Proposed Expansion of American Institute of Certified Public Accounts Independence Rule

Bureau of Competition
Michael Bloom
Assistant Director for Policy & Coordination
Direct Dial
(202) 326-2475
Kelly Hnatt
UNITED STATES OF AMERICA
FEDERAL TRADE COMMISSION
WASHINGTON, D.C. 20580
APR 	- 9 	2010
Willkie Farr & Gallagher LLP
787 Seventh Ave.
New York, NY 10019-6069
Dear Ms. Hnatt:
This letter responds to your request for a staff Advisory Opinion concerning the law
enforcement intentions of the Federal Trade Commission's ("FTC" or the "Commission")
Bureau of Competition ("BC") with respect to the American Institute of Certified Public
Accountants' ("AICPA") proposed expansion of its "independence rule."t For the reasons
discussed below, FTC staffhas no present intention to recommend to the FTC that it challenge
adoption of the expanded independence rule as it has been described to staff. This present
intention relies entirely on a review of the written materials you have provided to FTC staff,
other representations you have made, and an interview with Securities and Exchange
Commission ("SEC") officials to whom you directed FTC staff. Should there be information
that we are unaware of that qualifies, modifies, or contradicts any of this information or calls in
to question the conclusions we have drawn from it, or should the independence rule or its
implementation change in the future, we may change our law enforcement recommendation
accordingly.
Significantly, we cannot conclude, on the facts before us, that competitive concerns with
respect to AICP A's expansion of its independence rule can be wholly ruled out. Application of
the expanded independence rule could, at least in principle, produce anticompetitive effects in
some geographic markets, and facts necessary to evaluate that possibility are lacking.
Nonetheless, we find that the aggregate benefits of the independence rule expansion are likely to
be substantial, while the anticompetitive consequences, if any, are speculative and likely to be
localized. Thus, our present intention is not to recommend a challenge to the expansion of the
independence rule; however, we will be attentive to any customer complaints to the effect that
implementation of the expanded rule by a specific AICP A-member network has
anticompetitively limited available supply of accounting services or otherwise caused
anti competitive outcomes. Ifwe receive well-founded complaints of that kind, they could result
in our recommendation to the Commission to challenge the lawfulness of specific AICP A-
member networks or our reconsideration of our decision not to recommend that the Commission
challenge the expanded AICP A independence rule.
1. 	Letter from Kelly M. Hnatt to Donald S. Clark requesting an FTC staff Advisory Opinion
(April 2, 2010). ("Hnatt Letter")

Summary of Representations and Written Materials
Based on the representations you have made and the written materials you have provided,
we understand the following to be accurate:
• 	AICPA is a national, professional organization of certified public accountants, with
approximately 350,000 members.2 Nearly forty percent of AICPA's members perform
audit services for clients. 3 Membership in AICPA is voluntary.4
• 	AICP A has developed a Code of Professional Conduct ("Code") that governs all AICP A
members. 5 The Code is interpreted and enforced by AICPA's Professional Ethics
Executive Committee ("PEEC"t A member's violation of the Code may result in
expulsion from the organization.?
• 	The Code addresses various ethics principles relevant to the accounting profession,
including: independence, integrity, and objectivity; compliance with applicable
standards; responsibilities to clients; and other matters affecting the reputation of the
profession. 8
• 	Some of AICPA's members have formed "networks.,,9 A network is a collaborative
enterprise that, among other things, can assist small network member-firms to achieve
some efficiencies of size and scope. 10
• 	Accounting networks exist in a variety of forms. 11 PEEC defines a network as an
association of entities that includes one or more firms that cooperate for the purpose of
enhancing the firms' capabilities to provide professional services and whose members
