ABOUT THE POB

NEWS

CHARTER

ANNUAL REPORTS

AUDIT
EFFECTIVENESS
PANEL


You will need Adobe Acrobat Reader to view these files:

STATUS OF PANEL
RECOMMENDATIONS

SCHEDULE OF
EXPENSES


To download Acrobat Reader, click on the Adobe logo.

Acrobat Reader

CONTACTS

News




Via Federal Express

John M. Morrissey
Deputy Chief Accountant
Office of the Chief Accountant
United States Securities and Exchange Commission
450 5thStreet, N.W.,
Room 11214
Washington, DC 20549
March 5, 2002



Robert J. Kueppers
Chair
SEC Practice Section Executive Committee
c/o Deloitte & Touche LLP
Ten Westport Road
Wilton, CT 06897-0820


Dear Messrs. Morrissey and Kueppers:

I. Purpose


The purpose of this letter is to follow-up on my letter, as Chair of the Public Oversight Board (“POB”), to Harvey L. Pitt, Chair of the Securities and Exchange Commission (“SEC”), dated January 21, 2002, concerning the POB’s intention to terminate its existence no later than March 31, 2002, and the need for arrangements to be made for a transition of the POB’s responsibilities. In that January 21st letter, I stated that plans must be made to transfer from the POB to an independent person the POB’s responsibility for the conduct of, and issuance of public reports on, the reviews of the Big 5 accounting firms agreed to by the SEC and the firms in June 2000. This agreement between the firms and the SEC is set forth in the “Term Sheet for Independence Look-Back Testing Program” (“Term Sheet”).

On February 20, 2002, Mr.Morrissey, as SEC Deputy Chief Accountant, wrote a letter addressed “To Participants in the Independence Look-Back Testing Program and the Public Oversight Board” in which he stated the SEC staff was withdrawing its request that the POB conduct reviews and issue reports under the Term Sheet because of the POB’s intention to terminate its existence. Mr. Morrissey’s letter asked that the firms develop “an alternative approach” to the POB doing these reviews and reports that “must be acceptable to the SEC staff and must provide investors with a comprehensive and reasoned report on the independence systems of the participating firms, as originally contemplated by the Term Sheet.” Mr. Morrissey’s letter also pointed out that the program under the Term Sheet “is more important to investors than ever before."

In view of the foregoing, and in the interest of an appropriate transition, the POB in this letter sets forth its position (“Position”) on the transfer of its responsibility for conducting reviews and issuing reports pursuant to the Term Sheet to an independent person (e.g., individual, group, firm or entity) (“Independent Person”).

II. Term Sheet

The Term Sheet was announced by the SEC in a public release on June 7, 2000. The Term Sheet calls for the POB to conduct reviews and oversight of, and issue public written reports (“Reports”) on, the effectiveness of the systems, procedures and internal controls relating to independence (“Systems and Controls”) of the Big 5 U.S. public accounting firms (Arthur Andersen LLP, Deloitte & Touche LLP, Ernst & Young LLP, KPMG LLP and PricewaterhouseCoopers LLP) (“Firms”).1 The reviews and oversight of, and public written reports on, the Firms’ Systems and Controls pursuant to the Term Sheet are collectively referred to as the “Reviews.”

The Firms agreed in the Term Sheet “to cooperate with the POB” in the Reviews.

The Term Sheet provides in relevant part:

  • Systems and Controls. Firms would continue to implement the systems, procedures, and internal controls relating to independence set forth by the Commission’s Chief Accountant, in letters to Michael Conway, Chairman of the SEC Practice Section Executive Committee, dated December 9, 1999 and May 1, 2000, with implementation to be completed no later than January 1, 2001.
  • Firms would submit to review and oversight by the POB of the effectiveness of the design and implementation of these systems, procedures, and internal controls, and to testing by the peer reviewers or the POB of their effectiveness. If the testing is performed by a peer reviewer, the POB shall have oversight of the peer review. Firms would agree to cooperate with the POB in such review and oversight. The POB would issue public written reports with respect to (i) the design effectiveness and implementation of these systems, procedures and internal controls as of January 1, 2001, and (ii) the testing and evaluation of their operating effectiveness during the six-month period ending June 30, 2001. Such reports will not disclose violations.

