Mr. John T. Spotila
Administrator
Office of Information and Regulatory Affairs Office of
Management and BudgetEisenhower Executive Office Building, Room 350
17^th Street & Pennsylvania Avenue, N.W.
Washington, D.C. 20503

Dear Mr. Spotila:

As part of its mission, the Center for Regulatory Effectiveness (CRE) analyzes important federal regulations having a significant impact on major industrial sectors and monitors litigation brought to enforce laws pertaining to agency rulemaking. The Securities and Exchange Commission's recently proposed Revision of the Auditor Independence Requirements, 65 Fed. Reg. 43148 (July 12, 2000), is one such rule. There are a number of mechanisms through which OMB can and should exercise its oversight authority to improve the quality of this pending regulation.

Our views on the proposed SEC rule are respectfully set forth below and in the attached report.

A. CRE's "Report Card" on the SEC's Proposed Rule

CRE has developed a matrix of 48 legal requirements that govern agency rulemaking proceedings under what we refer to as the "good government" laws. These laws include such statutes as the Paperwork Reduction Act, the Unfunded Mandates Reform Act, and the Regulatory Flexibility Act, as well as Executive Orders pertaining to regulatory planning and review, federalism and civil justice reform. CRE has prepared and attached such a "Report Card" on the SEC's proposed auditor independence revisions. The Report Card is also available on CRE's website (www.TheCRE.com).

As the CRE Report Card details, there are a number of significant violations and inadequacies in the proposed rule. We have highlighted below what we believe are the particularly critical aspects of these deficiencies. Matters relating to judicial review are not discussed in this context.

B. Failure to Comply with the National Technology Transfer and Advancement Act of 1995

The SEC has failed to adopt an available and appropriate private voluntary consensus standard, in lieu of a government-unique standard, in violation of the National Technology Transfer and Advancement Act of 1995 (Technology Transfer Act), Pub. L. No. 104-113, 110 Stat. 775. Federal agencies are required to adopt such voluntary consensus standards unless the agency provides to OMB a specific reason for not doing so. Specifically, section 12(d) of that Technology Transfer Act provides:

"(1) In General. – Except as provided in paragraph (3) of this subsection, all Federal agencies and departments⁽¹⁾ shall use technical standards that are developed or adopted by voluntary consensus standards bodies, using technical standards as a means to carry out policy objectives or activities determined by the agencies and departments.

Section 12(d) of the Technology Transfer Act is implemented through OMB Circular A-119 (Federal Participation in the Development and Use of Voluntary Consensus Standards and in Conformity Assessment Activities). Section 6 of that Circular provides, in pertinent part:

6.   What Is The Policy For Federal Use of Standards?

All federal agencies must use voluntary consensus standards in lieu of government-unique standards in their procurement and regulatory activities, except where inconsistent with law or otherwise impractical. In these circumstances, your agency must submit a report describing the reason(s) for its use of government-unique standards in lieu of voluntary consensus standards to the Office of Management and Budget (OMB) through the National Institute of Standards and Technology (NIST).

Circular A-119 further states, in section 11:

11.   What Are The Procedures For Reporting My Agency's Use Of Standards In Regulations?

Your agency should use transaction based reporting if your agency issues regulations that use or reference standards. If your agency is issuing or revising a regulation that contains a standard, your agency must follow these procedures:

The National Technology Transfer and Advancement Act Plan for Implementation⁽²⁾ demonstrates that the federal government has an obligation to consider consensus standards developed at the international level as well: "On the international level, the U.S. must work toward harmonizing, or recognizing as equivalent, standards throughout the world. . . ."

With respect to the proposed SEC auditor independence rule, private consensus standards clearly exist. The Independence Standards Board (ISB), the voluntary standards body endorsed by the SEC, has promulgated a series of standards specifically addressing auditor independence and is in the late stages of developing a comprehensive framework for evaluating independence issues.

In proposing its government-unique auditor independence standards, however, the SEC has not given any consideration to the option of relying on the private sector standard. Thus, the SEC is not in compliance with the Technology Transfer Act.

