[Federal Register: March 13, 2006 (Volume 71, Number 48)]
[Notices]
[Page 12720-12736]
[DOCID:fr13mr06-82]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53427; File No. PCAOB-2006-01]

Public Company Accounting Oversight Board; Notice of Filing of
Proposed Ethics and Independence Rules Concerning Independence, Tax
Services, and Contingent Fees

March 7, 2006.
    Pursuant to Section 107(b) of the Sarbanes-Oxley Act of 2002 (the
``Act''), notice is hereby given that on August 2, 2005, 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 described in Items I, and II below, which
items have been prepared by the Board. On November 22, 2005, the Board
adopted certain technical amendments to the rule and amended its filing
on November 23, 2005. The Commission is publishing this notice to
solicit comments on the proposed rule from interested persons.

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

    On July 26, 2005, the Board adopted Rules 3501--Definitions of
Terms Employed in Section 3, Part 5 of the Rules; 3502--Responsibility
Not to Cause Violations; 3520--Auditor Independence; 3521--Contingent
Fees; 3522--Tax Transactions; 3523--Tax Services for Persons in
Financial Reporting Oversight Roles; and 3524--Audit Committee Pre-
approval of Certain Tax Services (``the proposed rules''). On November
22, 2005, the Board adopted certain technical amendments to Rule 3502,
including its title, and Rule 3522. The proposed rule text is set out
below.

SECTION 3. PROFESSIONAL STANDARDS--Part 5--Ethics

Rule 3501. Definitions of Terms Employed in Section 3, Part 5 of the
Rules

    When used in Section 3, Part 5 of the Rules, unless the context
otherwise requires:
(a)(i) Affiliate of the Accounting Firm
    The term ``affiliate of the accounting firm'' (or ``affiliate of
the registered public accounting firm'' or ``affiliate of the firm'')
includes the accounting firm's parents; subsidiaries; pension,
retirement, investment or similar plans; and any associated entities of
the firm, as that term is used in Rule 2-01 of the Commission's
Regulation S-X, 17 CFR 210.2-01(f)(2).
(a)(ii) Affiliate of the Audit Client
    The term ``affiliate of the audit client'' means--
    (1) An entity that has control over the audit client, or over which
the audit client has control, or which is under common control with the
audit client, including the audit client's parents and subsidiaries;
    (2) An entity over which the audit client has significant
influence, unless the entity is not material to the audit client;
    (3) An entity that has significant influence over the audit client,
unless the audit client is not material to the entity; and
    (4) Each entity in the investment company complex when the audit
client is an entity that is part of an investment company complex.
(a)(iii) Audit and Professional Engagement Period
    The term ``audit and professional engagement period'' includes
both--
    (1) The period covered by any financial statements being audited or
reviewed (the ``audit period''); and
    (2) The period of the engagement to audit or review the audit
client's financial statements or to prepare a report filed with the
Commission (the ``professional engagement period'')--
    (A) The professional engagement period begins when the registered
public accounting firm either signs an initial engagement letter (or
other agreement to review or audit a client's financial statements) or
begins audit, review, or attest procedures, whichever is earlier; and
    (B) The professional engagement period ends when the audit client
or the registered public accounting firm notifies the Commission that
the client is no longer that firm's audit client.
    (3) For audits of the financial statements of foreign private
issuers, the ``audit and professional engagement period'' does not
include periods ended prior to the first day of the last fiscal year
before the foreign private issuer first filed, or was required to file,
a registration statement or report with the Commission, provided there
has been full compliance with home country independence standards in
all prior periods covered by any registration statement or report filed
with the Commission.
(a)(iv) Audit Client
    The term ``audit client'' means the entity whose financial
statements or other information is being audited, reviewed, or attested
and any affiliates of the audit client.
(c)(i) Confidential Transaction
    The term ``confidential transaction'' means--
    (1) In general. A confidential transaction is a transaction that is
offered to a taxpayer under conditions of confidentiality and for which
the taxpayer has paid an advisor a fee.
    (2) Conditions of confidentiality. A transaction is considered to
be offered to a taxpayer under conditions of confidentiality if the
advisor who is paid the fee places a limitation on disclosure by the
taxpayer of the tax treatment or tax structure of the transaction and
the limitation on disclosure protects the confidentiality of that
advisor's tax strategies. A transaction is treated as confidential even
if the conditions of confidentiality are not legally binding on the
taxpayer.

