Auditor Independence After Sarbanes-Oxley
September 15, 2003
The requirements of the Sarbanes-Oxley Act and subsequent SEC rules have significant implications for the responsibilities of fund audit committees, the way they do business and the qualifications of their members. Not only did the act formalize measures to safeguard the independence of outside auditors, it redefined the role of fund audit committees in assuring transparency, and thus accountability, to shareholders. No less than in years past, the quality of a fund's financial reporting depends upon close and effective coordination among management, the audit committee and the audit firm. Sarbanes-Oxley altered, however, in crucial respects, the rules of engagement.
Understanding and adapting to this new environment is a challenge to audit committees throughout the fund industry. Particularly complex is the audit committee's role in pre-approving audit and non-audit services, given the relationships with the many service providers that support a fund's operations. Sarbanes-Oxley and the new SEC rules have entrusted to audit committees the responsibility for the actual engagement of auditors as well as specific pre-approval of both audit and non-audit services. These requirements underscore the need for audit committee members to exercise diligence in assuring the independence as well as the expertise, resources and experience of the firm selected to audit the fund.
The new definition of the fund audit committee's role requires audit committees to bring a healthy skepticism to the pre-approval process. All audit committee members should be asking questions of both the audit firm and fund management to fully understand the substance of each service provided to the fund. They need to ask why it is provided, over what period of time, how much it costs and how the service enhances the fund's operations or financial reporting.
It is imperative that fund audit committees adopt appropriate policies and procedures for pre-approval of audit and non-audit services. This responsibility cannot be delegated to management. Committees should ensure that they are informed of each service actually received by the fund, its advisors or certain other service providers. They also should be aware that certain services are prohibited. For instance, the auditor may not function in a management role, audit its own work or serve as an advocate for the fund.
The pre-approval process provides audit committee members the opportunity to consider in advance whether the non-audit assignment will impair the independence of the auditor in auditing the fund. The audit committee's pre-approval responsibilities depend on the nature of the service and the entity to which it is provided. Before implementing any process or procedures, it is necessary to understand the types of services an auditor provides and how the regulations categorize those services for purposes of pre-approval.
Audit Services encompass the audit of financial statements, as well as the review of tax provisions and other services that generally only the financial statement auditor can provide, such as consents for regulatory filings and prospectuses.
Non-Audit Services include: 1.) audit-related services such as procedures for fund mergers, AIMR reporting and compliance with various rules under the Investment Company Act, such as codes of ethics and inter-fund trading restrictions; 2.) tax services performed by tax professionals, such as tax compliance, preparation of tax returns and planning and advice; and 3.) certain advisory and consultation services.
The pre-approval obligations of a fund audit committee, in fact, are more extensive than those of an operating company's audit committee. In the case of funds, the scope of pre-approval also includes certain non-audit services for a fund's advisor, sponsor and service affiliates - and is not limited to services provided to the company of which the audit committee members are directors. This expanded scope for pre-approval assures that the fund's audit committee has the opportunity in advance to consider whether, in light of all the facts and circumstances, the non-audit assignment for the affiliate will impair the independence of the auditor with respect to the audit of the fund.
The audit committee's overriding goal is to assure that the auditor can perform its audit of the fund without influence from others that would compromise the auditor's objectivity or impede its candor.
-- Chip Voneiff is the leader of the U.S. investment management industry group at PricewaterhouseCoopers, and Paul Schott Stevens is a partner in the financial services group at Dechert. PricewaterhouseCoopers and Dechert recently published "Auditor Independence After Sarbanes-Oxley: A Guide to Auditor Services for Fund Audit Committees." For a copy of the guide, please see www.pwc.com or www.dechert.com.
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