Another Victory for Individual Investors

The Securities and Exchange Commission (SEC) announced the approval of rules aimed at shedding light on the conflicts of interest held by auditors and their clients. Coming on the heels of selective disclosure-busting Regulation FD, today's announcement is another battle in the SEC's fight for increased and more accurate information for investors.

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By Jay Perlman (TMF Jay)
November 15, 2000

The SEC unanimously approved new rules governing auditor independence today. While the news might not have the drama of a hotly contested presidential election, taken along with the recent implementation of regulations covering selective disclosure they illustrate a continuing move toward increased market transparency.

The rule reduces the number of audit firm employees and family members whose investments in, or employment with, audit clients would impair the auditor's independence. It also identifies non-audit services that, if provided to an audit client, would compromise auditor independence.

"I believe the scope of these prohibitions is targeted, sensible, and in many cases, consistent with the current restrictions on the profession's and the SEC's books," SEC Chairman Arthur Levitt said in a statement.

The issue that received the most attention was the restrictions on the services that an auditor could provide to a client. In its initial proposal, the SEC noted that auditors derived more than half of their revenues from these non-audit services. In order to protect this revenue stream, the SEC argued, auditors would possibly be more likely to overlook any accounting irregularities by the client. The result was that the integrity of the markets was being compromised because investors were receiving inaccurate information.

Needless to say, the accounting industry wasn't happy with the proposal and aggressively lobbied Congress to prevent the rules from being enacted. Thankfully, cooler heads prevailed and the accounting industry and the SEC arrived at a compromise. It allows the accounting industry to continue providing non-auditing services as long as two requirements are satisfied: 1) such services and the amounts are to be disclosed in the client's annual proxy statement, and 2) the client's audit committee determines that providing these services does not compromise the auditor's independence.

That's just what Tom Gardner, who testified before the SEC in September, hoped for.

"I think the first, best step the SEC should take is to, without delay, require public companies to disclose the nature and extent of their relationship with auditors, in its entirety," Tom said in his testimony. "This disclosure is not currently required. It should be. A complete, detailed disclosure would give investors the opportunity to decide for themselves whether or not accompanying commercial relations were impacting the purity of the audit."

Will the rules decrease the number of blown audits and allegations that companies and their accountants have "cooked the books"? Nobody knows for sure. But what is clear is that these rules, along with recently adopted rules relating to selective disclosure, continue to help put investors in control by giving them the information they need to make well-informed investment decisions. Congratulations, SEC -- and investors.

In other SEC news, the commission adopted two rules it hopes will "greatly increase the opportunity for public investors to evaluate what happens to their orders after they submit them to a broker-dealer for execution... [and] spur competition among market centers and broker-dealers to provide the best possible price and speed of execution for investor orders."

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