Public Company Accounting Oversight Board; Notice of Filing of Proposed Changes Regarding Ethics and Independence Rule 3526, Communication With Audit Committees Concerning Independence, Amendment to Interim Independence Standards, and Amendment to Rule 3523, Tax Services for Persons in Financial Reporting Oversight Roles, 40418-40426 [E8-15928]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 73, Number 135 (Monday, July 14, 2008)]
[Notices]
[Pages 40418-40426]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-15928]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-58121; File No. PCAOB-2008-03]


Public Company Accounting Oversight Board; Notice of Filing of 
Proposed Changes Regarding Ethics and Independence Rule 3526, 
Communication With Audit Committees Concerning Independence, Amendment 
to Interim Independence Standards, and Amendment to Rule 3523, Tax 
Services for Persons in Financial Reporting Oversight Roles

July 9, 2008.
    Pursuant to Section 107(b) of the Sarbanes-Oxley Act of 2002 (the 
``Act''), notice is hereby given that on April 24, 2008, the Public 
Company Accounting Oversight Board (the ``Board'' or the ``PCAOB'') 
filed with the Securities and Exchange Commission (the ``Commission'' 
or ``SEC'') the proposed rule changes described in Items I, II, and III 
below, which items have been prepared by the Board. The Commission is 
publishing this notice to solicit comments on the proposed rules from 
interested persons.

I. Board's Statement of the Terms of Substance of the Proposed Rule 
Change

    On April 22, 2008, the Board adopted Ethics and Independence Rule 
3526, Communication with Audit Committees Concerning Independence, an 
amendment to the Board's Interim Independence Standards, and an 
amendment to Rule 3523, Tax Services for Persons in Financial Reporting 
Oversight Roles. The proposed rule change text is set out below. 
Language deleted by the amendment to Rule 3523 is in brackets. Language 
that is added by the amendment to Rule 3523 is italicized.

Rules of the Board

* * * * *

Section 3. Professional Standards

* * * * *

Part 5--Ethics

* * * * *
Subpart I--Independence
* * * * *
Rule 3523. Tax Services for Persons in Financial Reporting Oversight 
Roles
    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, unless--
    (a) The person is in a financial reporting oversight role at the 
audit client only because he or she serves as a member of the board of 
directors or similar management or governing body of the audit client;
    (b) The person is in a financial reporting oversight role at the 
audit client only because of the person's relationship to an affiliate 
of the entity being audited--
    (1) Whose financial statements are not material to the consolidated 
financial statements of the entity being audited; or
    (2) Whose financial statements are audited by an auditor other than 
the firm or an associated person of the firm; or
    (c) The person was not in a financial reporting oversight role at 
the audit client before a hiring, promotion, or other change in 
employment event and the tax services are--
    (1) Provided pursuant to an engagement in process before the 
hiring, promotion, or other change in employment event; and
    (2) Completed on or before 180 days after the hiring or promotion 
event.

    Note: In an engagement for an audit client whose financial 
statements for the first time will be required to be audited 
pursuant to the standards of the PCAOB, the provision of tax 
services to a person covered by Rule 3523 before the earlier of the 
date that the firm: (1) Signed an initial engagement letter or other 
agreement to perform an audit pursuant to the standards of the 
PCAOB, or (2) began procedures to do so, does not impair a 
registered public accounting firm's independence under Rule 3523.

* * * * *
Rule 3526. Communication With Audit Committees Concerning Independence
    A registered public accounting firm must--
    (a) Prior to accepting an initial engagement pursuant to the 
standards of the PCAOB--
    (1) Describe, in writing, to the audit committee of the issuer, all 
relationships between the registered public accounting firm or any 
affiliates of the firm and the potential audit client or persons in 
financial reporting oversight roles at the potential audit client that, 
as of the date of the communication, may reasonably be thought to bear 
on independence;
    (2) Discuss with the audit committee of the issuer the potential 
effects of the relationships described in subsection (a)(1) on the 
independence of the registered public accounting firm,

[[Page 40419]]

should it be appointed the issuer's auditor; and
    (3) Document the substance of its discussion with the audit 
committee of the issuer.
    (b) At least annually with respect to each of its issuer audit 
clients --
    (1) Describe, in writing, to the audit committee of the issuer, all 
relationships between the registered public accounting firm or any 
affiliates of the firm and the audit client or persons in financial 
reporting oversight roles at the audit client that, as of the date of 
the communication, may reasonably be thought to bear on independence;
    (2) Discuss with the audit committee of the issuer the potential 
effects of the relationships described in subsection (b)(1) on the 
independence of the registered public accounting firm;
    (3) Affirm to the audit committee of the issuer, in writing, that, 
as of the date of the communication, the registered public accounting 
firm is independent in compliance with Rule 3520; and
    (4) Document the substance of its discussion with the audit 
committee of the issuer.
Amendment to PCAOB Interim Independence Standards
    Independence Standards Board Standard No. 1, Independence 
Discussions with Audit Committees (``ISB Standard No. 1''), ISB 
Interpretation 00-1, The Applicability of ISB Standard No. 1 When 
``Secondary Auditors'' Are Involved in the Audit of a Registrant, and 
ISB Interpretation 00-2, The Applicability of ISB Standard No. 1 When 
``Secondary Auditors'' Are Involved in the Audit of a Registrant, An 
Amendment of Interpretation 00-1, are superseded by Rule 3526.

II. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rule Change

    In its filing with the Commission, the Board included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rules. The text of 
these statements may be examined at the places specified in Item IV 
below. The Board has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements.

A. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rule Change

(a) Purpose
    Section 103(a) of the Act directs the Board, by rule, to establish 
``ethics standards to be used by registered public accounting firms in 
the preparation and issuance of audit reports, as required by th[e] Act 
or the rules of the Commission, or as may be necessary or appropriate 
in the public interest or for the protection of investors.'' Moreover, 
Section 103(b) of the Act directs the Board to establish such rules on 
auditor independence ``as may be necessary or appropriate in the public 
interest or for the protection of investors, to implement, or as 
authorized under, Title II of th[e] Act.''
    The Board adopted Rule 3526, Communication with Audit Committees 
Concerning Independence, because it believed that the accounting firm 
should discuss with the audit committee before accepting an initial 
engagement pursuant to the standards of the PCAOB any relationships the 
accounting firm has with the issuer that may reasonably be thought to 
bear on its independence. The rule is intended to build on the 
communication requirements in Independence Standards Board Standard No. 
1, Independence Discussions with Audit Committees (``ISB No. 1'') and 
provide the audit committee with information--including information 
about the firm's relationships with persons in financial reporting 
oversight roles (``FROR'') at the company--that may be important to its 
determination about whether to hire the firm as the company's auditor. 
The rule also requires a registered firm on at least an annual basis 
after becoming the issuer's auditor to make a similar communication and 
also affirm to the audit committee of the issuer, in writing, that the 
firm is independent. The Board intends for these communications to 
provide the audit committee with sufficient information to understand 
how a particular relationship might affect independence and to foster a 
robust discussion between the firm and the audit committee. The rule 
also includes a new requirement for the firm to document the substance 
of its discussion with the audit committee.
    The Board adopted amendments to Rule 3523, Tax Services for Persons 
in Financial Reporting Oversight Roles, to exclude the portion of the 
audit period that precedes the beginning of the professional engagement 
period. The Board believes that it is not necessary for the rule to 
restrict the provision of tax services during the portion of the audit 
period that precedes the professional engagement period. The Board also 
added a note to Rule 3523 that states that in an engagement for an 
audit client whose financial statements for the first time will be 
required to be audited pursuant to the standards of the PCAOB, the 
provision of tax services to persons covered by Rule 3523 before the 
earlier of the date that the firm (1) signed an initial engagement 
letter or other agreement to perform an audit pursuant to the standards 
of the PCAOB or (2) began procedures to do so, does not impair a 
registered public accounting firm's independence under Rule 3523.
    The proposed rule changes also amend the PCAOB interim independence 
standards because Rule 3526 will supersede the Board's interim 
independence requirement, ISB No. 1, and two related interpretations.
(b) Statutory Basis
    The statutory basis for the proposed rule is Title I of the Act.

B. Board's Statement on Burden on Competition

    The Board does not believe that the proposed rule changes will 
result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act. The proposed 
rule changes would apply equally to all registered public accounting 
firms.

C. Board's Statement on Comments on the Proposed Rule Change Received 
From Members, Participants, or Others

    The Board released the proposed rules for public comment in PCAOB 
Release No. 2007-008 (July 24, 2007). The Board received 16 written 
comments. A copy of PCAOB Release No. 2007-008 and the comment letters 
received in response to the PCAOB's request for comment are available 
on the PCAOB's Web site at www.pcaobus.org. The Board has carefully 
considered all comments it has received. In response to the written 
comments received, the Board has clarified and modified certain aspects 
of the proposed rule change, as discussed below.
Rule 3526. Communication With Audit Committees Concerning Independence
    Under Section 301 of the Act, ``[t]he audit committee of each 
issuer, in its capacity as a committee of the board of directors, shall 
be directly responsible for the appointment, compensation, and 
oversight of the work of any registered public accounting firm employed 
by that issuer * * * for the purpose of preparing or issuing an audit 
report or related work * * *.'' \1\ PCAOB interim

[[Page 40420]]

