The SOA attempts to eliminate specified potential conflicts of interest arising out of "non-audit services" and gives further power to the Audit Committee. The SOA explicitly prohibits large scale, big fee financial information systems design and implementation or information technology work. This was a very high profit area for the non-audit arms of the large accounting firms. The SOA also bars internal audit outsourcing and "expert" services.
   
Set forth below are the nine prohibited activities for a registered accounting firm performing an independent audit of a public company:

• bookkeeping or other services relating to the accounting records or financial statements of the audit client;
• financial information systems design and implementation;
• appraisal or evaluation services, fairness opinions or contribution-in-kind reports;
• actuarial services;
• internal audit outsourcing services;
• management functions or human resources;
• broker or dealer, investment advisor, or investment banking services;
• legal services and expert services unrelated to the audit;
• and any other service that the accounting board determines, by regulation, is impermissible.

The SOA goes on to provide that a registered public accounting firm may engage in any non-audit service, including tax services, that is not described in the foregoing nine activities, but only if the activity is approved in advance by the Audit Committee of the issuer as provided in Section 202 of the SOA.  Section 202 provides that all auditing services (which may entail providing comfort letters in connection with securities underwritings or statutory audits required for an insurance company for purposes of state laws) and non-audit services other than the de minimus exception shall be pre-approved by the issuer's Audit Committee. The de minimus exception, which is not subject to the pre-approval requirement of the Audit Committee, has three conditions:

1. the aggregate amount of all such non-audit services provided to the issuer constitutes less than 5% of the total amount paid by the issuer to its auditor during the same fiscal year in which the non-audit services are provided; 
2. such services were not recognized by the issuer at the time of the engagement to be non-audit services; and 
3. such services are promptly brought to the attention of the Audit Committee and approved prior to the completion of the audit by the Audit Committee or by one or more members of the Audit Committee.

Whether the Audit Committee approved the specified non-audit services to be performed by the auditor of the issuer shall be disclosed to investors.

There are certain comments with respect to this portion of the SOA and the required procedures which are appropriate.

• First, the statute draws a clear line around a specified limited list of non-audit services that the registered accounting firm shall not provide because it is deemed to create a fundamental conflict of interest for the outside auditor.
• Second, it places additional responsibilities on the Audit Committee by giving it the responsibility of scrutinizing what non-audit services may be performed by the registered accounting firm.
• Third, the Audit Committee must approve the non-audit function before it is performed. The Senate Committee Report makes it clear that this requirement is not satisfied by the Audit Committee voting for "any service that management determines appropriate for the auditor to perform" or "all non-audit services permissible under existing law."

In short, each proposed non-audit service must be separately approved based upon appropriate information being furnished to the Audit Committee. To a limited extent, the Audit Committee may designate the pre-approval authority to one or more of its independent members.
   
The Audit Committee must understand the nature of the proposed non-audit service to be provided and consider whether that proposed service raises independence concerns. This author believes that specific procedures with respect to approval of non-audit services be incorporated into the Audit Committee handbook/guidelines, which should be adopted by each Audit Committee. That handbook will have to be updated and revised to reflect not only the Audit Committee's experience, but the changes relating to this very new area of the law.
   
Most importantly, tax services are expressly permitted by the SOA, provided they are pre-approved by the Audit Committee. The Senate Committee Report at page 18 states: "The accounting firm should not act as an advocate to the audit client, which would be involved in providing legal and expert services to an audit client in legal, administrative or regulatory proceedings and thereby place the auditor ‘in the role of promoting' the client's interests." Applying this logic, it would appear that the registered accounting firm cannot represent the issuer before the tax authorities. A possible area of controversy is whether transfer pricing services would come within the appraisal or valuation services prohibition.
   
It would appear that the effective date for the pre-audit approval requirement is 450 days from the enactment of the SOA. This is because this provision applies to services rendered by a registered public accounting firm and that in turn brings into play both the 270-day and 180-day provisions referred to in my prior SmartPros articles.
   
In conclusion, the SOA has clarified and added further prohibited activities for the registered accounting firm. This provision of the SOA also, again, focuses on the importance of the Audit Committee to control and supervise the activities of the registered accounting firm. This section of the SOA is but one piece of the plan to strengthen the public's view that the independent accountants are truly independent and, thus, will give greater credibility to audits of publicly-owned companies.

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CHARLES HECHT has been a principal of his own law firm specializing in securities law since 1971. He was previously on the staff of the Division of Corporate Finance of the Securities and Exchange Commission at its headquarters in Washington, DC. Mr. Hecht would appreciate any input on subject matters within the SEC accounting area which you believe would be appropriate for a future article.