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January 18, 2002
SEC Clarifies Position on Auditor Independence Resolutions
    by William Baue

Although the SEC rejected a shareowner resolution early in 2001 that called for shareowners to choose a company’s auditor, the SEC recognizes the relevance of the auditor independence issue to shareowners.

The U.S. Securities and Exchange Commission (SEC) has indicated in the past that shareowners overstep their bounds when they file proposals asking to choose a company’s auditor. Now that legal action looms over Chicago-based Arthur Andersen, the big-five accounting firm that performed questionable auditing and consulting services for Enron, the SEC may need to revisit the idea that shareowners have a legitimate right to choose an independent auditor. The implosion of Enron brings into question management’s ability to choose an auditor who is truly independent.

Mark Latham, founder of the Corporate Monitoring Project in San Francisco, brought the issue of auditor independence to the SEC's attention some 13 months before the Enron debacle. Dr. Latham suggested that auditors should be hired by shareowner vote, thus preventing the potential conflict of interest inherent when management hires the very people who assess the company's performance.

"This would encourage auditors to build their reputations in the eyes of investors rather than in the eyes of management, creating new pressure for higher standards," wrote Dr. Latham in the memo filed with the SEC on November 2, 2000.

Dr. Latham filed a shareowner resolution with electronics manufacturer SONICblue (ticker: SBLU) proposing this very system of auditor selection. In January 2001, SONICblue responded by informing the SEC of its intention to omit the resolution from its proxy for several reasons. The most basic reason argued that auditor selection amounted to "ordinary business operations," and therefore management, not shareowners, should make that decision.

In February 2001, Dr. Latham answered this argument by pointing to the SEC's own publication, Revision of the Commission's Auditor Independence Requirements, released on November 21, 2000. The revised rules highlighted the importance of auditors serving the interests of investors.

"The commission has clearly determined that auditor selection should not just be left to management," Dr. Latham concluded.

Despite this input, the SEC informed SONICblue on March 23, 2001 of its decision to uphold the company's decision to omit the resolution on the grounds of the "ordinary business" argument alone.

The SEC has taken a different stance regarding resolutions that call on management to choose an auditor who is truly independent. The United Association of Journeymen and Apprentices of the Plumbing, Pipefitting and Sprinkler Fitting Industry pension funds recently filed a shareowner resolution with Walt Disney (DIS) calling for auditor independence. Walt Disney claimed "ordinary business" in its appeal to the SEC to omit the resolution from its proxy.

This time, the SEC sided with the shareowner proposal. However obliquely, the SEC referred to Enron in its decision: "In view of the widespread public debate concerning the impact of non-audit services on auditor independence and the increasing recognition that this issue raises significant policy issues, we do not believe that Disney may omit the proposal form its proxy materials in reliance on [the 'ordinary business'] rule . . ."

Unsurprisingly, a number of other auditor independence resolutions have since been filed for 2002 company annual meetings. Through its pension funds, the United Brotherhood of Carpenters and Joiners of America filed auditor independence proposals with 12 companies, including Apple Computer (AAPL), Avon Products (AVP), and Bristol-Meyer Squibb (BMY).


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