independence standards require the auditor to provide certain 
information to the audit committee about independence that could assist 
the audit committee in fulfilling these oversight responsibilities. 
Specifically, ISB No. 1 requires, among other things, firms to disclose 
at least annually to the audit committee 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 the auditor's independence. ISB No. 1 does not, 
however, require the firm to provide information to the audit committee 
about the firm's independence in connection with becoming the issuer's 
auditor (i.e., before the person or firm becomes the issuer's auditor).
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    \1\ The SEC has implemented this provision by adopting rules 
directing the national securities exchanges and national securities 
associations to prohibit the listing of any security of an issuer 
that is not in compliance with the audit committee requirements 
mandated by the Act.
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    As discussed in the proposing release, the Board proposed Rule 3526 
because it believed that the accounting firm should discuss with the 
audit committee before accepting an initial engagement pursuant to the 
standards of the PCAOB any relationships the accounting firm has with 
the issuer that may reasonably be thought to bear on its independence. 
The proposed rule was intended to build on the communication 
requirements in ISB No. 1 and provide the audit committee with 
information--including information about the firm's relationships with 
persons in FRORs at the company--that may be important to its 
determination about whether to hire the firm as the company's auditor. 
The Board also proposed to include in the rule a new requirement for 
the firm to document the substance of its discussion with the audit 
committee.
    All commenters were generally in favor of the Board adopting the 
proposed rule, and, as discussed more fully below, some recommended 
modifications. Commenters stated that Rule 3526 would assist audit 
committees in fulfilling their responsibilities and would aid them in 
their decision-making process. After carefully considering the 
comments, the Board is adopting Rule 3526 with one modification, as 
described below. If approved by the SEC, Rule 3526 will supersede ISB 
No. 1 and two related interpretations.\2\
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    \2\ ISB Interpretation 00-1, The Applicability of ISB Standard 
No. 1 When ``Secondary Auditors'' Are Involved in the Audit of a 
Registrant, and ISB Interpretation 00-2, The Applicability of ISB 
Standard No. 1 When ``Secondary Auditors'' Are Involved in the Audit 
of a Registrant, An Amendment of Interpretation 00-1. The 
interpretations state that the responsibility to comply with ISB No. 
1 rests solely with the primary auditor, but that the primary 
auditor should include in its report to the audit committee all of 
its relationships and those of its domestic and foreign associated 
firms that could reasonably bear on the independence of the primary 
auditor. Under these interpretations, if the primary auditor is 
relying on the work of secondary auditors not associated with the 
primary auditor's firm, the report of the primary auditor should 
either describe any such secondary auditors' relationships, or it 
should state that it does not do so. The treatment of secondary 
auditors under Rule 3526 will be similar to the treatment of 
secondary auditors under ISB No. 1 and the two interpretations. 
Secondary auditors will not need to comply with Rule 3526, but the 
primary auditor will need to disclose to the audit committee any 
relationships of the firm's affiliates that could reasonably be 
thought to bear on the independence of the primary auditor. As under 
ISB No. 1 and the related interpretations, the scope of any 
communications about secondary auditors under Rule 3526 should be 
clear to the audit committee. Accordingly, the Board expects the 
primary auditor's report to either include any covered relationships 
of any secondary auditors not affiliated with the firm or state that 
it does not do so. One commenter recommended that the Board consider 
providing an exemption for secondary auditors. Because the rule does 
not require communications by secondary auditors, an exemption is 
not necessary.
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Scope of the Required Communication
    The Board proposed in Rule 3526(a) to require the registered firm, 
prior to accepting an initial engagement pursuant to the standards of 
the PCAOB, to describe in writing to the audit committee \3\ all 
relationships between the accounting firm or any affiliates of the firm 
\4\ and the potential audit client or persons in FRORs at the potential 
audit client that may reasonably be thought to bear on independence. 
The Board also proposed to require the firm to discuss with the audit 
committee the potential effects of those relationships on the firm's 
independence. In Rule 3526(b), the Board proposed to require a 
registered firm on at least an annual basis after becoming the issuer's 
auditor to provide the same information described above and also affirm 
to the audit committee of the issuer, in writing, that the firm is 
independent in compliance with Rule 3520, Auditor Independence.\5\ As 
described in the proposing release, the Board intended for these 
communications to provide the audit committee with sufficient 
information to understand how a particular relationship might affect 
independence and to foster a robust discussion between the firm and the 
audit committee.
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    \3\ One commenter recommended the Board provide guidance in 
situations in which an issuer does not have an audit committee. 
Under Section 2(a)(3) of the Act, ``[t]he term `audit committee' 
means--(A) a committee (or equivalent body) established by and 
amongst the board of directors of an issuer for the purpose of 
overseeing the accounting and financial reporting processes of the 
issuer and audits of the financial statements of the issuer; and (B) 
if no such committee exists with respect to an issuer, the entire 
board of directors of the issuer.'' Accordingly, under Rule 3526, if 
an audit client does not have an audit committee, the auditor would 
be required to make the communications to the entire board of 
directors.
    Additionally, one commenter recommended that audit committees 
provide better disclosure, through the proxy, when approving non-
audit services performed by the auditor. The commenter stated that 
providing this type of transparency will permit investors a greater 
ability to evaluate audit committee's fiduciary performance of 
shareholders. The Board does not have statutory authority to require 
disclosure by audit committees.
    \4\ One commenter recommended that the Board adopt a definition 
of affiliate of the firm. This term is already defined in Rule 3501.
    \5\ Rule 3520 states that a registered public accounting firm 
and its associated persons must be independent of the firm's audit 
client throughout the audit and professional engagement period.
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    Commenters generally believed that the scope of the required 
communications was appropriate. Several commenters noted that, to a 
large extent, firms are already making the kinds of communications that 
would be required by proposed Rule 3526. One commenter acknowledged, 
however, that existing communications between the firm and a potential 
new audit client do not include the disclosure of tax services to a 
person in a FROR or his or her immediate family member. Additionally, 
some registered firms noted that communications regarding the auditor's 
independence currently vary in content and timing and may, in some 
instances, occur only orally.
    Most commenters did not believe that it was necessary for the Board 
to expand the scope of the required communication to include any 
additional matters. One commenter, however, recommended requiring the 
firm to confirm its independence in writing to the audit committee 
prior to accepting an initial engagement. Another commenter recommended 
revising Rule 3526(a) to require the firm to make the communications in 
its initial proposal to the company's audit committee.
    As discussed above, the Board proposed to require firms to affirm 
their independence annually but did not propose a similar requirement 
that would apply before the firm is initially engaged as the company's 
auditor. Rule 3526(a) requires registered firms to make certain 
communications about relationships that may reasonably be thought to 
bear on independence before accepting an initial engagement pursuant to 
the standards of the PCAOB. Rather than prescribing a particular time 
before that point when the communications must occur, however, the rule 
allows registered firms and audit committees the flexibility to make 
that determination. The Board understands that, in some cases, firms 
need time before a new engagement

[[Page 40421]]