possess one or more of the following characteristics: common brand name; common
2. 	Hnatt Letter at 2.
3. 	Id.
4. 	Id.
5. 	Id.
6. 	Id.
7. 	Id.
8. 	Id.
9. 	Id. at 4.
10. 	Id.
II. 	Id.
2

control; sharing of profits or costs; common business strategy; the sharing of significant
professional resources; and common quality control policies and procedures. 12 The
extent of economic integration across accounting networks can vary significantly. 13
• 	The business basis for the formation of networks is to enable AICPA members to
compete more effectively by enhancing their marketing efforts and allowing them to gain
access to new markets; improving the quality and efficiency of services by leveraging the
professional skills of other firms; and providing a referral network for clients that need
non-attest services that their auditors cannot provide. 14 The formation of networks
permits smaller and medium-sized firms to compete for the business of larger
companies. 15 This business is currently dominated by the "Big Four" accounting firms. 16
• 	Under AICPA's Code, members are obligated to adhere to "independence" standards. 1?
Independence has two components: independence of mind (also referred to as
independence in fact), and independence in appearance. 18 The purpose of the
independence standard is to assure that a CPA performing an audit or other attest service
acts with objectivity and professional skepticism when performing that service.
Independence is therefore fundamental to the reliability of auditors' reports and to
investors' confidence in financial statements. 19 Reliable financial statements reduce
investor, prospective creditor, and others' risk with respect to evaluating the financial
health of business entities. 20
• 	AICPA members perform many professional services, including audit services. 21 An
audit of a client's financial statements concludes with an opinion by the auditor on the
fairness of the client's financial statements, in all material respects, with regard to the
client's financial position, results of operations, and cash flows. 22 The auditor opines
12. 	PEEC Interpretation No. 101-17, "Networks and Network Firms." See Exhibit D.
13. 	Hnatt Letter at 4.
14. 	Id. at 4.
15. 	Id.
16. 	Id.
17. 	Id. at 2.
18. 	Id. at 3.
19. 	Id.
20. 	Id. at 9.
21. 	Id. at 4.
22. 	Id. at 3.
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whether the client's financial statements are presented in conformity with generally
accepted accounting principles ("GAAP,,).23 Audits are conducted in accordance with
generally accepted auditing standards ("GAAS,,).24
• 	AICPA members also perform non-audit services. 25 Non-audit services may include,
among other things, performing management functions; making management decisions;
preparing source documents used to generate the client's financial statements;
authorizing, executing, or consummating transactions; exercising authority on behalf of
the client; having custody of client assets; serving as a director or officer of the client;
being a lender to the client; supervising client employees; and performing tax,
bookkeeping, payroll, or consulting services. 26
• 	Adherence to AICPA's current independence rules generally requires that.a member
performing audit services for a given client not have performed certain non-audit services
for that client during the period covered by the financial statements and during the period
of the professional engagement (e.g., when performing the audit).27 Prohibited non-audit
services include performing management functions or making management decisions for
the client; preparation or review of client financial statements or other documents that
would be inputs to a subsequent audit; authorizing, executing, or consummating
transactions on behalf of the client; exercising authority on behalf of the client; having
custody of client assets; serving as a director or officer of the client; being a non-financial
institution lender to the client; and supervising client employees. 28
• 	In general, a failure of independence due to an auditor's furnishing prohibited non-audit
services to a client during the period covered by the financial statement or during the
audit cannot be purged. 29 If, however, a failure of independence would result solely from
a prospective auditor having a financial interest in a client (e.g., where the prospective
auditor is an investor in or creditor of the client), the independence rule would be
satisfied if the prospective auditor severed all financial interests in the client prior to
commencement of the audit. 30
23. 	Id. at 3.
24. 	Id.
25. 	Id. at 4.
26. 	Id.
27. 	Id. at 6.
28. 	Id. at 6-7.
29. 	Id. at 8.
30. 	Id.
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• 	Provided that the auditor complies with certain general requirements, the auditor may,
under AICPA's independence rule, provide other non-audit services such as performing
tax, bookkeeping, payroll, or consulting?!
