Consistent with this thinking, our firm has adopted a policy of scheduled, systematic rotation of audit personnel and we would support having a profession-wide requirement that firms adopt such a procedure. Performance of Non-Accounting The Study states that the performance of "non-accounting” management advisory services for audit clients is incompatible with the necessity of an auditor to be independent in appearance and in fact. Such non-accounting services are defined to include executive recruitment marketing analysis, plant layout studies, product analysis, actuarial services, and financial management services. As the Commission on Auditors' Responsibilities indicates in its Report of Tentative Conclusions,' surveys of financial statement users generally show that a significant minority of users are initially concerned about the potential conflict between management advisory services and the audit function. However, their concern decreases as their familiarity with the nature of services offered by public accounting firms increases, and their concern diminishes further when the services are provided by different functional divisions of the staff, such as a separate management advisory services function. As a general matter, substantial safeguards assure us that we do not lose our objectivity and effectiveness either as an independent auditor or as an independent management consultant. In the first place, our management advisory services activity is a separate function within the firm. Secondly, in our consulting work with clients we make a clear distinction between advising a client, which requires independence, and making management decisions for a client, a role which is inconsistent with independence. We are careful to act only in the capacity of independent advisors. It has been our experience that the additional knowledge of a client gained in the course of management advisory service engagements facilitates our rendering an opinion as to the client's financial statements. Increased knowledge of an audit client has, in fact, been the objective of all good auditors going back to the time of the early Scottish accountants, who themselves also engaged in management advisory service work; to preclude auditing firms from consulting activities would accomplish little but to hamper an additional source of information. In addition, if the role of the auditor is to be expanded, as some suggest, to cover such things as forecasts, the necessity for even greater knowledge of the client is vital, and this could be supplied through the management consulting activity. In any event, it appears that in spite of the merit of the above discussion, the Staff perceives that a potential problem of a lack of independence in appearance exists in the six areas of management advisory services work noted above, which we believe requires specific response. Marketing Analysis, Plant Layout Studies, and Product Analysis As a first point, Touche Ross does not perform marketing analysis, plant layout studies or product analysis as those terms are defined in the Staff Study. This may appear inconsistent with our response to the letter from Senator Metcalf dated December 19, 1975, but only because we responded affirmatively to those particular questions out of an abundance of caution in dealing with undefined terms. Turning specifically to each of those issues: 1. Marketing analysis - The Study describes this term as "performing studies to determine the feasibility of selling a client's products or services to a particular market...and may include identifying likely customers, surveying the attitudes of consumers, or finding areas of excess disposable income." The scope of our services in this area excludes any consumer research, and we do not perform engagements designed to discover areas of excess disposable income. However, we do assist our clients in determining whether contemplated major users of new products and services would view the new product or services as viable. In addition, we assist our clients in determining what channels of distribution are most appropriate and economic. Our services are limited to presenting our research to the client who, in turn, makes the ultimate management decision of whether to proceed with the marketing of the new goods or services. 2. Plant layout studies - The work contemplated by the Study requires broad engineering capabilities, which we do not possess and consider beyond our scope. In our prior affirmative response, we considered that the terms might include our inventory control work, which consists of assisting clients in achieving proper inventory levels and turnover. 3. Product analysis - We do not "analyze a client's product to determine its value to customers," as described in the Study. On the other hand, we do engage in product line analyses which employ well-established economic and managerial accounting techniques in order to assist clients in determining the relative profitability of existing product lines. We do not consider the work which we do as described in items 2 and 3 to be in conflict with our audit function. Indeed, they consist merely of well-accepted accounting tools being made available for management's use in its own day-today operations. Actuarial Services Touche Ross is indirectly engaged in performing actuarial services through a joint venture arrangement with a firm of actuaries; such joint venture is not under Touche Ross management but is supervised by its own separate board of directors. We consider such work a necessity as part of our auditing services since generally accepted auditing standards as promulgated by the AICPA and SEC require that the auditor either be satisfied with the actuarial assumptions reflected in financial statements or modify his opinion appropriately. For example, in the case of an audit of a life insurance company (where actuarial assumptions as to required reserves would be a very material consideration), inability to be so satisfied would require the auditor to disclaim an opinion. Because of this substantial responsibility in our auditing role, we have chosen to associate with a highly respected actuarial firm for expert assistance. We believe such a relationship is essential. We also make available to our clients the services of that separately managed joint venture for other specific needs of the client as, for example, the development of employee benefit plans. • Financial Management Services We perform work described in the Study as financial management services, specifically including such incicated services as "designing and implementing electronic data processing and other services which help management of client companies make financial decisions..... computer forecasting models and inventory control systems...." These services relate to advising clients in developing proper financial records, accounting controls and forecasting procedures, all of which are fundamental to reliable corporate accounting systems. The highest degree of expertise on this subject must by definition be available within independent accounting and auditing firms, and the assistance provided serves to improve the client's systems and procedures for developing proper records, controls, and abilities to make accounting and financial decisions. This activity is not in conflict with the firm's function of auditing financial results but is clearly supportive of the audit function because of the heightened reliability of underlying systems which is produced. It seems clear that to prohibit accounting firms from providing such expert service would be directly contrary to the public interest. Executive Recruitment The Staff appears to believe that to help a client fill a position is so conducive to a relationship which is other than arms length that independence would be compromised. Although we do not believe that such activities impair a firm's independence, we agree that auditing firms should not be in the business of executive recruiting, or purport to be. On the other hand, we believe that it is proper for a firm to accommodate the occasional requests of