Update: SEC Proposes Changes in Accounting Rules

Updated from 2:25 p.m. EDT

Federal regulators proposed new rules for the accounting profession Tuesday that seek to keep auditors independent of the companies they review while easing restrictions on stock ownership by accountants and their families.

The 4-0 vote by the Securities and Exchange Commission opens its proposals to public comment. The SEC's independence proposal drew immediate criticism from three of the top five accounting firms -- Arthur Andersen, Deloitte & Touche and KPMG -- who fear the rules would require them to split off their highly profitable consulting businesses. And four congresswomen scolded the SEC for tying those controversial changes to "long overdue" alterations to stock-ownership rules, which they characterized as relics relevant only in an era before women entered the workforce.

The comment period will last 75 days after the proposed rules appear in the Federal Register within seven to 10 days, according to the SEC. After that, the commission could adopt the rules, alter them and restart the process or rescind the proposal. The last option is highly unlikely, said John Heine, an SEC spokesman.

The proposal identifies a list of business, financial and employment relationships that would impugn an auditor's independence. Those include having a direct investment in an audit client, keeping a savings account in a client's bank with a balance higher than the amount insured by the government and auditing the books of a company that employs a close family member.

It also lists non-audit services, including bookkeeping, appraisal, legal services and expert services, that could create conflicts of interest. That final item, by virtue of its ambiguity, perhaps best reflects regulators' concerns. Arthur Levitt, chairman of the SEC, has said accounting firms are losing credibility as they become more dependent on consulting revenues. "Without confidence in an auditor's objectivity and fairness, how can an investor know whether to trust the numbers?" Levitt asked Tuesday in a prepared statement.

The SEC also sought to loosen the rules governing stock ownership by employees of accounting firms and their families. Current rules, for example, would bar an accountant's spouse from owning stock in a company that is an audit client of the firm. The firms say those rules are difficult to obey because accounting firms are structured as partnerships between many auditors who are hard-pressed to know all of their partners' clients.

The changes to stock ownership rules have widespread support. The current rules ignore "the dramatic changes that have occurred in the American workforce over the past 70 years," four female Republican representatives said in a letter sent to Levitt on Friday. "They were established in the Depression era, when most members of professional firms were male, the economy was far simpler, and working spouses and dual-income families were virtually unknown."

The representatives -- Jennifer Dunn of Washington, Deborah Pryce of Ohio, Tillie Fowler of Florida and Sue Myrick of North Carolina -- criticized the agency for bundling those changes with the proposed changes to consulting rules. "We hope the SEC moves forward with these reforms on an expedited basis and does not needlessly cause their delay by tying them to other controversial issues," they wrote.

Officials from KPMG, Arthur Andersen and Deloitte & Touche also praised the provisions loosening stock ownership restrictions, saying they should win quick approval -- but in a separate plan. They assailed the so-called scope-of-services proposals, accusing the SEC of a "disturbing" rush to win approval while Congress may be in recess and in the waning days of the Clinton administration.

"It seems like this is carefully calibrated," said Jeff Peck, a managing director of Arthur Andersen. But it "is highly controversial and requires extensive study and review."

Bill Ezzell, a partner for Deloitte & Touche, contested the SEC's assertion that consulting work can compromise audit integrity. For example, he said, work on financial information systems design and implementation, named by the SEC among services that could compromise independence, actually gives auditors insight and confidence.

"The more you know about a client, the better the audit is going to be," Peck added.

Stephen Allis, a KPMG partner, said, "We think it is not in the public interest to restrict our range of services, where no problem has been found and we see substantial benefit to investors."

The other two large accounting firms, which have already moved to separate their consulting businesses, said they would participate in the comment period.

Ernst & Young last month sold its consulting business to Cap Gemini. "We had the opportunity to satisfy the regulators' concerns and create opportunity for our consulting partners to get equity in their clients," said Lawrence J. Parnell, spokesman for the firm, who added that Ernst saw merit in the SEC's concerns.

PricewaterhouseCoopers, the world's largest accounting firm, has said it will separate its consulting business, though it will retain ownership. The firm said it supports "the SEC's efforts to enhance audit quality and investor protection."

"Enhanced audit quality, common sense independence rules and a cooperative relationship between securities regulators and accounting firms will benefit the investor, the companies we serve and the profession as a whole," the firm said in a statement. The firm's restructuring plan would divide its business into at least two units, separating its auditing, tax and business advisory practices from management and human resource consulting. An independent review, made public in January, found widespread violations of independence rules at PriceWaterhouseCoopers.

Earlier this month, the top five accounting firms agreed to report past violations of the independence rules in exchange for immunity from enforcement actions, except in cases involving the most serious violations.

In making Tuesday's proposals, the SEC did not release a full text, saying that won't be available until at least later in the week -- a move that also did not please the industry representatives.

The SEC also appeared mindful of the controversy it would ignite. It declared there would be public hearings on the proposed rules. Such forums have not been held on accounting matters in decades, officials said. And they repeatedly emphasized that they look forward to receiving comments that could lead to revisions before final proposed rules are presented to the full commission.

"We do not believe we have a monopoly on wisdom here," said Lynn E. Turner, the SEC's chief accountant. "We genuinely await the response of the public and the profession."

Even Levitt expressed misgivings, although of a different sort. He questioned whether, in relaxing the family relationship and financial investment rules, the commission may also be "undermining investor confidence."

"There are some purists who say, 'You're loosening up too much,'" said Harvey J. Goldschmid, Levitt's special senior adviser.