• 	AICP A intends to amend its Code so as to apply the independence rule to member
networks. 32 As amended, the Code would require that each member firm of an
accounting network be independent of financial statement audit and review clients of the
other firms in the network. 33 Thus, a network member may provide audit or review
services for a client only insofar as other network members are not providing, and did not
provide, during the period covering the financial statements, related, prohibited non-audit
services for that client; and may provide prohibited non-audit services for a client only
insofar as no other network member is then providing audit or review services. 34 As
amended, the independence rule is intended to address an ethical issue arising from the
increasing prevalence of accounting networks, ensuring the public that a firm providing
an audit or review of a client's financial statements will make required judgments in an
objective manner without regard to how its judgments will affect the other network
members. 35
• 	The proposed amended AICPA independence rule does not restrict any network member
from competing with any other network member in the offering of audit or review
services where no network member is providing, or recently has provided related,
prohibited non-audit services to the same client; nor does it restrict any network member
from competing with any other member in the offering of non-audit services where no
network member is then providing audit or review services. 36
• 	Before taking on an audit or review engagement, a network member would have to learn
from other network members or the prospective client whether any other network
member has a prohibited relationship with the prospective client. 37 Thus, prior to
providing audit or review services to a new client, a network member would have to
31. 	Id. at 7-8.
32. 	Id. at 5.
33. 	Id.
34. 	Id. 	"Related prohibited non-audit services" refers to prohibited non-audit services upon
which a provider of audit services would or might have to rely in the provision of audit services
in accordance with GAAS.
35. 	Id.
36. 	Id. at 6-8.
37. 	!d. at 8.
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detennine that no other network member was providing, or had recently provided related,
prohibited non-audit services to that client; and prior to providing non-audit services to a
new client, a network member would have to detennine whether any other member was
then providing audit or review services to that client. 38
• 	AICPA intends to issue guidance to its members urging them, in evaluating
independence, to seek needed infonnation from prospective clients to the greatest extent
reasonably possible, and, where needed infonnation can be obtained only from other
network finns, to ask only whether the other network finns had potentially prohibited
relationships with, or provided potentially prohibited non-audit services to, the
prospective client. 39 The rule would not require the exchange among potentially
competing finns of any infonnation regarding a network member's bids, bidding
strategy, capacity to bid, pricing or pricing plans, or other competitively sensitive
infonnation.40
• 	The SEC requires that publicly-traded companies file audited financial statements with
the agency that have been prepared by an accounting finn that adheres to SEC
independence rules. 41 The SEC also requires that broker/dealers submit audited
statements prepared by accounting finns that adhere to the SEC independence rules,
regardless of whether the broker/dealer is publicly traded. 42
• 	The SEC has detennined that, to be effective, the audits filed with it must be independent
both in fact and in appearance. 43 The SEC independence rule thus extends to all offices
of an individual accounting finn, any subordinate units, and any affiliated entities,
including any joint ventures or networks, including networks as defined by PEEC, to
which the accounting finn may belong.44
• 	AICP A seeks an opinion from FTC staff as to whether the application of the
independence rule to networks raises significant antitrust concerns or would result in a
38. 	Id.
39. 	Id. 	See also Exhibit F to Hnatt Letter.
40. 	Id. 	See also Exhibit F to Hnatt Letter.
41. 	Interview with SEC officials, January 20,2010.
42. 	Id.
43. 	Id.
44. 	Id.
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staff recommendation to the Commission that the application of the rule in such a manner
be challenged. 45
Bureau of Competition Analysis
The amended Code is aimed at the preservation of independence in the performance of
audit services by a network member. The antitrust risks, if any, that may arise from blanket
implementation of the amended Code across all AICP A member networks, regardless of the
degree of integration or limits on competition that may be inherent in any given individual
network, concern the degree to which the rule potentially further limits competition at the
margm.