clients to assist in filling vacancies in positions where we have professional expertise. Clients naturally expect us to be able to help in filling their technical accounting and financial personnel needs, and we comply with such requests when we can. On the other hand, we would be willing to accede to a rule, if universally applicable, which would preclude firms from engaging in any executive recruiting activity, including mere client accommodation efforts. We believe that the concerns of the staff about non-accounting management advisory services can be met by corporate audit committees. As discussed earlier, such committees should be responsible for oversight of auditor independence, and thus should be alert to any possible problems arising from consulting work provided by the auditing firm. Direct or Indirect Representation of Clients' Interests Before Governmental Agencies The Study asserts broadly that Big 8 accounting firms actively represent clients before federal, state and local governments and that they advocate the interests of clients on substantive issues regarding corporate taxation, pricing, government contract costing rules, federal regulations on corporate reporting, and uniformity of accounting for federal purposes. Touche Ross does, of course, represent identified clients before such governmental agencies as the SEC, IRS, state tax agencies, and utility regulatory commissions, but only if the position taken is consistent with a totally objective viewpoint of the issues involved. We nsider this activity a necessary part of our professional engagements and believe that we uld not fulfill our professional duties to our clients in any other way. Touche Ross also casionally makes its position known to legislative and regulatory agencies on technical sues or matters of principle, which the firm as a group of informed individuals believes is its ght and duty as a citizen body. On the other hand, the firm considers it inappropriate to tempt to influence legislative or regulatory bodies simply to satisfy specific interests of articular clients. Such an activity would not be practical in any event, since the interest of one lient is often diametrically opposed to that of another. The Study states that Touche Ross "is very active in testifying before state regulatory ommissions in utility rate cases," and we concur in that statement. However, the Study then sserts: "As such, it has supported controversial rate-making procedures which benefit utilities it the expense of consumers." That statement is incorrect. In our submission of April 30, 1976 o the Subcommittee we listed 71 instances in which we appeared before a governmental unit n order to offer testimony. In all but six of the engagements we were hired by a regulatory commission and in no instance did we testify on behalf of a public utility. As that suggests, the vast majority of our work in regulated industries is performed for regulatory bodies, public advocates, and municipalities which intervene in rate cases on their own behalf. Our public utility services clearly meet the test of serving the public interest. Our work has faced unique challenges, as it is often contested by the public utility involved and judged by a state regulatory commission. In addition, we have been engaged by several federal regulatory bodies such as the Federal Communications Commission and the Interstate Commerce Commission. As an example we are presently engaged by the Interstate Commerce Commission in a project to review the costs of the Trans-Alaska Pipeline system for purposes of setting rates. In short, for the Staff to imply that our work involving rate-making procedures primarily benefits utilities at the expense of consumers is wrong. A host of state and federal regulatory bodies will verify this position. Federal Government Engaging Management Advisory Services from Firms Supplying Auditing Services The Staff Study recommends that the federal government should not retain accounting firms for auditing services which also supply it management advisory services, on the grounds that the two functions are not compatible. We know of no evidence of past conflicts of interest where one firm has provided management advisory services and financial audit services in separate engagements to the same federal agency, and the Study cites none. Potential conflicts can be avoided so long as safeguards exist within the firms to assure that they do not lose their objectivity and effectiveness either as independent auditors or independent management consultants. As previously stated, we provide these safeguards by separating the audit and management advisory service functions, and by being careful in our consulting work to act only as independent advisors to client management, and not as decision makers. As we have stated above, we firmly believe that an accounting firm's performance of management advisory services is not inconsistent with its audit function, but in fact can facilitate its ability to render an opinion on the client's financial statements. That evaluation applies equally to work done in the public sector and in the private sector. In fact, the desirable interrelationship of the two functions is probably most clearly! exhibited by the official position of the most authoritative source on federal government auditing, the General Accounting Office. The GAO states that an audit of federal activities limited to strictly financial matters should not be considered a complete audit, and that an audit of this type can be considered to be of full scope only when expanded beyond traditional financial matters to include a detailed review and evaluation of the economy, efficiency, and effectiveness of the programs for which the particular federal agency is responsible. This broad approach requires the utilization of many of the disciplines contained in our management advisory services function, such as organization analyses and planning, management information systems evaluation and development, and operations management reviews. In essence the GAO has developed a very progressive concept which requires the application of the specialized management advisory skills in an auditing role working under the overall direction of audit partners. This GAO position is now showing signs of becoming an important wave of the future for improved auditing for the private sector as well. Since all of the Big 8 firms supply both auditing and management advisory services to the federal government, the Staff recommendation would effectively force each firm to choose in which of the two capacities it wishes to serve. The recommendation would be discriminatory to both the accounting firms and the federal government in a way that is self-defeating and contrary to the public interest. It would also create a very widespread problem of the same nature if the rule were extended to apply to federally-funded state and local programs. CONCENTRATION AND COMPETITION The Staff has made the following recommendations concerning competitive aspects of the profession: Federal action is needed to relieve excessive concentration in the supply of Competition among accounting firms should be increased as to the auditor It is our view that both of these recommendations are based upon invalid premises and accordingly are inappropriate. Specifically, we perceive that (1) present concentration in the large firms is not excessive but rather is essential to the proper rendition of accounting and auditing services in the public interest, and (2) open competition among the accounting firms not only exists but has indeed become very intense. Development of Existing Concentration The configuration of firms and individual practitioners comprising the public accounting profession today is radically changed from that which existed at the end of World War II. Although most of the major firms existed then, their geographic coverage, both internationally and domestically, and their divergence in relative size were substantially less than at the present time. The profession consisted of more equally-sized firms that often operated out of a |