III. POB Work on the Reviews

The Term Sheet states that the Reviews are to be conducted, and the Reports issued, by the POB. The POB, as its Charter states, is an “independent” entity. The POB, pursuant to the Term Sheet, has done a substantial amount of work in preparing to conduct the Reviews. This work, beginning in November 2000, includes, as discussed below, participation in a series of meetings and telephone conferences with the Firms and SEC staff that took place during the thirteen-month period between December 2000 and January 2002. In addition, as discussed below, the POB prepared a draft request for information and documents pursuant to the Reviews, furnished it to the Firms and SEC staff on May 22, 2001, and requested any comments. Thereafter, the POB finalized this draft request and sent it to the Firms on July 23, 2001 and to the SEC staff on August 1st. The POB prepared a draft work program for the first phase of the Reviews, and furnished it to the Firms and SEC staff on October 12, 2001. The POB also prepared a draft work program for the second phase of the Review and sent it, together with the first phase draft program, to the Firms and SEC staff on January 17, 2002, for comments. In addition, the POB has had correspondence, meetings, and telephone conferences with the Firms regarding a proposed confidentiality agreement for the Reviews going back to July 2001.  Issues pertaining to this proposed confidentiality agreement were not resolved, and representatives of the Firms didn’t appear at the last meeting to discuss those issues scheduled for December 18, 2001.

IV. Transition of POB Responsibilities

While the POB has done substantial work on the Reviews, and through the middle of January 2002 had planned on moving forward to complete these Reviews, it no longer, because of recent developments, is in a position to do so. As you know, the POB presently intends to terminate its existence no later than March 31, 2002, in accordance with its resolution unanimously approved on January 20, 2002. In my letter to SEC Chair Pitt dated January 21, 2002 discussing this resolution, I pointed out that his proposals for changing the system of self-regulation of the accounting profession, announced at his press conference on January 17, 2002, did not include a place for the POB. In addition, I noted that while the SEC had apparently been in talks with the American Institute of Certified Public Accountants (“AICPA”), SEC Practice Section (“SECPS”) Executive Committee and representatives of the Big 5 Firms on these proposals for some time,2 there, significantly, had been no consultation on the proposals with the POB, which is charged with representing the public interest. I also stated in this letter that, in voting its intent to terminate, the POB recognized that arrangements must be made for a transition of its responsibilities, including plans to transfer the POB’s responsibility for the Reviews and Reports from the POB to an Independent Person.3

As part of the transition of responsibility for the Reviews and Reports, and in a continuing effort to move these Reviews and Reports forward, the POB submits its Position to the SEC and the Firms. The POB, based on its work to date, believes that it would be in the public interest, and in furtherance of the Term Sheet, for the Reviews and Reports to be done by an Independent Person as soon as reasonably possible in a manner consistent with this Position.  The POB believes this is particularly important, given the serious and widespread concerns that have been recently expressed in Congressional hearings on the Enron collapse, as well as in the media, with respect to auditor independence.

V. Executive Summary

In a letter to the POB dated December 9, 1999, the then-SEC Chief Accountant expressed concern that public accounting firms possibly lacked adequate quality controls for independence. As a step to “safeguard the public interest,” he “strongly recommend[ed]” that the POB undertake “a special review of SECPS member firms’ current compliance” with independence requirements.  On December 21, 1999, the POB agreed to do so. Shortly afterwards, on January 6, 2000, the SEC announced that an internal investigation at PricewaterhouseCoopers LLP (“PwC”) had disclosed more than 8,000 independence violations there. At this time, there were publicly-expressed concerns that the widespread independence violations at PwC might also be found at the other large accounting firms if they were subject to a review of their compliance. The POB commenced preliminary work on the special reviews in January 2000, and had meetings with firm representatives to discuss the reviews.

Then, in early May 2000, the POB’s work on the special reviews was brought to a halt. At that time, the SECPS sent a letter to the POB dated May 3rd cutting off the POB’s funds for the special reviews. The then-Chair of the SEC stated that this May 3rd letter was “a significant setback to self-regulation and independent oversight” and raised “serious questions as to the profession’s commitment to self-regulation.” The special reviews did not go forward.  In June 2000, the SEC and the Firms entered into the Term Sheet, which calls for the POB to conduct the instant Reviews.