AICPA members are already subject to AICPA's independence rule on an individual
basis. They are also subject to compliance with the SEC's independence rule, both individually
and as part of any networks, to the extent they perform audits for publically-traded companies
and for broker/dealers that will be filed with the SEC. Thus, were AICPA to amend its
independence rule as proposed, the impact would be felt on accounting services for non-
publicly-traded businesses and other entities that are not required to file audited financial
statements with the SEC.
For these firms, application of the rule may reduce the number of AICPA members that
would be able to bid for contemporaneous audit and prohibited non-audit work. Specifically,
once the AICPA independence rule is expanded to cover networks, the individual members of
that network may not compete for the audit work of a business during the time surrounding the
provision of prohibited non-audit services to that same business by any single member of the
network; nor may the individual members compete for the prohibited non-audit work of a
business while any single member of the network is engaged to perform audit work for that same
business. Such a situation could potentially significantly reduce competition in localized
geographic markets in which there are few, if any, accounting competitors outside of the AICPA
network. As a result, some local privately-held businesses seeking both audit and prohibited
non-audit services could face higher bids because of the expanded independence rule.
As a general matter, the FTC recognizes that collaboration among competitors can be
pro competitive when it results in cost-saving efficiencies or creates a new competitor.
Collaboration, however, also may be anticompetitive if it eliminates one or more competitors or
reduces incentives to compete. The joint FTCIDOJ Antitrust Guidelines for Collaborations
Among Competitors provide the analytical framework for determining the net competitive
effects of any given joint venture. 46
45. 	Hnatt Letter at 1.
46. 	See FTCIDOJ, Antitrust Guidelines for Collaboration Among Competitors (April 2000).
Specifically, except where an agreement among competitors is per se unlawful, the agencies
apply the "rule of reason" to assess competitor collaborations. In so doing, the agencies weigh
any procompetitive effects of the collaboration against the potential for competitive harm. The
agencies generally will not challenge collaborations where the net effect is competitively benign
or procompetitive. Significantly, the Guidelines do not attempt to divide all collaborations into
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Even assuming that existing AICPA member networks satisfy the "rule of reason" test,
implementation of the expanded independence rule may, at the margin, tip the balance in the
other direction. On the facts provided, however, it is not possible to make that determination for
all potentially affected geographic markets. The analysis would depend on the number and size
distribution of market participants, as well as on some measure of any integrative efficiencies
appertaining to any given network of AICPA members.
Nonetheless, the potential for net competitive harm arising from expanding the AICPA
independence rule to AICPA networks appears, based on the information presently available, to
be small. 47 Audits of publically-traded companies are already covered by the stricter SEC
independence rule. In addition, significant benefits to the capital markets, even respecting
investors in non-publicly-traded businesses, can be expected to arise from AICPA's adoption of
an expanded independence rule to cover networks. Moreover, additional procompetitive benefits
can be expected to the extent that AICP A networks are better able to compete against larger
accounting firms for the business of larger privately-held clients. By contrast, potential
anticompetitive consequences are speculative, occurring, if at all, most likely in localized
geographic markets where there may be only a limited number of accounting firms available to
compete for the accounting work of local businesses.
Network members seeking to comply with the expanded independence rule will need to
obtain select information about recent and current engagements and activities of other network
procompetitive or anticompetitive lists. Rather,
the Agencies hope to assist businesses in assessing whether the Agencies will challenge a
competitor collaboration or any of the agreements of which it is comprised. However,
these Guidelines cannot remove judgment and discretion in antitrust law enforcement.
The Agencies evaluate each case in light of its own facts and apply the analytical
framework set forth in these Guidelines reasonable and flexibly.
Id. at 2 (citations omitted).