A claim that a transaction is proprietary or exclusive is not treated
as a limitation on disclosure if the advisor confirms to the taxpayer
that there is no limitation on disclosure of the tax treatment or tax
structure of the transaction.
    (3) Determination of fee. For purposes of this definition, a fee
includes all fees for a tax strategy or for services for advice
(whether or not tax advice) or for the implementation of a transaction.
These fees include consideration in whatever form paid, whether in cash
or in kind, for services to analyze the transaction (whether or not
related to the tax consequences of the transaction), for services to
implement the transaction, for services to document the transaction,
and for services to prepare tax returns to the extent that the fees
exceed the fees customary for return preparation. For purposes of this
definition, a taxpayer also is treated as paying fees to an advisor if
the taxpayer knows or should know that the amount it pays will be paid
indirectly to the advisor, such as through a referral fee or fee-
sharing arrangement. A fee does not include amounts paid to a person,
including an advisor, in that person's capacity as a party to the
transaction. For example, a fee does not include reasonable charges for
the use of capital or the sale or use of property.
    (4) Related parties. For purposes of this definition, persons who
bear a relationship to each other as described in section 267(b) or
707(b) of the Internal Revenue Code will be treated as the same person.
(c)(ii) Contingent Fee
    The term ``contingent fee'' means--
    (1) Except as stated in paragraph (2) below, any fee established
for the sale of a product or the performance of any service pursuant to
an arrangement in which no fee will be charged unless a specified
finding or result is attained, or in which the amount of the fee is
otherwise dependent upon the finding or result of such product or
service.
    (2) Solely for the purposes of this definition, a fee is not a
``contingent fee'' if the amount is fixed by courts or other public
authorities and not dependent on a finding or result.
(f)(i) Financial Reporting Oversight Role
    The term ``financial reporting oversight role'' means a role in
which a person is in a position to or does exercise influence over the
contents of the financial statements or anyone who prepares them, such
as when the person is a member of the board of directors or similar
management or governing body, chief executive officer, president, chief
financial officer, chief operating officer, general counsel, chief
accounting officer, controller, director of internal audit, director of
financial reporting, treasurer, or any equivalent position.
(i)(i) Immediate Family Member
    The term ``immediate family member'' means a person's spouse,
spousal equivalent, and dependents.
(i)(ii) Investment Company Complex
    (1) The term ``investment company complex'' includes--
    (i) An investment company and its investment adviser or sponsor;
    (ii) Any entity controlled by or controlling an investment adviser
or sponsor in paragraph (i) of this definition, or any entity under
common control with an investment adviser or sponsor in paragraph (i)
of this definition if the entity--
    (A) Is an investment adviser or sponsor; or
    (B) Is engaged in the business of providing administrative,
custodian, underwriting, or transfer agent services to any investment
company, investment adviser, or sponsor; and
    (iii) Any investment company or entity that would be an investment
company but for the exclusions provided by section 3(c) of the
Investment Company Act of 1940 (15 U.S.C. 80a-3(c)) that has an
investment adviser or sponsor included in this definition by either
paragraph (i) or (ii) of this definition.
    (2) An investment adviser, for purposes of this definition, does
not include a sub-adviser whose role is primarily portfolio management
and is subcontracted with or overseen by another investment adviser.
    (3) A sponsor, for purposes of this definition, is an entity that
establishes a unit investment trust.