begins to resolve any matters that could impair their independence. If 
a firm were required to affirm its independence prior to accepting a 
new engagement, it would need to wait until it has resolved any 
independence issues to make the required communications. These 
communications are intended to assist the audit committee in fulfilling 
its responsibility to hire the auditor--their usefulness for that 
purpose may diminish if they are left until immediately before the 
engagement begins. Accordingly, the Board does not believe a 
requirement for auditors to affirm that they are independent before 
accepting a new engagement is appropriate.
    Other commenters recommended certain exclusions from the scope of 
the required communications. For example, one commenter asserted that 
the auditor cannot be expected to know about all relationships that may 
reasonably be thought to bear on its independence, and recommended that 
the written communication to the audit committee state that the 
auditor's assessment is based on information provided to the auditor by 
the issuer. The Board does not believe that allowing auditors to 
include such a limitation in the communication would be appropriate. 
Complying with the Board's independence requirements is the 
responsibility of the auditor.\6\ To fulfill this responsibility, as 
well as their related responsibility under the SEC's independence 
rules, auditors need to ascertain what relationships with the issuer 
and persons in FRORs at the issuer may reasonably be thought to bear on 
their independence. Moreover, some of the information the auditor must 
assess in order to assure its independence and that may need to be 
communicated under Rule 3526--such as the firm's or its associated 
persons' financial interests in the audit client--can be more readily 
obtained by the auditor than its audit client.
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    \6\ Another commenter suggested that the audit committee should 
be able to rely on the firm to determine and resolve any 
independence issues, and that a requirement for the auditor to 
discuss these matters with the audit committee would increase the 
responsibilities of the audit committee with respect to 
independence. This commenter recommended that the Board not adopt 
these requirements. As discussed above, the rule is intended to 
provide audit committees with information to assist them in carrying 
out their responsibilities to oversee the audit engagement, but 
auditors remain responsible for complying with the independence 
requirements. Nothing in the rule adds to, or otherwise modifies, 
the responsibilities of the audit committee.
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    Another commenter recommended that the Board exclude tax services 
to a person in a FROR from the required communications because the 
commenter believed that compliance with Rule 3523, as amended, should 
adequately address any independence concerns regarding such services. 
As discussed in the proposing release, Rule 3526 is intended to require 
disclosure of not only whether the firm provided any specifically 
prohibited services or maintained any specifically prohibited 
relationships, but also whether any of the firm's relationships or 
services may reasonably be thought to bear on independence under the 
SEC's general standard of auditor independence \7\ and AU sec. 220, 
Independence.\8\ Because auditors will need to consider the relevant 
facts and circumstances in order to make such a determination, the 
Board does not believe that per se exemptions are appropriate.
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    \7\ 17 CFR 210.2-01(b). Under that standard, an accountant is 
not independent if ``the accountant is not, or a reasonable investor 
with knowledge of all relevant facts and circumstances would 
conclude that the accountant is not, capable of exercising objective 
and impartial judgment on all issues encompassed within the 
accountant's engagement.'' In considering this general standard, the 
SEC ``looks in the first instance to whether a relationship or the 
provision of service: Creates a mutual or conflicting interest 
between the accountant and the audit client; places the accountant 
in the position of auditing his or her own work; results in the 
accountant acting as management or an employee of the audit client; 
or places the accountant in a position of being an advocate for the 
audit client.'' 17 CFR 210.2-01, preliminary note.
    \8\ AU sec. 220, Independence, requires that ``[i]n all matters 
relating to the assignment, an independence in mental attitude is to 
be maintained by the auditor * * *'' AU sec. 220 notes that ``[i]t 
is of utmost importance to the profession that the general public 
maintain confidence in the independence of independent auditors'' 
and that public confidence in the auditor's independence ``would be 
impaired by evidence that independence was actually lacking, and it 
might also be impaired by the existence of circumstances which 
reasonable people might believe likely to influence independence.''
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    Some commenters suggested that, in certain circumstances, firms 
would be restricted in the information they could provide to the audit 
committee about relationships with persons in FRORs due to legal 
limitations imposed by confidentiality and privacy laws. Specifically, 
one commenter was concerned that the auditor would not be able to 
disclose to the audit committee information about tax services rendered 
to a person in a FROR prior to obtaining a consent from that person. 
Another commenter recommended that the Board address the need for 
obtaining such a consent in its final release, while another 
recommended that the Board provide an exemption in circumstances where 
applicable legal restrictions impede an auditor's ability to comply 
fully with the disclosure requirement.
    Under ISB No. 1, auditors have been required to disclose to the 
audit committee relationships with the company and its related entities 
and to discuss the auditor's independence with the audit committee. 
Accordingly, the required communications could include discussion of 
tax or other services provided to an entity or person other than the 
company itself. The Board understands that firms are subject to certain 
confidentiality requirements in the tax context \9\ and that other 
restrictions could arise outside of that context, depending on the 
facts and circumstances that a particular relationship presents. The 
Board is not, however, aware that firms have encountered difficulty in 
communicating with audit committees, as required by ISB No. 1 or any 
other professional practice standard, as a result of such privacy 
requirements.
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    \9\ See 26 U.S.C. 7216; 26 CFR 301.7216-3 (prohibiting 
disclosure or use of tax return information without written consent 
of taxpayer that meets specified requirements); 26 CFR 301.7216-1 
(defining ``tax return information'' to mean ``any information, 
including, but not limited to a taxpayer's name, address, or 
identifying number, which is furnished in any form or manner for, or 
in connection with, the preparation of a tax return of the 
taxpayer'').
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    As described above, Rule 3526 is a general requirement that, like 
ISB No. 1, requires disclosure of certain relationships that may be 
relevant to the audit committee's oversight of the engagement. It does 
not set forth a list of relationships that must always be disclosed or 
mandate specific information that must be communicated when disclosure 
is required. Rather, Rule 3526 allows firms significant flexibility to 
determine how to comply with the requirements to describe a covered 
relationship and discuss the potential effects of that relationship on 
the firm's independence. Accordingly, while the Board will monitor the 
application of the rule in this regard, it does not believe that the 
recommended exception is necessary or appropriate at this time.
    The Board also received several comments on its proposal not to 
include the words ``in the auditor's professional judgment'' in the 
rule's description of the scope of the required communications. ISB No. 
1 requires disclosure of certain relationships that ``in the auditor's 
professional judgment may reasonably be thought to bear on 
independence.'' In the proposing release, the Board explained that it 
believed that omitting the reference to the auditor's professional 
judgment would clarify the requirement by reminding auditors of the 
need to focus on the perceptions of reasonable third parties when 
making independence determinations.

[[Page 40422]]

