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As the Big Five watch with increasing horror, the Securities and Exchange Commission continues doggedly pushing on in its crusade to break up the major accounting firms. On Wednesday, the SEC held the second of four scheduled hearings on a proposed rule that will set new guidelines in hopes of ensuring the independence of financial auditors. In his opening remarks, SEC Chairman Arthur Levitt said that the commission had received more than 700 comment letters on the proposed rule. In addition to the third hearing scheduled for Sept. 20, the Chairman announced that a fourth hearing would be held the following day. However, he did not say that the SEC had any intention of extending the 75-day comment period, as requested by Congress and opponents of the rule. Critics argue that not only is the proposed rule a ham-fisted solution to a problem that does not exist, but that it is being rammed down everyone’s throats while mere lip service is paid to public participation. “It’s a sham process,” said Douglas R. Cox, a partner at the Washington, D.C., office of Gibson, Dunn & Crutcher who represents a coalition opposing the rule comprised of the American Institute of Certified Public Accountants (AICPA) and three of the Big Five: KPMG, Arthur Andersen and Deloitte & Touche. Cox said that not only did the SEC schedule 40 witnesses in one day, but also stacked the witness list heavily in favor of the SEC’s position. “The SEC is not taking this process seriously,” Cox said. Industry insiders suspected that the SEC might be hoping to sneak the rule through while people are distracted by the November elections. BOMB DROPPED The SEC dropped its bombshell on June 27, issuing 58 pages of proposals that the accounting industry greeted with panic and disbelief. Opponents were most troubled by the section limiting scope of services, which would ban auditors from offering a range of lucrative functions such as financial systems design and appraisal, actuarial and legal services. Over the past few decades, the Big Five have transformed themselves from the days of green eyeshades and sharpened No. 2 pencils into phenomenally successful professional service firms with a global reach. According to SEC data, the Big Five’s 1999 revenue from consulting services amounted to more than $15 billion in the United States, accounting for more than half their total revenue. The proposed rule is thus a “source of tremendous understandable angst on the part of the accounting profession,” said Michael R. Young, a partner at Willkie Farr & Gallagher. “They are at risk of watching substantial portions of their practices swept away by a hastily enacted set of SEC regulations,” he added. KPMG, Arthur Andersen and Deloitte & Touche immediately came out against the proposed regulations. The two other big accounting firms, PriceWaterhouseCoopers and Ernst & Young, both of which were in somewhat awkward positions, lay low. PriceWaterhouseCoopers was under investigation by the SEC for auditing and consulting services it had provided to a client, Microstrategy Inc., and Ernst & Young had just received the SEC’s blessings on its spin-off of its consulting business to Paris-based consultant Cap Gemini. Yet behind the scenes, both firms have expressed their dismay with the rule as proposed. In late July, shortly after the first hearing was held, the CEO of PriceWaterhouseCoopers, James J. Schiro, sent a letter to all its clients stating that, although “we have publicly supported” the SEC’s efforts, “the rule proposed by the SEC goes too far.” Three weeks later, in an Aug. 15 speech to the American Accounting Association, Ernst & Young Chairman Philip A. Laskawy, criticized the rule at length, arguing that although his firm was “supportive of an independence rule,” the proposed one “would actually create uncertainty and would go far beyond what anyone expected.” He questioned the need for such sweeping regulations, especially since several of the Big Five are in the process of shedding large portions of their consulting practices. Ernst & Young sold its practice in May. Earlier this week, it was reported that PriceWaterhouseCoopers, which had been shopping around its consulting unit for months, had a potential buyer in Hewlett-Packard Co. And KPMG has embarked on a five-year plan to divest itself of interest in its consulting group. In light of these changes, Laskawy said he believed “a paring knife, not an ax, should be the regulatory instrument of choice.” NO PROBLEM The SEC has argued that auditor independence is critical to the quality of audits, and by extension, to the integrity of the marketplace. It has also argued that such independence is compromised when auditing and consulting practices are combined. “Without confidence in an auditor’s objectivity and fairness, how can an investor know whether to trust the numbers?” Chairman Levitt has stated. Opponents counter that the SEC has no evidence that such conflicts actually exist. To the contrary, Richard I. Miller, general counsel and secretary of the AICPA, the industry’s leading trade group, contends that combining services enhances the quality of audits. “The more you learn about a company, the less likely you are to be fooled,” he said. A recent survey of corporate executives and individual investors disclosed that they too saw little reason for the types of safeguards proposed. The survey was commissioned by the Independence Standards Board, which was set up by the SEC and AICPA to study the issue of auditor independence. From a theoretical perspective, John O. Whitney, a professor at Columbia University Business School, disagreed with the very concept of auditor independence, given the fact that auditors are paid by the client they are auditing. He suggested that the way to improve financial reporting is to do away with the certified audit altogether, which he considered “not worth the powder it takes to blow it to hell.” Indeed, he noted, most major bankruptcies have been preceded by a “clean” audit. The problem, Professor Whitney said, has nothing to do with independence. Rather, inexperience, arcane tests and lack of timeliness make most audits “a monumental waste of money.” He said that Chairman Levitt called him last week after Barron’s published an article in which Professor Whitney outlined his proposal. The chairman, he said, agreed with many of his premises, but disagreed with his conclusions. The other major source of anxiety for many accountants is the section of the proposal that would require clients to disclose the non-audit services provided by their accountants. Companies would also be required to justify their use of services that might compromise auditor independence. Miller said that, as written, the rule was pointless. In fact, he said, the SEC repealed a similar rule in 1982 after finding that it was not serving any useful purpose. The disclosure requirement, Miller asserted, was actually “a backhand way of achieving the SEC’s goal” of stripping accountants of their consulting practices. It would operate to deter companies from using accountants for non-audit services at all, for fear of risking a negative public reaction, he said. Instead of public disclosure, Miller said, “disclose anything and everything to the audit committee. That’s where disclosure should be.” But others have said that the disclosure requirement has its benefits. William T. Allen, chairman of the Independence Standards Board, stated at the first hearing in July that although he understands the accounting profession fears that disclosure will cause them to lose business, he is “very much in favor of disclosure.” “I think it’s very helpful to the markets,” he said, “because we met with the groups from the investor community, and they all were very enthusiastic about having this kind of information.”

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