Subsequently, on October 10, 2000, the POB received a letter from the then-SEC Chief Accountant asking that the POB do the Reviews called for by the Term Sheet “in lieu of” the special reviews previously requested in his December 1999 letter to the POB. The POB agreed to do so, and commenced preliminary work on the Reviews in November 2000. Between then and January 2002, a period of more than a year, the POB did a substantial amount of work preparing to conduct the Reviews. Despite these efforts, by the middle of January 2002 the POB still had not been able to obtain information and documents for the Reviews it had requested from the Firms in July 2001.

The primary reason for this delay in the POB’s work was a lack of progress in the Reviews.  For example, the POB’s efforts to enter into a confidentiality agreement with the Firms, going back to July 2001, did not lead to an agreement.  Moreover, this lack of progress in the Reviews was one of the factors that led to the POB voting to terminate its existence.

The POB believes it is important for the public interest that the Reviews and Reports be completed by an Independent Person as soon as reasonably possible. To this end, there should be a prompt transfer of the POB’s responsibility for the Reviews and Reports to an Independent Person. This is particularly important, given the serious and widespread concerns that have been expressed in recent Congressional hearings on the Enron collapse, as well as in the media, with respect to auditor independence. As Mr. Morrissey pointed out in his letter to the Firms and the POB dated February 20, 2002, the program under the Term Sheet “is more important to investors than ever before.”

The SEC staff, in a revised draft letter dated December 14, 2001, has set forth proposed terms for the Reviews. The POB does not believe it would be in the public interest for the Reviews to be done in the manner called for by this draft letter.  In particular, the POB believes that the limitations in the draft letter on the scope of the Reviews, and on the form and content of the Reports, would be an undue constraint on the Independent Person, which would raise questions about the independence of the process.   Instead, the Reviews should be conducted, and the Reports issued, in the manner determined appropriate by the Independent Person, consistent with the Term Sheet and in furtherance of the public interest.

In this regard, the POB believes that its Position set forth in this letter, based on its substantial work on the Reviews, could be helpful to the Independent Person.   For example, the POB believes the Reports should be written in “plain English” with informative, meaningful and transparent disclosure.  In addition, the Independent Person’s significant observations and recommendations concerning the Firms’ Systems and Controls should be included with the Reports not, as the SEC revised draft letter proposes, omitted from the Reports and put in letters of comment in the AICPA public peer review files.

VI. Background

Some background would be helpful in considering this matter.

On January 14, 1999, the SEC announced its enforcement action and settlement against PwC for violations of the SEC independence rules. As part of this settlement, PwC agreed, among other things, to conduct a firm-wide internal investigation supervised by an independent consultant. The report on this internal investigation, announced by the SEC on January 6, 2000, disclosed there had been more than 8,000 independence violations at PwC. This received a lot of publicity. A number of commentators questioned whether the widespread independence violations at PwC might also be found at the other large accounting firms if they were subject to a review of their compliance.

On December 9, 1999, less than a month before this public announcement, the then-Chief Accountant of the SEC, Lynn Turner, sent a strongly-worded letter to the SECPS Executive Committee, expressing concern with the adequacy of SECPS member firms’ independence quality controls. The SEC Chief Accountant set forth in this letter what he called “[t]he basic requirements” of an independence quality control system, and said that “revised [SECPS] membership requirements incorporating [these]” should be implemented "no later than January 1, 2001."

On the same date as this letter to the SECPS Executive Committee, the SEC Chief Accountant also sent a letter to the POB, expressing concern that public accounting firms may lack adequate quality controls for independence. In this letter, as a step to “safeguard the public interest,” he “strongly recommend[ed] that the POB undertake a special review of SECPS member firms' current compliance” with independence requirements. In response, on December 21, 1999, the POB agreed to do so. The POB commenced preliminary work on the special reviews in early 2000, and had meetings with firm representatives to discuss the reviews.

On January 5, 2000, the POB placed in the public file of all SECPS member firms a letter discussing the above-mentioned December 9, 1999 letters from the SEC Chief Accountant to the SECPS Executive Committee and the POB. The POB’s letter gave notice to users of SECPS member firms’ peer review reports that existing peer review standards had not been adjusted to include additional tests that could be required in the future, as a result of actions taken in response to these two SEC letters.

On May 1, 2000, in another letter to the SECPS Executive Committee, the then-SEC Chief Accountant again raised concerns with the adequacy of SECPS member firms' independence quality controls, and asked that certain steps be taken to improve these controls.