    Some commenters supported the proposed exclusion of the words ``in 
the auditor's professional judgment'' from Rule 3526. Other commenters, 
however, believed that the absence of the reference to judgment could 
confuse, rather than clarify, the requirement and noted that it is 
reasonable and appropriate for audit committees to rely on the 
accounting firm's judgment as to what matters should be disclosed. One 
of these commenters contended that this aspect of the Board's proposal 
is inconsistent with the Board's recent focus on the importance of the 
use of auditor judgment. Conversely, one commenter did not object to 
the absence of a reference to judgment, provided that the adopting 
release contain an acknowledgement that the auditor must apply judgment 
in determining which matters are required to be communicated to the 
audit committee.\10\
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    \10\ Additionally, one commenter recommended including the 
reference to judgment and also referring to the SEC's general 
standard of auditor independence and the preliminary note to the 
SEC's independence rules in the proposed rule or the adopting 
release. Footnote 9 of the Board's adopting release refers to the 
general standard and the preliminary note.
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    As the Board explained in the proposing release, auditors will need 
to apply judgment to determine whether a relationship may reasonably be 
thought to bear on independence. After considering commenters' views, 
the Board continues to believe that adding specific reference to the 
auditor's professional judgment is unnecessary and inappropriate in 
this instance. While the Board agrees that auditors must exercise sound 
judgment in carrying out their responsibilities, it does not believe 
that specific reference to judgment in this rule is necessary to 
encourage auditors to do so. Judgment is called for in applying any 
reasonableness standard to particular facts and circumstances, and Rule 
3526 is no different. Determining what relationships may reasonably be 
thought to bear on independence requires consideration of how a third 
party--not the auditor--would view the relationship, which is 
consistent with the SEC's general standard of auditor independence and 
AU sec. 220. A reference to ``in the auditor's professional judgment'' 
could suggest otherwise, however, and therefore could discourage the 
necessary analysis. Accordingly, the Board has determined not to add 
the phrase to Rule 3526.
Time Period Covered by Rule 3526(a)
    In the proposing release, the Board solicited comment on whether 
the initial communication in Rule 3526(a) should be limited to 
relationships that existed during a particular period, and, if so, how 
long that period should be. Commenters provided a wide variety of 
recommendations in this area. Some commenters stated that the initial 
communication should not be limited to relationships that existed 
during a particular period. Some of these commenters noted that 
establishing a specific period could result in arbitrary exclusion of 
certain relationships and recommended that the audit committee and 
auditor be responsible for determining the relevant time frame.
    Other commenters recommended that the time period be limited to the 
audit and professional engagement period because, according to these 
commenters, the relevant relationships are those that exist currently 
or will continue to exist. One of these commenters stated that 
requiring communication of relationships that existed prior to this 
period would cause an unnecessary burden on the firm to identify and 
communicate these matters and on the audit committee to consider such 
information, because the firm was not subject to the auditor 
independence rules with respect to the audit client before the 
beginning of the audit and professional engagement period. One 
commenter recommended that the required time period should, at a 
minimum, be the audit period and that the rule should require auditors 
to consider communicating relationships that existed before that time. 
Finally, one commenter recommended that the time period should be no 
longer than two years prior to the commencement of the audit period, 
and two commenters recommended that the proposed rule should cover a 
time period of at least three years.
    After considering these comments, the Board has determined that the 
initial communication required by Rule 3526(a) should not be limited to 
relationships that existed during a particular time period. While the 
Board agrees that a relationship that existed during the audit and 
professional engagement period may be more likely to bear on 
independence than a relationship that ended substantially before that 
time, it does not believe that the passage of time is the only factor 
relevant to a determination of whether a relationship may reasonably be 
thought to bear on independence. The nature of the relationship must 
also be considered. For example, if the firm customized and implemented 
the company's financial reporting system, that relationship, depending 
on the circumstances, might reasonably be thought to bear on 
independence even if the engagement to design the system was concluded 
before the beginning of the audit and professional engagement period. 
Determining whether a particular relationship is covered by Rule 
3526(a) will, therefore, depend on the relevant facts and 
circumstances.
    The Board is making one modification to the rule in response to a 
comment recommending that Rule 3526 make clear that the relationships 
required to be disclosed are those that may reasonably be thought to 
bear on independence as of the date of the communication. Because the 
relevant relationships are those that continue to bear on independence 
at the time of the communication, the Board has modified the rule by 
adding the words ``as of the date of the communication'' where 
appropriate. This clarification should help firms distinguish 
relationships that are covered by the rule from those that are not.
    This modification should also clarify that, if a relationship may 
reasonably be thought to bear on independence as of the date of the 
communication, it must be disclosed regardless of whether it was 
disclosed in a prior year. Some commenters suggested that auditors 
should not be required to repeat a previously made disclosure. The 
Board believes that an earlier disclosure may reduce the amount of 
information that needs to be disclosed, but it does not obviate the 
need for disclosure altogether. If the nature of the relationship and 
the potential effects of the relationship on independence remain 
substantially unchanged, a reference to the earlier disclosure will 
generally be sufficient when disclosure is required. Moreover, as 
discussed above, after some amount of time, the length of which depends 
on the nature of the relationship, a relationship may no longer 
reasonably be thought to bear on independence and, therefore, would no 
longer need to be disclosed.
Timing of the Communications
    As discussed above, the Board proposed Rule 3526(a) because it 
believed that auditors should communicate relevant information about 
independence before becoming the issuer's auditor. A few commenters 
expressed concern that the proposed rule could cause undue burden on 
private companies pursuing an initial public offering if the 
communication were required before the auditor accepts an engagement to 
assist an existing private company client in going public. According to 
commenters, a requirement to complete the independence assessment 
before the auditor could commence work related to

[[Page 40423]]

