Executive Director of Independence Standards Board Talks to Auditing Academics

Arthur Siegel, Executive Director of the Independence Standards Board (ISB), spoke at the Auditing Section’s annual Midyear Meeting in Atlanta. He stated that his remarks reflected only his personal views and not necessarily those of the ISB or of individual board members.

INTRODUCTORY REMARKS
The primary objective of Siegel’s remarks was to create interest in the intellectual challenges in which the ISB is involved, in hopes that audience members will become active participants in this area. Siegel suggested that within these challenges lay tremendous research opportunities, and that accounting academics should have a central role in addressing these challenges and opportunities. He also commented on the great need to instill or reinforce ethical values of students entering the profession, noting that if those values aren’t there to begin with, it is unlikely that much will change post-employment. He strongly encouraged those in the audience to teach students that auditing is an honorable profession, that ethical values are needed and rewarded, and that an attitude of “everyone does it” is not tolerated by any reputable firm. His purpose was to demonstrate—through action—that the ISB values and wants academic input.

The remainder of Mr. Siegel’s speech was divided into two parts: background, matters of organization, mission, and general operation; and a discussion about the ISB’s activity to date and where the board is headed. Essential points of those remarks are as follows.

BACKGROUND
The Independence Standards Board came into being because both the SEC and the accounting profession have long wanted a clear conceptual framework for independence rules for auditors of public companies. So why might a conceptual framework be needed? Since the federal securities laws were enacted in the 1930s, the independence rules have evolved in a piecemeal fashion, with no clear underlying set of principles. There are now more than 200 pages of published rules, interpretations and “no-action” letters of the SEC and its staff. These are in addition to 50 pages of rules, interpretations and ethics rulings of the AICPA. The absence of clearly articulated principles means that the rules often cannot be used to provide guidance for new situations. Finally, the multitude of detailed independence rules would eventually make it difficult to harmonize U.S. independence requirements with those of other nations, and in a global economy with increasing amounts of cross-border investing, this has become a higher priority.

However, despite its shortcomings, the current system has worked. Therefore, before discarding the current framework, the ISB is adamant that viable alternatives must be evaluated in terms of how they may better protect the public interest. The ISB’s formal operating policies clearly define its objectives and mission: “To establish independence standards applicable to audits of public entities in order to serve the public interest and to protect and promote investors’ confidence in the securities markets.” A simple and straightforward charge, but a very complex assignment.

The board is comprised of eight members—four from the public and four from the accounting profession. The Chief Accountant of the SEC also attends Board meetings as an observer. The Board is an independent body funded by the AICPA’s SEC Practice Section. It sets its own budget and operates autonomously. It is very similar to the FASB. In addition, the Board’s deliberative processes are conducted “in the sunshine.” The next meeting is April 8, 1999 in New York. One of the ISB’s committees is the Independence Issues Committee (IIC). This committee is comprised of eight members from the profession. The IIC’s principal role is to deal with emerging independence issues in the same way FASB’s Emerging Issues Task Force does on emerging accounting issues.

CURRENT ACTIVITIES
The Board is currently working on a project in each of the following areas: development of a conceptual framework for independence, annual independence confirmation to client’s independence, implications of partners and staff being employed by audit clients, and effect of family relationships on independence. The most important project on the Board’s agenda is the conceptual framework. Some early thinking on the possible contents of a conceptual framework includes:

• The investor’s need for reliable and credible financial statements
• The objectives of audits and of auditor independence
• The relationship of independence to objectivity and integrity, including the definition of independence
• If there is a “reasonable investor” test, how that theoretical person might be defined

Another issue involves identifying which factors should be considered in setting independence standards. Examples include:

• Can costs and benefits, if measurable, be considered?
• Can threats to independence be satisfied by firm-specific safeguards, or compensating controls, and if so, when?
• When should the appearance of impaired independence be a factor, and how should that be determined?
• Is materiality a consideration in reaching—or applying—independence standards, and if so, how should it be measured?
• What does “mutuality of interests” mean and when might it properly be considered a threat to independence?

When this project is completed, it will not, of itself, “answer” independence questions, but it should define the parameters within which one would logically find conceptually consistent answers. At the Board’s latest meeting, it approved its first pronouncement, which included requirements for firms auditing public companies to annually describe, in a written report, all relationships with an audit client that could impact independence. In addition, a firm would be required to confirm in that written report its independence and discuss the contents of the report with the client’s audit committee.

Audit professionals often leave firms to join audit clients. Various concerns have been expressed about this practice. One concern involves whether members of the audit team, who may have been friendly with, or respectful of, that person when he or she was with the firm, would be reluctant to challenge the decisions of that individual. Another aspect of this issue relates to situations where partners or other team members resign to accept positions with audit clients. Sometimes, questions may be raised regarding whether the individuals exercised an appropriate level of skepticism during the audit process prior to their departure. Finally, the departing partner or professional may be familiar enough with the firm’s audit approach and testing strategy so as to be able to circumvent its design. Two solutions have been proposed. One involves the establishment of safeguards or mitigating controls by the audit firm. The other establishes a mandated cooling-off period.

The fourth project is in the area of family relationships. Related questions involve the nature of a family relationship. In addition, the notion of “who is the auditor” has evolved. There are a number of complex issues that need to be considered in this area. These include:

• Should considerations be different for those participating in an engagement vs. firm personnel not on an engagement?
• What is a “close family” relationship?
• Do different rules for partners, managers and all other employees make sense?
• Is geographic distance a mitigating control today, or is using the chain of command better?
• Are there materiality considerations that need to be considered?
• Can “firewalls” within the auditing firm be effective?
• What is the best practice?

Finally, the Independence Issues Committee is considering two important issues: Alternative Practice Structures, and FAS No. 133. The latter relates to FAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The subject of this project addresses the kind and level of assistance that auditors can provide their audit clients in accounting for and valuing derivatives as part of implementing FAS No. 133.

In wrapping up his comments, Siegel indicated that the ISB has a web site at www.cpaindependence.org.

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