Rule 3502. Responsibility Not To Knowingly or Recklessly Contribute to
Violations

    A person associated with a registered public accounting firm shall
not take or omit to take an action knowing, or recklessly not knowing,
that the act or omission would directly and substantially contribute to
a violation by that registered public accounting firm of the Act, the
Rules of the Board, the provisions of the securities laws relating to
the preparation and issuance of audit reports and the obligations and
liabilities of accountants with respect thereto, including the rules of
the Commission issued under the Act, or professional standards.

Subpart 1--Independence

Rule 3520. Auditor Independence

    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.

    Note 1: Under Rule 3520, a registered public accounting firm or
associated person's independence obligation with respect to an audit
client that is an issuer encompasses not only an obligation to
satisfy the independence criteria set out in the rules and standards
of the PCAOB, but also an obligation to satisfy all other
independence criteria applicable to the engagement, including the
independence criteria set out in the rules and regulations of the
Commission under the federal securities laws.

    Note 2: Rule 3520 applies only to those associated persons of a
registered public accounting firm required to be independent of the
firm's audit client by standards, rules or regulations of the
Commission or other applicable independence criteria.

Rule 3521. Contingent Fees

    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 service or product to the
audit client for a contingent fee or a commission, or receives from the
audit client, directly or indirectly, a contingent fee or commission.

Rule 3522. Tax Transactions

    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 non-audit service to the
audit client related to marketing, planning, or opining in favor of the
tax treatment of, a transaction--
    (a) Confidential Transactions--that is a confidential transaction;
or
    (b) Aggressive Tax Position Transactions--that was initially
recommended, directly or indirectly, by the registered public
accounting firm and a significant purpose of which is tax avoidance,
unless the proposed tax treatment is at least more likely than not to
be allowable under applicable tax laws.

    Note 1: With respect to transactions subject to the United
States tax laws, paragraph (b) of this rule includes, but is not
limited to, any transaction that is a listed transaction within the
meaning of 26 CFR 1.6011-4(b)(2).

    Note 2: A registered public accounting firm indirectly
recommends a transaction when an affiliate of the firm or another
tax advisor, with which the firm has a formal agreement or other
arrangement related to the

promotion of such transactions, recommends engaging in the
transaction.

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.

Rule 3524. Audit Committee Pre-Approval of Certain Tax Services

    In connection with seeking audit committee pre-approval to perform
for an audit client any permissible tax service, a registered public
accounting firm shall--
    (a) Describe, in writing, to the audit committee of the issuer--
    (1) The scope of the service, the fee structure for the engagement,
and any side letter or other amendment to the engagement letter, or any
other agreement (whether oral, written, or otherwise) between the firm
and the audit client, relating to the service; and
    (2) Any compensation arrangement or other agreement, such as a
referral agreement, a referral fee or fee-sharing arrangement, between
the registered public accounting firm (or an affiliate of the firm) and
any person (other than the audit client) with respect to the promoting,
marketing, or recommending of a transaction covered by the service;
    (b) Discuss with the audit committee of the issuer the potential
effects of the services on the independence of the firm; and
    (c) Document the substance of its discussion with the audit
committee of the issuer.
* * * * *

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

    In its filing with the Commission, the Board included statements
concerning the purpose of, and basis for, the proposed rule and
discussed any comments it received on the proposed rule. 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