47. 	In California Dental Ass'n v. F.T.C, 526 u.S. 756 (1999), the Court observed that, in the
context of professional services where members of the public may not possess the specialized
knowledge to evaluate the quality of provided services, the likelihood of net anti competitive
effects arising from ethical codes that otherwise restrict competition is not "comparably
obvious" relative to restrictions in non-professional services situations. Id. at 771-772. For this
reason, the Court held that a "quick look" rule-of-reason analysis is inappropriate in these
instances. Id. at 780-781. On the one hand, the Court's opinion suggests that AICPA's
expansion of its independence rule to cover networks may be a proper stand-in for lenders'
(assumed) inability to evaluate the quality of an audit of a non-publicly-traded business, thus
enhancing economic value. On the other hand, the Court's precise holding highlights the
difficulty presented here, namely our inability to do more than render a "quick look" judgment
about the likely competitive effects of the expansion of the independence rule, given the
unavailability of facts required to assess the likely impact of the expanded independence rule on
the lawfulness of particular networks in specific localized geographic markets.
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members, and they might seek this information from other network members that are their
potential competitors. The exchange among competitors of some kinds of information could
itself result in anti competitive outcomes in some markets, for example by reducing accounting
firms' uncertainty as to the capacity or interest of other network members in competing for new
clients. The reduction of uncertainty as to potential rivals' bidding intentions may, where only
one or a few likely viable competitors remain, permit firms to increase bid prices for affected
accounting services. The exchange of certain kinds of information among competitors may
cause anti competitive outcomes through other mechanisms as well.
Compliance with the expanded independence rule, however, will not require network
members to seek from other network members any information about current or future capacity
or bidding intentions. Moreover, in most instances a network member will be able to obtain the
limited information needed to determine whether it may provide audit or prohibited non-audit
services to a prospective client from the prospective client, with little or no risk to competition.
AICP A intends to encourage the networks to do so, further reducing any risk of information
sharing among network members that harms competition.
On balance, FTC staff has concluded that, although, in principle, there may be instances
in which the expansion of the AICPA independence rule to networks reduces competition, the
likelihood that the expanded rule would significantly reduce competition does not appear to be
high. By contrast, the countervailing benefits of that expansion-in enabling small- and medium-
sized accounting firms to increase their effective size and scope to compete for additional
accounting work while ensuring the public that their audit work is untainted by auditor self-
interest-appear substantial. On that basis, Commission staff has no present intention to
recommend an enforcement action were AICPA to adopt the expanded rule. Having reached this
conclusion, however, we note that its basis rests on incomplete facts respecting the specific
geographic markets in which AICPA member networks do business. Therefore, although we do
not at present intend to pursue further investigation, we also do not intend this Advisory Opinion
to be construed as a blanket assessment that the expansion of the rule to networks could not raise
competition concerns sufficiently great to induce future agency action. If more complete facts
about individual networks come to light, or if the FTC receives specific complaints about higher
bidding respecting individual AICPA networks because of the implementation of the expanded
independence rule, our conclusion may change. 48
Conclusion
Based on the above, the Bureau does not intend to recommend a law enforcement action
to the FTC at this time.
This letter expresses the current opinion of FTC staff, and is predicated on the accuracy
of the information that you have provided to us. In accordance with normal practice, BC
reserves the right to reconsider the questions involved and, with notice to the requesting party, to
rescind the opinion if actual conduct in compliance with the Code proves to be anticompetitive
48. 	Additional facts, in this case, does not mean "changed" facts. It should also be
understood that if known facts change, our conclusion could similarly be revised.
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in any purpose or effect or if facts change significantly in the future such that it would be in the
public interest to bring an enforcement action.
The views of FTC staff contained herein are provided as authorized by Rule 1.1 (b) of the
Commission's Rules of Practice, 16 C.F.R. § 1.1 (b). Under Commission Rule 1.3(c), 16 c.F.R. §
1.3(c), the FTC is not bound by this staff opinion.
Assistant Director for Policy & Coordination
Bureau of Competition
Federal Trade Commission
600 Pennsylvania Ave. N.W.
Washington, D.C. 20580
10