require compliance with the new record-keeping requirements for audits of fiscal years beginning before Dec. 15, 2003.

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