Later in May 2000, the POB’s work on the special reviews was brought to a halt.   At that time, the SECPS sent a letter dated May 3rd to the POB stating that it would not approve or authorize payment for the special reviews.   Within a few days, on May 5th and 8th, the POB received letters from two of the Firms (PwC and Ernst & Young LLP (“E&Y”) stating that they knew nothing of the May 3rd letter before it was sent, and that the letter did not represent the position of their firms.

In a speech on May 10, 2000, the then-Chair of the SEC, Arthur Levitt, stated that this May 3rd letter was “a significant setback to self-regulation and independent oversight” and raised “serious questions as to the profession’s commitment to self-regulation”. In addition, he noted that Melvin Laird, the longest-serving member of the POB and former Secretary of Defense, had said this was “the worst incident in my 17 years on the POB’s Board.”

After this cut off of funding, the special reviews did not go forward.

The following month, June 2000, the SEC and the Firms entered into the Term Sheet. This Term Sheet requires the Firms to (i) participate in a voluntary look-back program to report any past violations of auditor independence rules, under the oversight of an independent counsel selected by the Firms with non-objection from the SEC, (ii) complete implementation of the systems and controls in the above-mentioned SEC December 1999 and May 2000 letters by January 1, 2001, and (iii) submit to the Reviews by the POB.

The POB was not involved in the negotiations on, nor was it a party to, the Term Sheet. Further, at the time they entered into the Term Sheet, the Firms and SEC did not request the input of the POB on the scope of the Reviews or the form and content of the Reports.

In a letter dated September 13, 2000, which was received by the POB on October 10, 2000, the then-SEC Chief Accountant asked that the POB conduct the Reviews called for by the Term Sheet “in lieu of the special review requested in my December 9th [1999] letter to you”. The POB agreed to do so.

The POB commenced preliminary work on the Reviews in November 2000. At the POB meeting on December 4, 2000, the then-Chair of the SECPS Executive Committee suggested a deferral of commencement of the Reviews for various reasons, including the Firms’ pending work on the “look-back reviews” (also called for by the Term Sheet) and their gearing up for compliance with new SEC independence rules (which were to become effective in early 2001).

The next month, on January 19, 2001, POB representatives met with the then-Chief Accountant and then-General Counsel of the SEC, as well as other members of the SEC staff, to discuss the Reviews and Reports. The discussion at the meeting focused on a number of issues concerning the Reviews, including the proposed deferral.

Subsequent to the January 2001 meeting, and continuing through May 2001, POB representatives spent a substantial amount of time reacting to, and furnishing comments on, the SECPS’s Joint Task Force on Independence and Quality Controls (“Task Force”) draft White Paper, which was designed to, among other things, support a deferral of commencement of the Reviews.  In particular, from March to June 2001, POB representatives, in meetings and telephone conferences, discussed with the Task Force five different drafts of this Task Force White Paper. It was apparent from these discussions that the Firms had very different views than the SEC staff on the meaning of certain provisions of the Term Sheet and how the Reviews should be done.

Because this matter was taking longer than expected, the POB started work on a draft request to the Firms for documents and information for the Reviews. This draft request was furnished to the Firms and SEC staff on May 22, 2001, and comments were requested. Work also continued on the White Paper, but in mid-June 2001, the POB was advised that the Task Force had decided not to go forward with its proposal to defer the Reviews.

On July 23, 2001, after receiving comments from the Firms and SEC staff, the POB sent to them the final version of its request for information and documents. This request asked the Firms to complete their submission of information and documents in response to the request “as soon as possible, but in no event later than August 31, 2001.” The cover letter with the request pointed out that POB representatives wanted to meet with the Firms “as soon as possible to work out confidentiality agreements” for the Reviews, and asked “that this be done as soon as feasible in order to expedite the POB’s work” on the Reviews.  The cover letter also requested that the Firms, in the meantime, “furnish [the POB] with any written information and documents in response to the [r]equest which you are willing to provide prior to the execution of a confidentiality agreement.” The Firms have not provided the POB with the information and documents it requested on July 23, 2001.

