Traditionally, one way of cementing the accounting-client relationship was for the company's outside accounting firm to prepare the tax returns for the key decision-making executives of the client. Although this was not considered a major source of revenue, it was considered a critical bonding requirement. 
 
The PCAOB has taken the position that this type of service creates the appearance of a lack of independence, and thus the independent auditor for a public company can no longer provide these services to these decision makers at the company.  Rule 3523, "Tax Services for Persons in Financial Reporting Oversight Roles," provides that:
 
A registered public accounting firm is not independent of its audit client if the firm, or any affiliate of the firm, during the audit and professional engagement period provides any tax service to a person in a financial reporting oversight role at the audit client, or an immediate family member of such person. 
 
There are exceptions. For instance: if that person is in a financial oversight role solely because he or she is a member of the board of directors, for example an outside director who is a member of the audit committee; if he or she is in a financial oversight role of a subsidiary whose financials are not a material component to the consolidated financial statements of the entity being audited or the affiliate's financial statements are audited by an outside accounting firm; and other exceptions that relate to persons who were promoted into a financial oversight role after the engagement is in process.
 
The term "financial reporting oversight role" includes "any person who has direct responsibility for oversight over those who prepare the issuer's financial statements and related information (for example, management's discussion and analysis) that are included in filings with the Commission.  (PCAOB Release No. 2005-014 at p. 34)
 
I believe that the major impact on the new rule will be on the smaller independent accounting firms servicing publicly held companies.  Currently the big four accounting firms service approximately 80 percent of the public companies, which account for approximately 99 percent of the U.S. stock market's valuation. This rule will make it more difficult for the small accounting firm to cement the type of client relationships needed to sustain continued growth in this area to compete for a share of that business.

This trend, in this writer's opinion, is also consistent with the overall impact of Sarbanes-Oxley to favor the extremely large public companies and to discriminate against the smaller companies seeking to raise capital in the American marketplace.
 
Ironically, one of the purposes for the swift adoption of Sarbanes-Oxley was to restore the confidence of foreign investors in companies listed on the American stock exchanges.  Yet, in practice the effect of Sarbanes-Oxley has been that foreign companies seeking to raise capital are now looking to foreign exchanges, and the smaller American companies seeking to raise capital no longer view being a U.S. public company a viable option.  Attempts to modify Sarbanes-Oxley to make the United States capital markets more competitive and to enable smaller public companies or private companies seeking equity capital in the public marketplace have met with strong institutional resistance.

It is this writer's belief that unless suitable modifications are promptly implemented, the United States will no longer be the center for the raising of equity capital.  This will also have a long term adverse effect on both the United States economy and its ability to compete with emerging economic powers such as the ECU, China and India.

Return to SEC Central

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. Contact him at 212.490.3232 or visit www.securitiescounselors.com