C. Noncompliance with the Paperwork Reduction Act

As you know, OMB has both the statutory authority and duty to review the "information collection" aspects of the proposed auditor independence rule under the Paperwork Reduction Act of 1995, 44 U.S.C. § 3501-3520 (PRA). The purpose of the PRA is to ensure that certain review and approval procedures are followed before an agency such as the SEC imposes a burdensome recordkeeping or reporting requirement on the regulated community. These procedures are intended to ensure that: (i) affected members of the public will have a meaningful opportunity to address the appropriateness and usefulness of the proposed information collection; (ii) the sponsoring agency (here, the SEC) considers the public comments and documents the appropriateness of the proposal in light of such comments; (iii) the sponsoring agency demonstrates that the proposed information collection complies with ten substantive standards mandated by Congress; and (iv) OMB makes a final, independent determination to approve or disapprove the information collection, based on its review of a complete clearance package.

As further detailed in the CRE Report Card, we have identified a number of serious deficiencies in the PRA review and approval procedures in connection with the proposed rule. First, as a practical matter, the 30-day comment period is a grossly inadequate amount of time for stakeholders to collect the necessary data on recordkeeping and reporting burdens and submit this data in public comment form in response to the proposed information collection. Second, under the statute, stakeholders are entitled to two separate and distinct comment periods, a 60-day period at the SEC level and a 30-day period at OMB. This procedure is not being followed. Third, because the SEC and OMB have failed to adhere to the prescribed three-step review and approval procedure (see 44 U.S.C. §§ 3506(c), 3507), the SEC cannot have reviewed the public comments and certified that the information request satisfies the enumerated statutory requirements including "purpose", "need" and "practical utility."

We believe that there are, in fact, significant problems under the "purpose," "need" and "practical utility" requirements under the proposed rule. As discussed further below, these stem from the fact that the regulatory strategy being pursued by SEC is not the most efficient or cost-effective mechanism to prevent auditor conflicts, bias or loss of investor confidence. The rule would not have practical utility, for example, because the rule would not improve the actual quality of audits performed. The basic point, however, is that a full airing and assessment of these issues has been rendered difficult if not impossible by the PRA violations described above and the other PRA deficiencies noted in the CRE Report Card.

D. Noncompliance with the Regulatory Principles in Executive Order 12866

Executive Order 12866 on Regulatory Planning and Review sets out important principles for federal agencies to follow in adopting new or revised regulations. Although the Order is not formally binding on rulemaking proceedings conducted by independent agencies such as the SEC, a number of years ago the SEC agreed to abide by the Order's principles. This means that, although OMB cannot exert formal review authority over the SEC's rulemaking activities, OMB may review the SEC's compliance with key principles and procedures set forth in Executive Order 12866 and issue a formal report to the SEC. Because of the substantial noncompliance in the proposed rule, we urge OMB to undertake such an effort.

Moreover, OMB historically has been criticized for emphasizing the review of environmental regulations and giving less attention to review of economic regulations that significantly affect the economy. OMB has indeed played an active role in reviewing a number of key EPA regulations, such as ozone particulate standards and the TMDL rule. SEC's auditor independence regulation affords OMB an opportunity to exercise its oversight leadership over economic regulations to ensure that the public is subjected only to cost-effective rules.

The proposed rule fails both the compelling public need and least cost alternative principles of the Executive Order. These issues are discussed below.

1.   No "Compelling Public Need"

The proposed rule fails to satisfy the "compelling public need" requirement of Executive Order 12866 section 1(a). Under this provision, a federal agency should not issue a new regulation unless there is a "compelling public need, such as material failures of private markets to protect or improve the health and safety of the public, the environment, or the well-being of the American people." Section 1(a) further provides that the determination of a "compelling public need" must take into account costs and benefits of available regulatory alternatives.

The SEC has not demonstrated that: (i) auditor bias is a significant existing problem, either in terms of adverse affects on audit results or investor confidence in the markets; and (ii) existing SEC rules and regulations, together with the rules of the ISB and the American Institute of Certified Public Accountants (AICPA), are inadequate to address the agency's concerns. The SEC proposal contains virtually no evidence to support any additional regulatory measures, to say nothing of the extreme provisions that are contained therein.