A letter from POB counsel to the Chair of the Task Force dated July 23, 2001 (“July 23rd Letter”), which was copied to the Firms, set forth the POB’s position on significant open issues concerning the Term Sheet and Reviews that had been raised (in some instances for the first time) in a July 6, 2001 letter to the POB from the Chair of the Task Force. These issues concerned the scope of the Reviews, including with respect to foreign-associated firms, the standards to be used by the POB in the Reviews for evaluating the effectiveness of the Firms’ Systems and Controls, the form and content of the POB’s Reports, the POB’s work programs for the Reviews, a confidentiality agreement to cover the information and documents submitted by the Firms to the POB in the Reviews, and the timing for the Reviews.  With regard to a confidentiality agreement, the POB’s July 23rd Letter stated that the Term Sheet required the POB to “issue public written reports” on the Reviews, and that, “[c]onsistent with this requirement,” the POB would be pleased to work with Firm representatives to develop a confidentiality agreement for the Reviews. This July 23rd Letter also stated that POB representatives wanted to meet with the Firms on a confidentiality agreement “as soon as feasible,” and asked that the Firms contact the POB “to arrange a date and place for the meeting.” The Firms to date have not entered into a confidentiality agreement with the POB.

On July 24, 2001, POB representatives met with E&Y. In an effort to move forward on the Reviews, the POB representatives proposed that the POB conduct a prototype Review of E&Y. The POB and E&Y exchanged draft correspondence on, and further discussed, this prototype Review, but it did not go forward.

On August 10 and 21, 2001, POB representatives met with representatives of the SEC and discussed, among other things, the status of the Reviews and certain open issues that still had not been resolved.

During the fall of 2001, POB representatives and the Firms continued to discuss open issues concerning the Reviews, some of which had been the subject of continuing POB discussions with the Firms and the SEC staff going back to January 2001. For example, POB representatives met with the Firms on September 11th in New York City to discuss issues concerning the scope of the Reviews and the form and content of the Reports. In response to the Firms’ request at this meeting, POB representatives on September 17, 18 and 25, and October 1 and 2, 2001, visited the five Firms for preliminary presentations on their independence systems.

On October 12, 2001, the POB sent to the Firms and SEC staff a draft “POB Preliminary Work Program for Phase I (Design and Implementation) of Oversight Reviews of Firm Systems and Controls Relating to Independence” (“Phase I Draft Work Program”). This Draft Work Program contains work steps for evaluating whether a Firm’s Systems and Controls were effectively designed and implemented. The focus of these work steps is on nine elements of Firm Systems and Controls:

  • written independence policies and procedures;

  • automated tracking system and restricted entity list;

  • independence training;

  • internal monitoring;

  • senior management and others responsible for independence;

  • “tone at the top” and culture relating to independence;

  • prompt reporting of personnel employment negotiations;

  • reporting by personnel of apparent independence violations; and

  • a disciplinary mechanism.

On October 15 and 17, 2001, POB representatives again met with the SEC staff to discuss the Reviews. Later in the month, the POB submitted two letters to the staff (dated October 19th and 23rd) with additional information, including correspondence between the Firms and the POB, concerning the Reviews.

On October 25, 2001, representatives of the POB, Firms and SEC staff met at the offices of the SEC to discuss the Reviews. This meeting was followed by an SEC staff draft letter dated November 5th setting forth proposed terms for the Reviews. On November 7th, a second meeting between representatives of the POB, Firms and SEC staff was held at the SEC offices to again discuss the Reviews. This meeting was followed by a second SEC staff draft letter dated November 15th containing revised proposed terms for the Reviews.

Pursuant to the discussion at the above-mentioned October 25, 2001 meeting, two meetings were held between the Firms and POB representatives to discuss a confidentiality agreement for the Reviews, one on November 13th (three Firms present), and the other on November 26th (four Firms present). In addition, another meeting to discuss a confidentiality agreement was scheduled for December 18th in New York City, but the Firms, without prior notice, did not attend. POB counsel was later told that day the Firms had decided to postpone the meeting, and that the POB should have been, but inadvertently was not, told of the postponement.

On December 10, 2001, POB representatives met with representatives of the SEC to discuss, among other matters, the Reviews.

On December 14, 2001, the SEC staff issued a third draft letter (“SEC Revised Draft Letter”) discussing further changes in proposed terms for the Reviews. On December 17th and 19th, POB counsel gave extensive comments to the SEC staff on this Revised Draft Letter.

