Stephen Butler, KPMG's chief executive and chairman.

The AICPA, whose concerns were echoed by KPMG, oppose the proposed rule which they believe will force accounting firms to split from their consulting units and will decay audit quality.

"We believe the proposed rule will limit accounting firms to limited services," Barry Melancon, AICPA's president and chief executive, told the Commission. "In its current form, it will do harm to our profession."

The growth in lucrative consulting engagements with audit clients sparked the SEC to issue a proposal to modernize the rules for auditor independence, limiting the services provided by the audit firms to their audit clients. The proposal has been met with great criticism from many in the profession, including the AICPA, Arthur Andersen, Deloitte & Touche and KPMG. Thursday's hearing was the fourth and final public hearing on the matter.

During Wednesday's hearing, PricewaterhouseCoopers and Ernst & Young sided with the Commission on limiting the services an audit firm can provide to audit clients and offered an 18-page proposal of their own.

Melancon said his concern, among other things, is that the proposed rule is, in his view, "vague, open-ended principles and a catch-all provision which allows for the prohibition of virtually any activity based on the regulator's perception of appearance."

He also believes the proposed rule will put a severe damper on small firms.

"I think it is a ripple effect. This rule would be emulated by the states and would put a cramp on small firms to serve small businesses," said Melancon.

SEC chairman Arthur Levitt considered that concern far-fetched and said, "The notion that what the Commission does will be mirrored by the states is overstated. I think we should restrict ourselves at drawing lines at the extreme."

Echoing many of the AICPA's concerns, KPMG's chief executive and chairman Stephen Butler told the Commission, "The fact is that this profession, including KPMG, has been providing nonaudit services to audit clients for over a century, without incident and to the great benefit of our clients and the economy."

To support his arguments, Butler cited the Earnscliffe study which found a "positive view of auditors and the way in which they performed their jobs." He further stated that Phase II of the study found that investors "were saying that they felt that the level of risk was modest, the track record was pretty good, and the checks and balances seemed to be functioning reasonably well."

Butler, who criticized the SEC-formed Independence Standards Board for not handling the matter, believes the proposal, if approved, threatens firms' ability to provide investor protection and attract talent.

"The fundamental flaw of this rulemaking, besides its reliance on appearance, is that it is firmly grounded in yesterday's financial reporting model," Butler told the Commission. "By locking audit firms into that model, this rule would ensure that we never attract the talent or develop technologies necessary to provide true investor protection in the information economy."

-- By Antoinette Alexander

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