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March 5, 2003
Nutter McClennen & Fish LLP
Kenneth F. Ehrlich
Direct Line: 617-439-2989
Fax: 617-310-9989
Public Information Room
Office of the Comptroller of the Currency
250 E Street, SW, Mail Stop 1-5
Washington D.C 20219
Attention: Docket No. 02-15
Robert E. Feldman
Executive Secretary
Attention: Comments
Federal Deposit Insurance Corporation
550 17th Street, NW
Washington, D.C. 20429
Secretary, Board of Governors
Federal Reserve System
20th Street and Constitution Avenue, NW
Washington, D. C. 20551
Docket No. R-1139
Regulation Comments
Chief Counsel's Office
Office of Thrift Supervision
1700 G Street, NW
Washington, D.C. 20552
Attention: 2002-58
Ladies and Gentlemen:
We appreciate the opportunity to comment on regulations that have been
proposed by the four federal banking agencies (the "Agencies") relating
to Removal, Suspension, and Debarment of Accountants From Performing
Audit Services, which were published in the Federal Register on January
8, 2003 (68 Fed. Reg. 1116) (the "Proposal") and on which comments are
due by March 10, 2003. We submit these comments on behalf of three
accounting firms headquartered in Massachusetts that provide audit
services to publicly held and non-publicly held depository institutions.
For the reasons described below, we believe that negligence in any
form was never intended by Congress to constitute "good cause" for
removing, suspending or debarring accountants from performing audit
services for depository institutions under Section 36(g)(4) of the
Federal Deposit Insurance Act (the "FDI Act"), 12 U.S.C. 1831m(g)(4).
Unlike the federal securities laws and regulations on which the Proposal
was modeled, the federal banking laws do not contemplate administrative
sanctions against accountants for conduct short of knowing or reckless
behavior, and any decision to change that policy should be made by
Congress, not the Agencies. As a result, for the reasons described
below, we urge you to remove negligence in any form as a basis for
removing, suspending or debarring accountants in the final regulations.
In addition, as discussed below, there is no authority in the statute
to remove, suspend, or debar a firm or office. The removal, suspension
and debarment allowed by Section 36(g)(4) of the FDI Act is of "an
independent public accountant. " Such an interpretation would allow an
Agency, after finding good cause with respect to one accountant, to
effectively remove, suspend or debar other individual accountants within
the same firm from performing audit work for banks, despite the fact
that good cause to remove, suspend or debar each of them may not
exist or in any event has not been determined. As a result, we urge you
to remove from the final regulations the Agencies' authority to remove,
suspend or debar an entire accounting firm or office on the basis of the
acts of one of its independent public accountants.
Finally, the reinstatement procedures should explicitly permit a firm
to petition for the reinstatement of an office which has been suspended,
removed or debarred, which the Proposal does not allow.
1. Negligence in Any Form Was Not Intended by Congress to Constitute
"Good Cause"
Section 36(g)(4)(A) of the FDI Act, 12 U.S.C. 1831m(g)(4)(A) ,
provides that, in addition to any authority contained in Section 8 of
the FDI Act, 12 U.S.C. 1818, the Agencies may "remove, suspend or bar an
independent public accountant, upon a showing of good cause, from
performing audit services required by this section." 1
Section 36(g)(4)(B) requires the Agencies to jointly issue rules of
practice to implement that authority.
The Proposal, in pertinent part, would allow the Agencies to remove,
suspend or debar an accountant if the accountant has engaged in, among
other conduct, "negligent" conduct in the form of (A) a single instance
of "highly unreasonable conduct" that results in a violation of
applicable professional standards in circumstances in which an
accountant knows, or should know, that "heightened scrutiny is
warranted" or (B) repeated instances of "unreasonable conduct, " each
resulting in a violation of applicable professional standards, that
indicate a lack of competence to perform audit services. The terms
"highly unreasonable conduct" and “unreasonable conduct” are not defined
in the Proposal.
The standards in the Proposal were "drawn principally" from the
Agencies' existing practice rules and from the SEC's practice rules at
17 C.F.R. 201.102(e). 68 Fed. Reg. 1118. The SEC practice rules were
recently codified in Section 602 of the Sarbanes-Oxley Act of 2002, Pub.
L. 107-204, 116 Stat. 745 (2002). 68 Fed. Reg. 1118, n. 12.
Although the SEC rules do permit removal, suspension or debarment for
what the rules acknowledge amounts to gross negligence, the SEC
preferred to use the term "highly unreasonable" conduct because courts
have not interpreted the term "gross negligence" on a uniform basis. 63
Fed. Reg. 57168, n. 49. Furthermore, in determining that this
"intermediate" standard, which covers conduct worse than ordinary
negligence but not as severe as recklessness, 63 Fed. Reg. 57167, was an
appropriate standard to include in its rules, the SEC expressly relied
on provisions of the federal securities laws that have been interpreted
by the courts as imposing liability on auditors "without requiring
intentional misconduct. " 63 Fed. Reg. 57167, n. 38.