On January 9, 2002, POB representatives met with the chief executive officers of two of the Firms, as well as the Chair of the SECPS Executive Committee, to further discuss the Reviews.

On January 17, 2002, the POB sent to the Firms and the SEC staff a draft “POB Preliminary Work Program for Phase II (Operating Effectiveness) of Oversight Reviews of Firm Systems and Controls Relating to Independence” (“Phase II Draft Work Program”). This Draft Work Program contains work steps to test the operating effectiveness of Firm Systems and Controls, with a focus on the same nine elements included in the Phase I Draft Work Program. In a cover letter, the POB requested comments on both the Phase I and Phase II Draft Work Programs by January 31st.

Although the POB did substantial work preparing to conduct the Reviews, going back to November 2000, by January 2002 it still had not been able to obtain the information and documents it requested from the Firms in July 2001. The POB believes that the time, effort and expense associated with much of its work on the Reviews could have been avoided if more progress had been made in the Reviews.

For context here, it should be noted that in a letter dated January 17, 2001, Congressman John Dingell, Ranking Member of the House Committee on Energy and Commerce, requested the U.S. General Accounting Office (“GAO”) to conduct a study of the accounting profession’s governance system. In a subsequent letter dated June 7, 2001, Congressman Dingell asked the GAO to include in this study, among other matters, the adequacy and effectiveness of the Reviews. Further, it is evident from recent media coverage, as well as Congressional hearings on the Enron collapse, that Congress has increased its focus on the accounting profession, including auditor independence.

VII. POB'S Position

As previously noted, in a letter to SEC Chair Pitt dated January 21, 2002, I stated that, in view of the POB’s intention to terminate its existence no later than March 31, 2002, and as part of the transition, plans must be made to transfer responsibility for the Reviews and the Reports from the POB to an Independent Person.

The POB believes that, consistent with the Term Sheet, and to further the public interest, the Reviews should be performed, and the Reports issued, by an Independent Person. The Firms have previously suggested that the Reviews be conducted, and the Reports issued, by the peer reviewers of the Firms. The POB, as it told the Firms at the time, does not agree with this approach because it is not in accordance with the Term Sheet. Concerns regarding the peer review process recently expressed by Congressmen and others also indicate peer reviewers should not be given responsibility for the Reviews and Reports.

In addition, the POB does not believe the Reviews should be conducted, and the Reports issued, as proposed in the SEC Revised Draft Letter.4 Rather, it is the view of the POB, based on its work on the Reviews, that the Reviews and Reports should be done by an Independent Person in the manner discussed below. In particular, the Reports should be written in “plain English” with informative, meaningful and transparent disclosure, in furtherance of the public interest.

A. Scope of Reviews

The POB believes that, in evaluating the “effectiveness” of the design, implementation and operation of the Firms’ Systems and Controls pursuant to the Term Sheet, the Independent Person should determine whether those Systems and Controls provide reasonable assurance of compliance with applicable SEC, AICPA, SECPS and Independence Standards Board (“ISB”) independence requirements (collectively, “Independence Requirements”).

B. Form and Content of Reports

It is the position of the POB that the “public written reports” on the design, implementation and operating effectiveness of the Firms’ Systems and Controls called for by the Term Sheet should be in “plain English” with meaningful disclosure. Moreover, these Reports should be “informative [so] that the public clearly understand[s] what has occurred,” as stated in the letter from Mr. Morrissey, as SEC Deputy Chief Accountant, to POB counsel dated July 13, 2001.

In addition, the POB believes that the Independent Person should include in the Reports a discussion of the following:

  • A description of the scope, methodology, and work performed.

  • A description of each Firm's U.S. practice, including lines of business, and the approximate number of partners and professionals covered by the Independence Requirements.

  • A description of the Firm's policies, procedures and practices to achieve compliance with the Independence Requirements.

  • A description of the findings and evaluation of whether the design, implementation and operating effectiveness of the Firm's Systems and Controls provide reasonable assurance of compliance with the Independence Requirements.

  • If the Firm’s System and Controls provide reasonable assurance there was compliance with the Independence Requirements, but there were significant deficiencies in the design, implementation or operating effectiveness of the Firm's Systems and Controls, then observations and recommendations concerning those deficiencies would be set forth in an appendix attached to the Reports. This appendix would also include any letter from the Firm in response to these observations and recommendations.