the initial public offering might disadvantage the audit client by 
causing delay. One commenter stated that auditors generally begin work 
on the initial public offering based upon an initial review of 
relationships between the accounting firm and the company and complete 
their independence assessment before the company's registration 
statement is filed. This commenter suggested that the Board reconsider 
the required timing of the communications in the context of an initial 
public offering.
    After considering these comments, the Board has determined that 
relieving a firm whose private company audit client is pursuing an 
initial public offering from compliance with Rule 3526 is not necessary 
or appropriate. As discussed above, the rule is intended to provide 
audit committees with the information they need to effectively oversee 
the audit engagement. When a private company undertakes an initial 
public offering, it must, for the first time, have its financial 
statements audited by an auditor that is independent within the meaning 
of the rules of the SEC and PCAOB. Among other decisions an audit 
committee must make is whether to engage its existing auditor for the 
initial public offering or whether to retain a new auditor for that 
purpose. In this context, the Board believes that the communication 
about an existing auditor's independence--which is relevant to the 
existing auditor's ability to continue as the company's auditor 
through, and after, the initial public offering--should not be delayed 
until just before the registration statement is filed. Moreover, the 
Board believes that this evaluation will not cause an unnecessary 
burden because the private company is already a client of the 
accounting firm and therefore should already be aware of most of the 
relationships that would need to be communicated.
    The Board also received comment on the timing of the annual 
communication requirement that the Board proposed in Rule 3526(b). Like 
ISB No. 1, proposed Rule 3526 did not specify when during the year the 
firm would be required to make the annual communication.\11\ One 
commenter recommended that the Board specify in Rule 3526(b) when the 
annual communication should take place to make sure that these critical 
discussions do not take place at the end of the audit engagement. The 
commenter recommended that the proposed rule be changed to state that 
firms should apply Rule 3526 as early in the audit process as 
practicable, preferably during the planning stage of the audit. One 
commenter recommended that the communication occur before substantial 
planning procedures commence, while another recommended that the annual 
communication should take place at the time the engagement letter is 
signed and then again near the end of the audit. Finally, one commenter 
recommended adding a section to Rule 3526 requiring an auditor to 
update the communications when he or she becomes aware of a covered, 
previously unknown or new relationship.
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    \11\ The Board understands that, under ISB No. 1, the 
communication typically occurs at the end of the audit when the 
financial statements are issued.
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    After considering these comments, the Board does not believe it is 
appropriate to mandate specifically when the Rule 3526(b) annual 
communication takes place. In most cases, the communications will be 
more useful if they take place near the beginning of the audit process. 
However, by not prescribing the timing of the communication, Rule 
3526(b) will allow the auditor and audit committee to determine the 
timing that is most appropriate in the circumstances of the particular 
engagement. Similarly, the Board does not believe that it is necessary 
for the rule to explicitly address how a firm should correct an 
incomplete communication.
Rule 3523. Tax Services for Persons in Financial Reporting Oversight 
Roles
Amendment to Rule 3523 To Exclude the Portion of the Audit Period That 
Precedes the Professional Engagement Period
    Rule 3523, as adopted by the Board, prohibits a registered public 
accounting firm, or an affiliate of the firm, from providing tax 
services during the ``audit and professional engagement period'' to a 
person in, or an immediate family member of a person in, a FROR at the 
audit client. Consistent with the SEC's independence rules,\12\ the 
phrase ``audit and professional engagement period'' is defined to 
include two discrete periods of time. The ``audit period'' is the 
period covered by any financial statements being audited or 
reviewed.\13\ The ``professional engagement period'' is the period 
beginning when the firm either signs the initial engagement letter or 
begins audit procedures, whichever is earlier, and ends when either the 
company or the firm notifies the SEC that the company is no longer that 
firm's audit client.\14\
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    \12\ 17 CFR 210.2-01(f)(5).
    \13\ Rule 3501(a)(iii)(1).
    \14\ Rule 3501(a)(iii)(2).
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    In circumstances in which a registered firm has been the auditor 
for an audit client for more than a year, the ``audit period'' is a 
subset of the ``professional engagement period.'' However, when a 
registered firm accepts a new audit client, the audit period may cover 
a period of time before the commencement of the professional engagement 
period. In such circumstances, Rule 3523, as adopted, provides that the 
firm is not independent of its audit client if the firm, or an 
affiliate of the firm, provided tax services to a person covered by 
Rule 3523 during the audit period but before the beginning of the 
professional engagement period. This aspect of the rule therefore 
effectively prevents a firm from accepting a new audit client if the 
firm, or an affiliate of the firm, provided tax services to such a 
person during the period covered by any financial statements to be 
audited or reviewed.
    In preparing for implementation of the Board's tax services and 
independence rules, the Board decided to revisit the application of 
Rule 3523 to tax services provided during the audit period. As 
discussed above, on April 3, 2007, the Board issued a concept release 
to solicit comment about the possible effects on a firm's independence 
of providing tax services to a person covered by Rule 3523 during the 
portion of the audit period that precedes the beginning of the 
professional engagement period, and other practical consequences of 
applying the restrictions imposed by Rule 3523 to that portion of the 
audit period. After careful consideration of comments received in 
response to the concept release, the Board, on July 24, 2007, proposed 
to amend the rule to exclude the portion of the audit period that 
precedes the beginning of the professional engagement period.\15\
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    \15\ See PCAOB Release No. 2007-008, which includes a discussion 
of the comments the Board received on the concept release.
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    The Board received 13 comments on the proposed amendment to Rule 
3523. Almost all of the commenters supported the Board's recommendation 
to amend Rule 3523.\16\ Many of these commenters

[[Page 40424]]