For example, the SEC pointed out that the Supreme Court has
recognized that Section 11 of the Securities Exchange Act of 1934 (the
"1934 Act") allows recovery for "negligent conduct." 63 Fed. Reg. 57167,
n. 38 (citations omitted). The SEC also relied on Section 21C of the
1934 Act, which imposes liability when a person is a "cause" of a
"violation `due to an act or omission the person knew or should have
known would contribute to such violation'." Id.; see 15
U.S.C. 78u-3.
By contrast, there is no place in the FDI Act where Congress imposes,
or authorizes the Agencies to impose, any similar liability of any kind
upon any institution-affiliated party, as that term is defined in 12
U.S.C. 1813(u),2 other than against officers and directors of
failed depository institutions.3 The sanctions - including,
in pertinent part, removal, suspension and prohibition orders - which
the Agencies are authorized to impose under Section 8 of the FDI Act
against an accountant for various types of misconduct may only be
imposed if, among other things, the accountant has engaged in knowing or
reckless behavior. See 12 U.S.C. 1818.
The FIRREA House Report stated that the knowing or reckless standard
"limits the exposure of independent contractors to those who
knowingly or with reckless disregard participate in a violation of law
or engage in an unsafe or unsound practice, which caused or is likely to
cause a loss or other adverse effect. "H.R. REP. No. 54, 101st
Cong., 1st Sess., 392 (1989) (emphasis supplied).
Although Section 36(g)(4) of the FDI Act authorizes the Agencies to
remove, suspend or debar an accountant upon a showing of "good cause"
in addition to any authority contained in Section 8 of the FDI Act,
there is no evidence that Congress by the use of the italicized language
above intended to authorize the Agencies to expand on the bases for
sanctions against independent contractors contained in 12 U.S.C.
1813(u).
Fundamental principles of statutory construction require that the
authority granted in Section 36(g)(4) be construed in a manner
consistent with, and able to be rationalized with, the FIRREA sanctions
set forth in 12 U.S.C. 1813(u) and 1818. If Congress had wanted to
authorize the Agencies to remove, suspend or debar accountants upon a
showing of ordinary or gross negligence in connection with violations of
law, unsafe or unsound practices or other conduct covered under 12 U.S.C.
1818, Congress would not have gone to the effort to fashion the "knowing
or reckless" standard in 12 U.S.C. 1818.
Because FDICIA, which added Section 36(g)(4), indicated no intention
to revise the specific statutory approach Congress had taken two years
earlier in FIRREA, and in particular said nothing about creating a
limited exception to the FIRREA rules to cover accountants, the best
interpretation is that Congress meant "good cause" to address
transgressions by accountants other than those already covered by the
FIRREA sanctions.
The transgressions, we submit, that Congress intended in 1991 to be
covered by the term "good cause" may include certain failures to provide
working papers or adhere to professional qualification requirements,
practice standards and other similar requirements and standards,
including peer reviews, that would not directly constitute those kinds
of violations of law, unsafe or unsound practices, or other acts that
can give rise to sanctions under 12 U.S.C. 1818.
This interpretation is supported by the FDICIA legislative history.
The House Report stated:
"Audit services required by new section 36 may be performed only by
an independent public accountant who has agreed to provide related
working papers, policies, and procedures to the FDIC and the appropriate
Federal banking agencies, if requested; and who has received a peer
review that meets guidelines acceptable to the FDIC. The FDIC or the
appropriate Federal banking agency may remove, suspend or bar an
independent public account for good cause from performing audit services
required by new section 36. " H. REP. No. 330, 102nd Cong., 1st
Sess., 117 (1991).
Like the House Report, the Senate Report included the only
explanation of the removal, suspension and debarment provision in the
same paragraph that included the committee's explanation of the working
paper, peer review and other qualification standards.
"Title II includes standards for the qualification of independent
public accountants for insured depository institutions performing audits
required by the amendment. Specifically, such accountants must agree to
provide, upon request, any related working papers, policies and
procedures to the FDIC and any appropriate Federal or State regulator,
and must have received a peer review that conforms to guidelines
acceptable to the FDIC. The FDIC and the appropriate Federal banking
agency may remove, bar or suspend any independent public accountant from
performing these audit services upon a showing of good cause. " S. REP.
No. 167, 102nd Cong. , 1st Sess., 41 (1991).
These FDICIA committee report excerpts indicate that the Section
36(g)(4) sanctions are intended to address an accountant's failure to
provide working papers or adhere to professional qualification
requirements, practice standards and other similar requirements and
standards, including peer reviews, that would not directly constitute
those kinds of violations of law, unsafe or unsound practices, or other
acts that can give rise to sanctions under 12 U.S.C. 1818.
As a result, if the final regulations include negligence in any form
- including gross negligence - as a basis for removing, suspending or
debarring accountants, the Agencies, in effect, will be expanding upon
the bases for sanctions against independent contractors contained in 12
U.S.C. 1813(u), which is a policy determination we urge you to leave to
the Congress.