(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.''
    As discussed more fully in Exhibit 3, two types of tax services
have raised serious concerns among investors, auditors, lawmakers, and
others relating to the ethics and independence of accounting firms that
provide both auditing and tax services--
    1. The marketing to public company audit clients of questionable
tax transactions used improperly to avoid paying taxes or to manipulate
financial statements in order to make such statements appear more
favorable to investors, and
    2. The provision of tax services, including tax shelter products,
to executives of public company audit clients who are involved in the
financial reporting process at such companies.
    Accordingly, the Board adopted a set of rules designed to establish
a framework for addressing the concerns that have arisen in connection
with auditors' provision of tax services to their public company audit
clients. Specifically, the proposed rules are designed, among other
things, to prevent auditors from providing (1) certain aggressive tax
shelter services to public company audit clients, (2) any other service
to a public company audit client for a contingent fee, which is a fee
arrangement often used in tax work, and (3) any tax service to certain
persons who serve in financial reporting oversight roles at a public
company audit client. The rules also codify, in an ethics rule, the
principle that persons associated with a registered public accounting
firm should not cause the firm to violate relevant laws, rules, and
standards, and introduce a foundation for the independence component of
the Board's ethics rules. Finally, the rules implement the requirements
of the Act and the SEC's independence rules when an auditor seeks audit
committee pre-approval to provide tax services that are not prohibited
by the Board's or the SEC's rules.
(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 rules will result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act. The proposed rules would apply
equally to all registered public accounting firms and their associated
persons. Although some of the proposed rules would prohibit a
registered public accounting firm from providing certain non-audit
services to its audit clients, they would not restrict the provision of
these same services to other companies.

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

    The Board released the proposed rules for public comment in PCAOB
Release No. 2004-015 (December 14, 2004). A copy of PCAOB Release No.
2004-015 and the comment letters received in response to the PCAOB's
request for comment are available on the PCAOB's Web site at http://www.pcaobus.org.
 The Board received 807 written comments. The Board has

modified certain aspects of the proposed rules in response to comments
it received, as discussed below.
    When the Board adopted the rules on July 26, 2005, it stated the
following: \1\
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    \1\ As discussed above, the Board adopted technical amendments
to the rules on November 22, 2005. These amendments are discussed
under The Technical Amendments, below.