reiterated their belief that the firm's independence would not be 
affected by the provision of tax services to a person in a FROR during 
the portion of the audit period that precedes the beginning of the 
professional engagement period. Commenters also reaffirmed their belief 
that, if Rule 3523 is not amended, it could adversely affect companies' 
ability to change auditors by limiting the companies' choice of 
auditors.
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    \16\ Only one commenter on the proposed rule objected to the 
amendment of Rule 3523. This commenter's objection stemmed from the 
contention that the terms ``professional engagement period'' and ``a 
person in a financial reporting role'' were not defined. Definitions 
for ``professional engagement period'' and ``financial reporting 
oversight role'' are provided under Rules 3501(a)(iii)(2) and 
3501(f)(i), respectively. The same commenter, while not specifically 
addressing the proposed amendment, also expressed concern with Rule 
3523(a), which provides an exception for tax services to a person 
who is in a FROR only because he or she serves as a member of the 
Board of Directors, and, referring to the responsibilities of 
directors, recommended deleting this section in its entirety. This 
commenter also recommended that the Board eliminate Rule 3523(b), 
which provides an exception, under certain circumstances, for tax 
services to a person who is in a FROR only because of the person's 
relationship to an affiliate of the entity being audited. The Board 
does not believe that eliminating these exceptions is warranted.
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    The Board has carefully considered these comments, as well as the 
comments on the concept release,\17\ and determined to adopt the 
amendment to Rule 3523. The Board continues to believe that it is not 
necessary for the rule to restrict the provision of tax services during 
the portion of the audit period that precedes the professional 
engagement period. Rule 3523 relates to services provided to 
individuals and not the audit client that issues the financial 
statements subject to audit. Additionally, registered firms would 
remain responsible for considering the relevant facts and circumstances 
of a specific tax engagement and determining whether their independence 
is impaired under the SEC's general standard of auditor 
independence.\18\
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    \17\ In response to the concept release, two commenters stated 
that Rule 3523 should not be amended to exclude the portion of the 
audit period that precedes the professional engagement period. These 
commenters believed that providing tax services to a person in a 
FROR during the audit period impairs independence, and suggested 
that audit firms may plan for a change of auditors sufficiently in 
advance to avoid or minimize any problems resulting from the 
application of the rule to the audit period.
    \18\ 17 CFR 210.2-01(b); see footnote 7.
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    One commenter objected to the discussion in the proposing release 
(and included here in the paragraph above) describing the firm's 
obligation to consider whether the firm's independence is impaired 
under the SEC's general standard of auditor independence. This 
commenter stated that the discussion sends a contradictory message by 
calling for firms to assess whether their independence is impaired 
despite the Board's conclusion that restrictions are unnecessary to 
preserve independence. The Board disagrees. As a result of the Board's 
amendment, firms will not be specifically prohibited by Rule 3523 from 
providing tax services to persons in a FROR during the portion of the 
audit period that precedes the professional engagement period. That 
does not mean, however, that such services are categorically permitted. 
Rather, as discussed in the proposing release, the amendment reflects 
the Board's belief that a more tailored approach, based on facts and 
circumstances and measured against the general standard of auditor 
independence, is preferable to a per se prohibition. Accordingly, as 
with any other service or relationship that is not specifically 
prohibited by the independence rules, firms must determine whether the 
service or relationship impairs independence under the SEC's general 
standard of auditor independence.
Application of Rule 3523 to New Issuers
    The Board proposed adding a note to Rule 3523 concerning the 
application of Rule 3523 in the context of an initial public offering 
in light of comments received on the concept release. The proposed note 
stated that, in the context of an initial public offering, the 
provision of tax services to a person covered by Rule 3523 before the 
earlier of the date that a registered firm: (1) Signed an initial 
engagement letter or other agreement to perform an audit pursuant to 
the standards of the PCAOB, or (2) began procedures to do so, does not 
impair a firm's independence under Rule 3523. Commenters generally 
recommended that the Board adopt the note and encouraged the Board to 
consider expanding it to include other corporate life events, noting 
that corporate life events other than an initial public offering may 
also result in the need for an audit client's financial statements to 
be audited pursuant to the standards of the PCAOB for the first 
time.\19\
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    \19\ Commenters suggested the following as examples of when an 
audit client's financial statements would, for the first time, need 
to be audited pursuant to the standards of the PCAOB--mergers, 
reverse mergers in which a privately-held entity merges with a 
public company and succeeds to the public company's reporting 
obligations under the Securities Exchange Act of 1934, issuance of 
publicly traded debt, issuance of partnership or other units, 
inclusion of a public company's securities in an employee benefit 
plan, decision by a foreign private issuer to list its securities in 
the United States, and companies that have greater than 500 U.S. 
shareholders and total assets exceeding $10 million as of the latest 
fiscal year-end.
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    In response to these comments, the Board determined to revise the 
note to Rule 3523 to describe events, other than just initial public 
offerings, pursuant to which a company's financial statements must be 
audited in accordance with the standards of the PCAOB for the first 
time. Specifically, the Board replaced the words ``[i]n the context of 
an initial public offering'' with ``[i]n an engagement for an audit 
client whose financial statements for the first time will be required 
to be audited pursuant to the standards of the PCAOB.'' This situation 
may occur when a company decides to conduct an initial public offering 
of its securities,\20\ which would require the company to file, for the 
first time, a registration statement under the Securities Act of 1933. 
Additionally, this situation may occur when a foreign private issuer 
decides to list its securities on a national securities exchange, which 
would require the company to register its securities, for the first 
time, under the Securities Exchange Act of 1934. In both cases, the 
company's audited financial statements would be required, for the first 
time, to be audited pursuant to the standards of the PCAOB.\21\
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    \20\ The company may offer equity securities, debt securities, 
limited partnership interests, trust interests, or another type of 
securities in the initial public offering.
    \21\ The Board intends the note to Rule 3523 to describe all 
circumstances in which a company that was not an ``issuer,'' as 
defined by the Act, becomes an issuer as a result of a corporate 
life event or otherwise. These circumstances include those in which 
a private company that was once an issuer becomes an issuer again. 
As long as the company was not required to have its financial 
statements audited pursuant to the standards of the PCAOB prior to 
being required to do so, the Board will consider the requirement to 
be a ``first-time'' requirement for purposes of the note.
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    The Board does not believe it is appropriate to list in the note 
the various corporate life events identified by commenters, such as 
mergers or acquisitions, reverse mergers or other similar transactions. 
The relevant factor is not the name given to a transaction or event but 
whether the transaction or event triggers the initial requirement for 
an audit pursuant to the standards of the PCAOB. For example, the 
surviving company in a merger or acquisition transaction may be an 
issuer that is already filing with the SEC financial statements 
required to be audited pursuant to the standards of the PCAOB. The 
Board did not intend the note to Rule 3523 to describe such a 
scenario.\22\ By focusing on the need for a first-time audit pursuant 
to the standards of the PCAOB, the company and its auditors are better 
able to determine whether a

[[Page 40425]]