We also note that the SEC has indicated that the term "repeated
instances of unreasonable conduct" could include "as few as two separate
instances of unreasonable conduct occurring within one audit, or
separate instances of unreasonable conduct occurring within different
audits." 63 Fed. Reg. 57169. Such an interpretation effectively would
permit an ordinary negligence standard to be applied to determine if
accountants should be removed, suspended or debarred. If negligence is
retained in the final rules as a basis for removal, suspension or
debarment, the final rules should make clear that the Agencies do not
agree with the SEC's assessment that "repeated instances of unreasonable
conduct" might include as few as two separate instances of merely
negligent conduct occurring within one audit, or separate instances of
unreasonable conduct occurring within different audits.
2. There Is No Authority in the Statute for the Removal, Suspension,
or Debarment of Firms or Offices
The Proposal also provides, in pertinent part, that if an Agency
determines that there is good cause for the removal, suspension or
debarment of a member or employee of an accounting firm, the Agency
"also may remove, suspend, or debar such firm or one or more offices of
such firm. " In considering whether to remove, suspend, or debar a firm
or one or more offices of such firm, and the term of any sanction
permitted by the Proposal, the Agency "may consider, for example" one or
more of five listed factors.4
The removal, suspension and debarment allowed by Section 36(g)(4) of
the FDI Act is of "an independent public accountant. " There is no
mention in the statute of the possible extension of those sanctions to
accounting firms or offices, or of extended or vicarious liability in
any other way or of any kind. Such an interpretation would allow an
Agency, after determining that good cause exists with respect to one
accountant, to effectively remove, suspend or debar other individual
accountants within the same firm from performing audit work for banks,
in the discretion of the Agency, despite the fact that "good cause, " as
that term would be defined in the rules, to remove, suspend or debar
each of them may not exist or in any event has not been determined.
As a result, we urge you to remove from the final regulations the
Agencies' authority to remove, suspend or debar an entire accounting
firm or office on the basis of the acts of one of its independent public
accountants.
3. The Rules Should Permit Reinstatement of Offices
The Proposal allows the removal, suspension or debarment of
individual public accountants, offices of firms, and the firms
themselves, but only allows reinstatement of individual public
accountants and the firms themselves. If authority to remove, suspend or
debar firms and offices is retained in the final rules. we suggest that
the reinstatement procedures explicitly permit a firm to petition for
the reinstatement of an office which has been suspended, removed or
debarred in addition to individual public accountants and the firms
themselves.
Thank you for your attention to the foregoing comments. If you have
any questions, please do not hesitate to contact the undersigned at the
telephone number or address set forth above.
Sincerely,
Kenneth F. Ehrlich
World Trade Center West
155 Seaport Boulevard
Boston, MA 02210-2604
1 As implemented by 12 C.F.R. Part 363, Section 36
of the FDI Act requires, in pertinent part, that each depository
institution with total assets of $500 million or more produce an annual
report containing the institution's financial statements and certain
management assessments, and that each such institution obtain an audit
of its financial statements and an attestation on management's
assertions regarding internal controls over financial reporting by an
independent public accountant. The accountant's audit and attestation
reports are required to be included in the institution's annual report.
Section 36(d)(2) of the FDI Act requires each independent public
accountant performing an audit to determine and report whether the
institution's financial statements are presented fairly in accordance
with GAAP and comply with such other disclosure requirements as the
Agencies may prescribe.
2 The definition of "institution-affiliated party"
includes bank officers and directors and, in pertinent part: "any .. .
accountant ... who knowingly or recklessly participates in (A)
any violation of any law or regulation; (B) any breach of fiduciary
duty; or (C) any unsafe or unsound practice, which caused or is likely
to cause more than a minimal financial loss to, or a significant adverse
effect on, the insured depository institution. " 12 U.S.C. § 1813(u)
(Emphasis supplied).
3 In a civil action by the FDIC acting as conservator or
receiver or in certain other capacities, a director or officer of an
insured depository institution may be held personally liable for
monetary damages for "gross negligence" or conduct that "demonstrates a
greater disregard of a duty of care 12 U.S.C. 1821(k) .
4 The five factors which the Agencies "may consider"
include: (1) the gravity, scope or repetition of the act or failure to
act that constitutes good cause for the removal, suspension, or
debarment, (2) the adequacy of, and adherence to, applicable policies,
practices or procedures for the accounting firm's conduct of its
business and the performance of audit services, (3) the selection,
training, supervision and conduct of members or employees of the
accounting firm involved in the performance of audit services, (4) the
extent to which managing partners or senior officers of the accounting
firm have participated, directly, or indirectly through oversight or
review, in the act or failure to act, and (5) the extent to which the
accounting firm has, since the occurrence of the act or failure to act,
implemented corrective internal controls to prevent its recurrence. 68
Fed. Reg. 1118.
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