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Rule 3502--Responsibility Not to Cause Violations
    Rule 3502, as proposed, provided that a person associated with a
registered public accounting firm shall not cause that firm to violate
the Act, the Rules of the Board, the provisions of the securities laws
relating to the preparation and issuance of audit reports and the
obligations and liabilities of accountants with respect thereto,
including the rules of the Commission issued under the Act, or
professional standards, due to an act or omission the person knew or
should have known would contribute to such violation. The Board
proposed the rule to codify the ethical obligation of associated
persons of registered firms not to cause registered firms to commit
such violations. Proposed Rule 3502 also made clear that an associated
person's ethical obligation is not merely to refrain from knowingly
causing a violation but also to act with sufficient care to avoid
negligently causing a violation.
    The Board received a number of comments on proposed Rule 3502.
Several commenters supported the rule as proposed and noted that they
saw the rule as essential to the Board's ability to carry out its
disciplinary responsibilities under the Act. Other commenters, however,
including the largest accounting firms and an accounting trade
association, did not support the rule as proposed. In general, these
commenters objected to the proposed rule's use of a negligence standard
in light of the complex regulatory requirements with which auditors
must comply. Some of these commenters also questioned the Board's
authority to adopt the proposed rule, or at least the proposed rule
with a negligence standard.
    The Board has carefully considered these comments and determined to
adopt Rule 3502, with some modifications. The Board continues to
believe that it is authorized to adopt the rule. Section 103(a) of the
Act directs the Board to, ``by rule, establish * * * such ethics
standards to be used by registered public accounting firms in the
preparation and issuance of audit reports, as required by this Act or
the rules of the Commission, or as may be necessary or appropriate in
the public interest or for the protection of investors.'' The Board
believes that the rule is an appropriate exercise of this authority to
set ethical standards for accountants subject to the Board's
jurisdiction.
    Under the Act and Board rules, both registered firms and their
associated persons must comply with PCAOB rules and standards, as well
as related laws. When an associated person with such a responsibility
causes the firm with which he or she is associated to violate such
rules, standards or laws, this conduct operates to the detriment of the
protection of investors and the public interest and may bear on the
ethics of the responsible associated person. When such a person engages
in this conduct with knowledge that, or in reckless disregard of
whether, it would directly and substantially contribute to the firm's
violation, the Board believes this conduct plainly reflects an ethical
lapse by the responsible person and, therefore, is within the Board's
authority--and indeed responsibility--to proscribe.
    At least one commenter asserted that the proposed rule was not a
proper exercise of the Board's ethics standards-setting authority
because it reached a range of conduct, rather than delineating
``particular impermissible conduct.'' The Board disagrees and believes
the type of conduct addressed by the rule is plainly the type of
conduct the Board's ethics rules can and should address. In fact, the
accounting profession's existing ethical code at the time of enactment
of the Act reaches any act that may ``discredit[]'' the profession--
thereby reaching ranges of conduct, including violations of certain
laws, rather than just specifying ``particular impermissible conduct.''
\2\ When Congress vested the authority to set ethics standards in the
Board, the Board believes it intended for this authority to be at least
as broad as the scope of the existing ethics rules, at least as to
matters within the Board's jurisdiction. This authority, in the Board's
view, plainly includes the ability to require that persons subject to
the Board's jurisdiction, as an ethical obligation, not cause a
violation of relevant laws.
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    \2\ See AICPA Code of Professional Conduct, ET section
(``sec.'') 501, ``Acts Discreditable'' (``A member shall not commit
an act discreditable to the profession.''). Interpretations of this
part of the ethical code provide that an accountant member will be
considered to have committed a discreditable act if, among other
things, he or she: ``fails to comply with applicable federal, state
or local [tax] laws or regulations,'' ET sec. 501.08, Interpretation
501-7; fails to follow applicable requirements of a governmental
body, such as the SEC, in performing accounting services, ET sec.
501.06, Interpretation 501-5; or fails to follow government audit
standards and rules in conducting a governmental audit, ET sec.
501.04, Interpretation 501-3.
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    Commenters opposed to the proposed rule also sought to analogize
the rule to a theory of liability that the Supreme Court rejected in
Central Bank of Denver, N.A. v. First Interstate Bank of Denver,
N.A.\3\ In Central Bank, the Supreme Court held that that there is no
private right of action for aiding and abetting a violation of Section
10(b) of the Securities Exchange Act of 1934 (``Exchange Act''). That
decision turned on the fact that the text of Section 10(b) does not
provide for aiding-and-abetting liability.\4\ The Board does not
believe this decision affects the scope of the Board's explicit
authority to set ethics standards under Section 103 of the Act.\5\
Again, the Board notes that the profession's existing ethics code also
reaches what can be characterized as ``secondary'' conduct contributing
to a violation.\6\
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    \3\ 511 U.S. 164 (1994).
    \4\ See id. at 190 (``Because the text of Sec.  10(b) does not
prohibit aiding and abetting, we hold that a private plaintiff may
not maintain an aiding and abetting suit under Sec.  10(b).'').
    \5\ Rule 3502, of course, differs from an aiding-and-abetting
cause of action in important respects. Among other things, the rule
does not apply whenever an associated person causes another to
violate relevant laws, rules and standards. Rather, Rule 3502
applies only when an associated person causes a violation by the
registered firm with which the person is associated.
    \6\ See AICPA Code of Professional Conduct, paragraph .02(2) of
ET sec. 91, ``Applicability'' (``A member shall not knowingly permit
a person, whom the member has the authority or capacity to control,
to carry out on his or her behalf, either with or without
compensation, acts which, if carried out by the member, would place
the member in violation of the rules. Further, a member may be held
responsible for the acts of all persons associated with him or her
in the practice of public accounting whom the member has the
authority or capacity to control.''); see also ET sec. 102.02,
Interpretation 102-1(c) (violation of ethics rules not just to sign,
but to ``permit[] or direct[] another to sign a document containing
materially false and misleading information'') (adopted as a Board
interim ethics rule in Rule 3500T).
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    The power to adopt Rule 3502 also is inherent in, and necessary to,
the Board's authority to enforce PCAOB standards, rules, and related
laws against both registered firms and their associated persons.
Section 105 authorizes the Board to investigate and, when appropriate,
discipline registered firms and their associated persons. Certain types
of violations, by their nature, may give rise to direct liability only
for a registered public accounting firm. Such firms, however, can only
act through the natural persons that comprise them, many of whom are
``associated persons'' subject to the Board's ethics standards and
disciplinary authority. When one or more of those associated persons
has caused that firm to violate PCAOB standards, rules, or related laws
with the requisite state of mind, it is appropriate, and consistent
with the Board's duty to discipline registered