  • Any observations and recommendations relating to deficiencies that were not significant would be communicated in writing to the Firm, but not included in the Reports.

  • Identification of any “best practices” observed.

  • Any recommendations to the SECPS or other standard setters on the development of a written document, or other appropriate action, with respect to “best practices.”

The SEC Revised Draft Letter does not take this approach. It proposes that the scope of the Reviews, and the form and content of the Reports, be more limited, as specified in that Letter. For example, the Draft Letter states that significant observations and recommendations on the Firms’ Systems and Controls should not be part of the Reports, but instead put in letters of comment in the AICPA’s public peer review files.

The POB does not agree that the form and content of the Reports on the Reviews should be limited as proposed in the SEC Revised Draft Letter.  Such limitations would be an undue constraint on the Independent Person in a manner that, in the POB’s view, is not consistent with the Term Sheet.

The POB, in particular, does not agree with the proposal in the SEC Revised Draft Letter that significant observations and recommendations be omitted from the Reports, and instead placed in letters of comment to the Firms, with copies put in the AICPA public peer review files.5 The POB believes that significant observations and recommendations constitute important information that should be readily available to readers of the Reports and other members of the public. Further, physically separating the significant observations and recommendations from the Reports would likely be viewed as a device intended to make it more difficult for readers of the Reports to have ready access to that information. The rationale in the SEC Revised Draft Letter that these significant observations and recommendations, if placed in the Reports, could be “confusing” or distracting to readers is not persuasive, particularly given the SEC’s mandate for “full and fair disclosure” and the transparency in other reporting processes.

The POB believes that the Independent Person, as the party responsible for conducting the Reviews and issuing the Reports, should have the discretion, within the parameters of the Term Sheet, to determine the form and content of the Reports based on its findings in the course of the Reviews. To provide otherwise would raise questions about the independence of the process.

C. Work Programs for the Reviews

The POB believes that it would be in the public interest for the Independent Person to use the Phase I and Phase II Draft Work Programs in its conduct of the Reviews.  These Draft Work Programs were prepared by Tucker Alan, Inc., auditing and systems consultants to Fulbright & Jaworski L.L.P. (“F&J”), counsel to the POB for the Reviews and Reports.  In developing these Draft Work Programs, Tucker Alan received input from Jerry Sullivan, Executive Director of the POB; Henry Jaenicke, independence consultant to F&J; George Fritz and David Pearson, auditing and peer review consultants to F&J; and attorneys at F&J working on the Reviews. A substantial amount of time, effort and expense was spent in developing the Draft Work Programs, and the POB believes they would be very helpful to the Independent Person in conducting the Reviews.

The POB also recommends that the Independent Person consider obtaining the assistance of Tucker Alan, as well as Messrs. Sullivan, Jaenicke, Fritz and Pearson, in conducting the Reviews and preparing the Reports.

D. Confidentiality Agreement

The POB believes that a confidentiality agreement should be entered into between the Firms and the Independent Person with regard to Firm information and documents to be submitted to the Independent Person for the Reviews.

The Firms provided the POB with a proposed confidentiality agreement on September 7, 2001. This proposed agreement, among other things, required that the POB not retain any documentation underlying the Reviews beyond the date of issuance of the POB’s Reports, and that the POB not provide information about the Reviews to any third parties without the prior approval of the Firms. In a telephone conference on September 19th, POB counsel told counsel for the Firms that the proposed confidentiality agreement was not acceptable to the POB, and provided extensive comments on that agreement. These comments included, among others, that the POB should retain the documents underlying the POB’s conclusions, recommendations and observations in the Reports for a reasonable period of time after issuance of the Reports, and not dispose of those documents at the time it issues the Reports. In addition, POB counsel stated that the POB should not be in the position of being unable to grant a request for information or documents from the United States Congress, the SEC, the GAO, or other governmental entities (“Governmental Entities”), without having to first obtain the approval of the Firms.

E. Foreign-Associated Firms

There have been extensive discussions among representatives of the POB, Firms and SEC staff concerning the issue of whether the Firms’ foreign-associated firms should be included in the Reviews. The SEC Revised Draft Letter calls for the Reviews to cover these foreign-associated firms in a limited manner.

