Ethics Rules Get Tighter: New PCAOB Independence Rules Focus on Tax Services and Contingent Fees
Allen, Catherine, Journal of Accountancy
* The PCAOB in April 2006 issued a set of seven rules for auditors of public companies. The rules focus primarily on tax services, but also address contingent fees, audit committee preapproval of tax services and fundamental requirements for ethics and independence.
* Individuals who contribute directly and substantially to their firm's violation of the Sarbanes-Oxley Act, PCAOB rules, professional standards or securities laws can be held personally accountable. Individuals are responsible for compliance with the new standards whether they knew their actions (or failure to act) would cause a violation or were recklessly ignorant of such facts.
* Auditors cannot accept commissions or contingent fees from audit clients during the audit and professional engagement period. Both direct and indirect fees, including those paid to "affiliates of the accounting firm" by the audit client or any other party on behalf of the audit client, are prohibited. The one allowable exception is for noncontingent fees set by a public authority acting in the public interest.
* While tax services that are approved by a client's audit committee and meet existing SEC standards generally can be provided to audit clients, the PCAOB adopted two explicit exceptions: confidential or aggressive tax transactions, and personal tax services provided to the audit client's financial management.
* Preapproval of tax services now requires auditors to (1) provide a detailed description of the proposed services, related fee and other arrangements to the audit committee; (2) discuss the proposal and the potential impact on independence with the audit committee; and (3) document the substance of the discussion.
In its first major rule-making initiative on independence and ethics, the Public Company Accounting Oversight Board (PCAOB) in April 2006 issued a set of seven rules for auditors of public companies. The rules focus primarily on tax services, but also address contingent fees, audit committee preapproval of tax services and fundamental requirements for ethics and independence. We'll outline the key points of the new rules and give you some tips on how to implement them.
LAYING THE FOUNDATION
Rule 3520, "Auditor Independence," requires that an audit firm and its associated persons be independent throughout the audit and professional engagement period. According to Rule 3501 (a)(iii), "Audit and Professional Engagement Period," the period has two components. The "professional engagement period" relates to the client. It begins when the auditor accepts a new audit or attestation client upon signing the engagement letter (or other agreement to review or audit a client's financial statements) or begins services, whichever is sooner, and ends when the auditor or the client terminates the relationship. The "audit period" relates to the audit or other attestation service itself and comprises, for example, the period of the financial statements under audit--often multiple years.
While these are not new terms (the PCAOB adopted the existing SEC definition from Rule 2-01 of SEC Regulation S-X), they are fundamental to applying the rules. For example, prohibitions against a financial relationship between the audit firm and client--such as stock ownership and loans--apply during the professional engagement period, but do not apply to any audit period that precedes the professional engagement period, which is generally the case in a new attestation engagement. For an existing attest client (for example, for the annual audit), the professional engagement period is ongoing--that is, it does not end each year when the audit opinion is issued. Nonaudit services, fee and business relationship rules, on the other hand, apply during the entire audit and professional engagement period, meaning they apply retroactively to new attestation engagements. As a result, firms may have difficulty meeting these rules for the relevant prior periods. …