firms and their associated persons under Section 101(c)(4) of the Act,
that the Board be able to discipline the associated person for that
misconduct.\7\
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    \7\ Some commenters suggested that the reference to ``any act,
or practice * * * in violation of this Act'' in Section 105(c)(4)--
the part of the Act authorizing the Board to impose certain
sanctions--was inconsistent with the proposed rule. The Board notes,
however, as it did in the proposing release, that Section 105(c)(5)
expressly provides that the more severe of these sanctions may be
imposed when intentional, knowing, or reckless conduct, or repeated
instances of negligent conduct, ``results in'' violation of law,
regulations, or professional standards.
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    After carefully considering the comments received, the Board has
determined, however, to modify the scope of Rule 3502 to apply only
when an associated person causes the registered firm's violation due to
an act or omission the person ``knew, or was reckless in not knowing,
would directly and substantially contribute to such violation.'' This
revised formulation reflects two changes to the rule as proposed.
    First, the Board has determined to change the state-of-mind
requirement in the rule. Specifically, Rule 3502, as adopted, will
apply to ``an act or omission the [associated] person knew, or was
reckless in not knowing,'' would cause the violation. While the Board
believes it has the authority to adopt a negligence standard,\8\ the
Board believes the revised standard strikes the right balance in the
context of this rule. The Board believes that the phrase ``knew, or was
reckless in not knowing'' is a well-understood legal concept, and the
Board intends for the phrase to be given its normal meaning.
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    \8\ A number of commenters argued that Section 105(c) of the Act
prevents the Board from imposing discipline based on a negligence
standard. The Board's determination to change the rule's state-of-
mind requirement to recklessness moots these comments. The Board
notes, however, that Section 105(c)(5) identifies a range of
sanctions that the Board may not impose in the absence of knowing
conduct, reckless conduct, or repeated instances of negligent
conduct. The Act does not similarly limit the Board's authority to
impose certain other sanctions.
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    Second, the Board has determined to modify the phrase used to
describe the connection between the associated person's conduct and the
violation. Specifically, Rule 3502, as adopted, provides that the
associated person's act or omission must ``directly and substantially
contribute to [the firm's] violation.'' In particular,
``substantially'' in this context means that the associated person's
conduct (i.e., an act or omission) contributed to the violation in a
material or significant way. The term ``substantially'' also means,
however, that the associated person's conduct does not need to have
been the sole cause of the violation. ``Directly'' means that the
associated person's conduct either essentially constitutes the
violation--even though it is the firm and not the individual that
actually commits the violation--or is a reasonably proximate
facilitating event of, or a reasonably proximate stimulus for, the
violation. ``Directly and substantially'' does not mean that the
associated person's conduct must be the sole cause of the violation,
nor that it must be the final step in a chain of actions leading to the
violation. In addition, the term ``directly'' should not be
misunderstood to excuse someone who knowingly or recklessly engages in
conduct that substantially contributes to a violation, just because
others also contributed to the violation, or because others could have
stopped the violation and did not. At the same time, the term does not
reach an associated person's conduct that, while contributing to the
violation in some way, is remote from, or tangential to, the firm's
violation.
    A number of commenters expressed concern that adoption of a
negligence standard would allow the Board, or the SEC, to proceed
against associated persons who in good faith, albeit negligently, have
caused a registered firm to violate applicable laws or standards. For
example, commenters suggested that the proposed rule could be used
against compliance personnel within a firm who inadvertently design a
firm's compliance system in a flawed manner. Commenters also expressed
concern that, because the SEC can enforce PCAOB rules under Section 3
of the Act, the Board's rule could have the practical effect of
altering the state-of-mind requirement applicable in SEC enforcement
proceedings against accountants.
    It was not the Board's intention to establish a new standard for
SEC enforcement of the securities laws and related applicable rules.
The Board also recognizes that persons subject to its jurisdiction must
comply with complex professional and regulatory requirements in
performing their jobs. The Board does not seek to create through this
rule a vehicle to pursue compliance personnel who act in an
appropriate, reasonable manner that, in hindsight, turns out to have
not been successful. Nor does the Board seek to reach those whose
conduct, unbeknownst to them, remotely contributes to a firm's
violation. At the same time, the Board continues to believe that it is
necessary and appropriate for its ethics rules to apply when an
associated person has engaged in an act or omission with knowledge
that, or in reckless disregard of whether, it would directly and
substantially contribute to a violation.\9\
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    \9\ While the Board's proposed rule tracked some of the language
of Section 21C of the Securities Exchange Act of 1934 (``Exchange
Act''), the rule, as adopted, differs significantly from, and should
not be interpreted in pari material with, that statutory provision.
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    The Board also believes that, because the rule is essential to the
functioning of the Board's independence rules, this rulemaking provides
the appropriate forum to adopt the rule. For example, Rule 3521
provides, in part, that a registered firm is not independent of its
audit client if the firm provides that audit client with a service for
a contingent fee. When an associated person causes, in a manner
consistent with the discussion above, the registered firm to provide
that service for a contingent fee, Rule 3502 would allow the Board to
discipline the associated person for that conduct.\10\
---------------------------------------------------------------------------