With respect to the need for additional disclosure requirements, investors already have access to significant sources of information related to auditor independence. For example, under the SEC's existing rule on Audit Committee Disclosure (Release No. 34-42266, December 22, 1999), corporate audit committees must attest in their proxy statements that they have received disclosures on auditor independence, as required under ISB Standard No. 1. That standard requires that at least annually an auditor shall:

1. disclose to the audit committee of the company (or the board of directors if there is no audit committee), in writing, all relationships between the auditor and its related entities and the company and its related entities that in the auditor's professional judgment may reasonably be thought to bear on independence;

2. confirm in the letter that, in its professional judgment, it is independent of the company within the meaning of the Acts; and

3. discuss the auditor's independence with the audit committee.

Also, the SEC Practice Session of the AICPA (SECPS) has previously published information describing the mix of services that an accounting firm may provide to all of its clients. Efforts could be made to revive and possibly expand the public availability of such information. In light of these and other industry practices, the compelling need for additional disclosure provisions is far from obvious. Moreover, as discussed further below, any reinstated disclosure requirements should not exceed the requirements that were adopted in 1978, and subsequently withdrawn as unnecessary in 1982.

2.   Availability of a Less Costly Alternative

As noted, neither a systemic breach of auditor independence nor actual loss of investor confidence has been demonstrated. Even if such problems had been demonstrated, however, there are readily apparent, less costly alternatives that would address the problems. Such alternatives could be accomplished either through cooperative efforts with existing standard-setting bodies or through appropriate SEC regulation. Once adopted, and after a period of careful review and consultation with interested parties on their effectiveness, the SEC could then consider whether further measures are (a) necessary, and (b) consistent with the Commission's statutory authority.

One less costly alternative to the core SEC proposal would be to modify the disclosure requirements pertaining to audit and non-audit activity. Without commenting on the specific disclosure requirements in the proposed rule, there is strong support for an approach that focuses on disclosure rather than command-and-control regulatory directives. OMB itself endorsed such "disclosure regulations" just two years ago:

There is a strong consensus among economists that regulations requiring the disclosure of information . . . can produce significant benefits for consumers and improve the functioning of markets when this information would not otherwise be available.

OMB Report to Congress on the Costs and Benefits of Federal Regulations (1998), p. 21. Disclosure requirements increase transparency and the store of public information without the risk of market distortion or other anti-competitive effects, associated particularly with the scope-of-services provisions, which are likely to occur under the command-and-control prohibitions in the proposed SEC rule.

Another argument in favor of the disclosure approach is that the proposed SEC rule undermines the authority of corporate audit committees and their existing relationships with accounting firms. It also undermines the authority of the accounting profession, and of private standard setting bodies such as the ISB and the Public Oversight Board, to assume responsibility for the professionalism and integrity of its members.

We note that the proposed rule largely restates the reporting requirements adopted in Accounting Series Release (ASR) No. 250, 43 Fed. Reg. 18611 (June 29, 1978), which was later rescinded in ASR No. 304 because the Commission ". . . concluded that it is not generally of sufficient utility to investors to justify continuation of the disclosure requirement" ASR No. 304, "Relationships Between Registrants and Independent Accountants," January 28, 1982, p. 1. We thus question the need for even this, more limited, regulatory requirement. However, if the SEC feels that market circumstances have changed sufficiently to warrant reinstatement of some disclosure requirements, the SEC should at lease take limit these requirements to the before also imposing the other aspects of the proposed rule.

CRE would be pleased to work with the SECPS, the ISB, the Public Oversight Board, and any other organizations dealing with standards for the accounting industry to review existing disclosure standards to determine how they might be revised to further assure investor confidence. CRE would report to the Commission on the results of its inquiry. Meanwhile, CRE would urge that OMB encourage the SEC to review and revise its proposed rule with an eye toward developing less-costly alternatives, particularly the possibility of some kind of limited disclosure requirement.

E. Recommendations

Based on the considerations outlined above, CRE respectfully recommends the following actions:

The SEC's proposed rule, if adopted, would have a profound impact on SEC registered companies, accounting firms, investors and the public generally. We hope that OMB will exercise its leadership in this regard to insure that any rule that is adopted is consistent with all laws, regulations and best practices relevant to agency rulemaking. Such action will serve the public interest and may lessen the likelihood of judicial review under the "good government" laws.

Sincerely,

Jim J. Tozzi
Member, CRE Board of Advisors

cc: Jonathan G. Katz, SEC