By Peter Silvern, JD, Writer/Analyst, Federal Securities Law Reports, Mutual Funds Guide, Investment Adviser Newsletter

Widespread Independence Violations Reported

In a report made public by the Securities and Exchange Commission earlier in the month, the public accounting firm PricewaterhouseCoopers LLC (PwC) comes under attack for sweeping violations of independence rules made by partners and managers of the company. The report is the culmination of an investigation that began with an Opinion and Order issued January 14, 1999, in which PwC was censured for violating auditor independence rules and for improper professional conduct. Attorney Jess Fardella was appointed by the Commission to conduct a review of alleged PwC independence violations.

The SEC and American Institute of Certified Public Accountants have promulgated rules and regulations regarding the independence of accountants. The rules constitute a wide range of prohibitions regarding investments, bank accounts, credit card limits and stock holdings in client companies. Under the rules covered personnel of an accounting firm may not directly own stock or mutual fund shares in audit clients, nor have credit cards issued by audit clients with balances over $5,000. In addition, covered personnel cannot own interests in IRA accounts or 401(k) plans investing in audit client securities. These prohibitions, in many circumstances, extend to spouses, co-habitants and dependents.

The initial SEC action in this case stemmed from an investigation involving the Tampa, Florida office of Coopers & Lybrand, prior to their merger with Price Waterhouse. In July, 1998, in anticipation of the merger, a Transition Memo was sent to all partners of the two companies outlining the independence compliance requirements. In August 1998, another memo was sent requesting each partner confirm their compliance with the company's independence policy. In November, 1998, a third notice was sent to partners stating that an independence violation in the Tampa office had been discovered and new policies were forthcoming. These new rules were to include audits of partner's brokerage statements and tax records to assure compliance.

The SEC's Opinion and Order came two months later.

All 2,698 partners of PwC were asked to report independence violations as part of the SEC's Opinion and Order. Of that number, 1,301 reported at least one violation. Thirty-seven partners reported twenty-one to seventy violations. Of a total 8,064 reported violations, more than eighty-one percent were reported by partners, seventeen percent by managers and less than two percent by employees. Audit professionals, comprising thirty-four percent of the company's entire professional staff, accounted for more than forty-five percent of the violations. Prohibited spousal investments accounted for another twenty-two percent of reported violations. According to the report, the majority of violations were made up of investments in audit client company stock and mutual funds investing in audit company stock.

As part of the investigation, Mr. Fardella and his staff conducted random interviews with individuals found to have under-reported violations. As of December, 1999, forty-five of 150 partners have been interviewed, most accompanied by counsel. The reasons they gave for not disclosing all their violations ranged from a failure to remember portfolio holdings to an inability to access the company's computerized compliance database. Some stated they did not properly understand the independence rules, while others cited the volume of daily e-mail as a reason for not paying closer attention to internal communications regarding compliance.

The report concludes there is clear evidence of widespread non-compliance at PwC. Despite warnings that the SEC was overseeing a review of admitted violations, more than seventy-seven percent of the partners selected for audit failed to report some or all of their violations. The report also concludes, while many on the professional staff did make efforts to comply, many others made little or not effort at all.

The Public Oversight Board, at the SEC's request, will sponsor similar independence reviews at other firms and oversee development of enhancements to quality control and other professional standards. SEC Chief Accountant Lynn E. Turner said, "This report is a sobering reminder that accounting professionals need to renew their commitment to the fundamental principle of auditor independence."