    \10\ Rule 3502, of course, is not the exclusive means for the
Board to enforce applicable Board rules and standards against
associated persons. Among other provisions, Rules 3100 and 3200T
through 3600T directly require associated persons to comply with
certain auditing and related professional practice standards. In
addition, PCAOB standards generally contain directives to the
``auditor.'' The term ``auditor'' is defined in PCAOB Rule
1001(a)(xii) to include both registered firms and their associated
persons. Accordingly, an associated person of a registered firm that
does not comply with such a directive may be charged with violations
of such other standards, independent of any charges under Rule 3502.
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Rule 3520--The Fundamental Independence Requirement
    Rule 3520 sets forth the fundamental ethical obligation of
independence: 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. This requirement encompasses
the independence requirements set out in PCAOB Rule 3600T and goes
further, as a matter of the auditor's ethical obligation, to encompass
any other independence requirement applicable to the audit in the
particular circumstances. Accordingly, in the case of an audit client
subject to the financial reporting requirements of the securities laws
and the SEC's rules, the ethical obligation under Rule 3520 requires
the firm and its associated persons to maintain independence consistent
with the SEC's requirements.\11\
---------------------------------------------------------------------------

    \11\ 17 CFR 210.2-01.
---------------------------------------------------------------------------

    By giving this scope to Rule 3520, the Board is not promulgating
any new independence requirement. The Commission's independence
requirements exist independently of Rule 3520 and are subject to change
at the discretion of the Commission, without Rule 3520 purporting
separately