We note that at the above-mentioned meeting on January 9, 2002, POB representatives concurred with the chief executive officers of two of the Firms, as well as the Chair of the SECPS Executive Committee, that reviews of foreign-associated firms should be deferred until January 2003, when specific quality control provisions in the SEC independence rules become effective for those firms. Because of the importance of this issue, the POB believes there should then be a special review of foreign-associated firms, separate from the instant Reviews.

F. Dates for Reviews

The SEC Revised Draft Letter proposes an amendment to the Term Sheet which would change the “as of” date for the Reviews from January 1, 2001 to June 30, 2001 and the testing period from the six-months ended June 30, 2001 to the shorter period May 7 to June 30, 2001. The POB concurs with this change in view of the fact the SEC’s new independence rules were not in effect on January 1, 2001, but, for the most part, were by May 7, 2001. At the above-mentioned meeting on January 9, 2002 with the chief executive officers of two of the Firms, as well as the Chair of the SECPS Executive Committee, POB representatives confirmed this view.

We also note that, consistent with comments given by POB counsel to the SEC staff on December 17 and 19, 2001, there should be flexibility for the Independent Person to test items outside of the designated time period, in order to obtain reasonable assurance that the Firms’ Systems and Controls were operating effectively during the time period, to identify “best practices” or otherwise to achieve the purposes of the Reviews.

VIII. Conclusion

The POB believes that, consistent with the Term Sheet and the public interest, the Reviews should be performed, and the Reports issued, by an Independent Person in the manner discussed above. In particular, it is the view of the POB that the Reports should be written in “plain English” with informative, meaningful and transparent disclosure, in furtherance of the public interest.

It is important that the Reviews and Reports be undertaken and completed as soon as reasonably possible. As stated in Mr. Morrissey’s letter dated February 20, 2002, referred to above, any “protracted delay” in completing the Reviews and Reports “could undermine investor confidence in the audit process.”

We note that Mr. Morrissey’s February 20th letter requests that the Firms develop “an alternative approach” for completing the Reviews and Reports for consideration by the SEC staff. The POB believes that this request is not in the best interest of the Firms or the public, or in the spirit of the Term Sheet. An approach for the Reviews developed by the Firms themselves could be subject to criticism as lacking independence and thus credibility. Accordingly, we believe it is in the public interest, as well as consistent with the Term Sheet, for the Reviews and Reports to be developed by an Independent Person.

Sincerely,

Charles A. Bowsher
Chair

cc: Robert K. Herdman
Chief Accountant
United States Securities and Exchange Commission

Charles D. Niemeier, Esq.
Chief Accountant
Division of Enforcement
United States Securities and Exchange Commission

Robert W. Gramling
Consultant
United States General Accounting Office

Michael A. Conway
KPMG LLP

Edmund Coulson
Ernst & Young LLP

Michael O. Gagnon
PricewaterhouseCoopers LLP

Charles A. Horstmann
Andersen Worldwide

2002 Public Oversight Board


1 The SEC informed the POB that, after the Term Sheet was entered into by the SEC and the Big 5 Firms, the next three largest firms (BDO Seidman LLP, Grant Thornton LLP, and McGladrey & Pullen LLP) volunteered to participate in the Reviews. The POB was advised subsequently that these three firms may not participate in the Reviews.

2 See “Accounting Industry Oversight Board Votes to Disband to Protest SEC Plans” at page A2 of the January 23, 2002 issue of The Wall Street Journal, and “SEC Chief Pushes Accounting Agenda” at page C1 of the January 24, 2002 issue of the Los Angeles Times.

3 In a subsequent letter to SEC Chair Pitt dated January 31, 2002, I stated that, after having given serious consideration to the matters discussed with Chair Pitt and the content of his letter of January 22, 2002, and having consulted with the leadership of the AICPA and the Chair of the SECPS Executive Committee, the POB believed it would not serve the public interest for it to continue. In particular, I said, “Given the recent events and the SEC’s proposal for a new structure, we believe that we cannot effectively oversee the activities of the accounting profession and it would mislead the public to seem to do so.”

4 As previously noted, POB counsel provided extensive comments on the SEC Revised Draft Letter to the SEC staff on December 17 and 19, 2001. While the POB believes that all these comments have merit, in the interest of keeping the discussion in this letter relatively brief, only some of the comments are discussed here.

5 See note 4.