proposed transaction or corporate life event is described by the note.
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    \22\ Another example is a private operating company becoming a 
reporting company through a reverse merger with a reporting shell 
company. In this scenario, even though the operating company assumes 
the reporting obligations of the former shell company, the surviving 
reporting company is the former shell company whose financial 
statements already were required to be audited pursuant to the 
standards of the PCAOB. Therefore, the note to Rule 3523 does not 
describe this situation.
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    One commenter stated that, while it is easy to identify the date on 
which the initial engagement letter to perform an audit pursuant to the 
standards of the PCAOB is signed, it would be very difficult to apply 
the second prong of the note, which requires identification of the date 
that the auditor began procedures to perform an audit pursuant to the 
standards of the PCAOB, especially if the registered firm audited the 
company's prior years' financial statements.\23\ Another commenter 
similarly questioned whether this period begins when the auditor begins 
planning for the audit. The Board recognizes that, in certain 
circumstances, it may be difficult to identify when a continuing 
auditor began procedures pursuant to the standards of the PCAOB. An 
auditor begins procedures for purposes of Rule 3523 when he or she 
begins procedures, including required audit planning procedures, to 
update its earlier audits to conform them to the standards of the PCAOB 
or begins procedures on a new audit pursuant to those standards. This 
point in time will depend on the facts and circumstances of the 
particular engagement and corporate life event, rather than on any more 
specific triggering event that the Board could establish by rule.
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    \23\ The commenter noted that, when a company undertakes an 
initial public offering, it is required to include in the 
registration statement audited financial statements for its past 
three completed fiscal years. These financial statements may have 
previously been audited pursuant to generally accepted auditing 
standards (``GAAS''). The commenter was concerned that if the 
company does not retain a new auditor for its initial public 
offering, there may be a question as to whether the auditor should 
consider its audits of the prior years in assessing when it ``began 
procedures'' as provided under the note to Rule 3523. An auditor 
should not consider work already performed on previously completed 
GAAS audits for determining when the auditor ``began procedures'' 
because those audits were not performed pursuant to the standards of 
the PCAOB.
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Transition Periods
    Rule 3523 prohibits the provision of tax services to covered 
persons once the professional engagement period begins. Some commenters 
on the concept release recommended that the Board amend Rule 3523 to 
allow a transition period after a company changes auditors so that the 
new auditor may complete any tax services in progress to any persons in 
FRORs affected by the issuer's change of auditors.\24\ Other commenters 
stated that tax services to persons in FRORs should, as is currently 
required, cease before the professional engagement period begins. The 
Board decided to seek further feedback on this topic in the proposing 
release. Specifically, the Board asked commenters to specify why they 
believed any transition period was necessary and how long any such 
transition period should be.\25\
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    \24\ Rule 3523(c) provides a time-limited transition period for 
an auditor to complete in-progress tax services to a person that 
becomes a FROR at the audit client through a hiring, promotion, or 
other change in employment event. That transition period is 
unaffected by the proposed rules changes.
    \25\ See PCAOB Release 2007-008 (July 24, 2007), at 12.
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    The majority of commenters on this topic recommended that the Board 
provide for a 180-day transition period to allow an accounting firm to 
complete covered tax services once the professional engagement period 
begins. Most of these commenters stated that, since the Board has 
previously determined that a 180-day transition is appropriate when a 
person is hired or promoted into a FROR,\26\ the Board should provide 
the same transition when an issuer changes its auditor. The commenters 
stated that, without a transition period, the person in a FROR could 
experience undue hardship because he or she may have to switch tax 
preparers in the middle of the personal tax services engagement. 
Additionally, some commenters stated that some accounting firms may not 
be able to terminate the in-process personal tax services engagements 
within a timeframe that would also allow them to submit their proposal 
for the new audit engagement. Conversely, some commenters stated that 
they believed that the Board should not provide a transition period and 
that it is appropriate for the firm to cease the personal tax services 
before the professional engagement period begins or that a transition 
period should only be available on a case-by-case basis where cessation 
of services would cause significant hardship.\27\
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    \26\ See Rule 3523(c).
    \27\ Another commenter stated that Rule 3523 should be effective 
immediately for issuers with fiscal years ending on or after 
December 15, 2007, that all personal tax services in process should 
be allowed to continue until the filing of the applicable tax 
return, and that such services, along with the related fees, should 
be disclosed in the issuer's filings with the SEC and documented in 
the minutes of meetings of the audit committee.
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    After considering these comments, the Board does not believe that a 
transition period is necessary when a company changes its auditor and 
has determined not to amend Rule 3523 to include one. The Board adopted 
Rule 3523 because the provision of tax services to a person in a FROR 
after the accounting firm is hired as the auditor creates an 
unacceptable appearance that the firm lacks independence. While the 
Board believed a time-limited exception was warranted to accommodate 
persons who, through a hiring or promotion event, abruptly become 
covered by the rule, it does not believe that such a transition period 
is similarly necessary after an auditor change. In the former 
situation, the firm already is the issuer's auditor and has no control 
over whether or when the person is promoted or otherwise moved into a 
FROR. In contrast, the firm controls whether and when it begins a new 
engagement. The Board therefore believes that the firm is able to 
conclude, or transition to another provider, any tax services to 
persons in FRORs at a new audit client before beginning the 
engagement.\28\
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    \28\ Nothing in Rule 3523 requires a firm to complete or 
terminate tax services to persons in FRORs at a potential audit 
client before submitting a proposal for a new audit engagement. 
Rather, the rule requires the accounting firm to complete or 
terminate those services by the beginning of the professional 
engagement period.
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    Some commenters also encouraged the Board to consider providing a 
transition period for firms to complete tax services to persons who 
become covered by Rule 3523 as a result of a corporate life event, such 
as a merger, acquisition, or initial public offering. Commenters 
suggested that such corporate life events present conceptually similar 
transition issues to those related to the hiring or promotion of a 
person into a FROR and that Rule 3523(c) should therefore be expanded 
to accommodate them. Commenters also stated that the absence of 
transitional relief may cause unnecessary hardship for persons in FRORs 
whose tax return preparation work was well underway at the point of the 
initial public offering, merger, or acquisition.\29\
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    \29\ The commenters further stated that, because persons in 
FRORs may receive tax services from a number of accounting firms, 
the application of the rule to the audit period may unreasonably 
restrict a company's ability to either continue or change auditors 
after a corporate life event. As discussed above, the Board has 
amended the rule to exclude the portion of the audit period that 
precedes the professional engagement period.
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    As discussed above, in the context of an initial public offering, 
the rule, as amended, makes clear that tax services provided to a 
person in a FROR do not impair independence as long as those tax 
services are concluded before the earlier of the date that the firm: 
(1) Signed an initial engagement letter or other agreement to perform 
an audit pursuant to the standards of the PCAOB, or (2) began 
procedures to do so. Auditors should have sufficient time before that 
date to conclude any tax services to persons that would be covered by 
the rule. Accordingly, the Board does not believe that the recommended 
transition period is

[[Page 40426]]

necessary in the context of an initial public offering.
    The Board also considered whether a transition period is necessary 
to allow a firm to conclude tax services to persons who become covered 
by the rule after a merger or acquisition. As discussed above, Rule 
3523(c) already provides a transition period for a firm to conclude tax 
services to a person who was not in a FR