to lock in place any aspect of those requirements. Instead, Rule 3520
is based on the simple premise that ethical standards for auditors can
and should encompass a duty by the auditor to maintain independence
necessary to ensure compliance with independence requirements in the
circumstances of the particular engagement.
    A note to the rule emphasizes the scope of the obligation in the
rule by pointing out that, even in circumstances to which the
Commission's Rule 2-01 applies, a registered public accounting firm and
its associated persons still may need to comply with other independence
requirements, including those requirements separately established by
the Board. Using this foundation, the Board may adopt additional rules
in the ``Independence'' subpart of the ethics rules that effectively
set out additional requirements. As described below, with the new rules
adopted today, the Board's independence rules include contingent fee
arrangements and tax services.
    After carefully considering the comments on proposed Rule 3520, the
Board has determined to adopt the rule, with only one change. Most
commenters supported the scope and content of the proposed rule. A few
commenters, however, asked the Board to add text to the proposed rule
to clarify or emphasize that the rule incorporates certain concepts in
the existing independence requirements. While these comments are
discussed in more detail below, the Board did not adopt these
suggestions, as a general matter, because of the purpose of Rule 3520.
Rule 3520 was simply intended to require, by Board rule, compliance
with applicable independence requirements. The rule was not intended
to, and does not, add to--or subtract from--these existing
requirements. Nor is it intended to reflect the Board's conceptual
approach to independence issues. Accordingly, while the Board does not
necessarily disagree with the intent of the commenters who suggested
adding text to the proposed rule, it does not believe it is necessary
or appropriate to modify the rule to reflect their specific
suggestions.
    Three commenters suggested that Rule 3520 expressly require that
auditors maintain independence from their audit client ``both in fact
and appearance.'' As proposed, the rule already requires auditors to
maintain independence both in fact and appearance, because the SEC's
independence rules--which are incorporated in Rule 3520, as discussed
above--are``designed to ensure that auditors are qualified and
independent of their audit clients both in fact and in appearance.''
\12\ In addition, Statement on Auditing Standard (``SAS'') No. 1,
Codification of Auditing Standards and Procedures, adopted by the Board
as an interim standard, requires that auditors ``not only be
independent in fact; [but also] avoid situations that may lead
outsiders to doubt their independence.'' \13\ Therefore, the Board does
not believe it is necessary to include this additional language in Rule
3520 to preserve these existing principles.
---------------------------------------------------------------------------

    \12\ 17 CFR 210.2-01, Preliminary Note 1; accord United States
v. Arthur Young & Co., 465 U.S. 805, 819 n.15 (1984).
    \13\ SAS No. 1, Codification of Auditing Standards and
Procedures, paragraph .03 of AU sec. 220. The standard further
states that ``[p]ublic confidence 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.'' Id.
---------------------------------------------------------------------------

    Some commenters also recommended that Rule 3520 expressly include
the SEC's four overarching independence principles that it will look to
in determining whether a particular service or client relationship
impairs the auditor's independence.\14\ Other commenters asked the
Board to explicitly note in the rule that certain tax services are
consistent with the SEC's four principles. For the reasons described
above, the Board has decided not to change the rule in response to
either of these suggestions. The Board notes, however, that the SEC's
independence rules already refer to the four principles, and these
rules must be complied with under Rule 3520.
---------------------------------------------------------------------------

    \14\ See 17 CFR 210.2-01, Preliminary Note 2. Specifically,
under those principles, the SEC looks to whether a relationship or
the provision of a service: (a) Creates a mutual or conflicting
interest between the accountant and the audit client; (b) places the
accountant in the position of auditing his or her own work; (c)
results in the accountant acting as management or an employee of the
audit client; or (d) places the accountant in a position of being an
advocate for the audit client.
---------------------------------------------------------------------------

    Two commenters suggested that Rule 3520 include the text of the
American Institute of Certified Public Accountants' (``AICPA'') Ethics
Rule 102, which provides, in pertinent part, that members of the AICPA
should avoid any subordination of their judgment.\15\ Although the
Board shares these commenters' view about the importance of this
principle, the Board has already adopted Ethics Rule 102 as part of its
interim ethics rule, Rule 3500T. Accordingly, this rule is already part
of the Board's ethical standards and need not be separately repeated in
Rule 3520 to be enforced by the Board.
---------------------------------------------------------------------------

    \15\ See AICPA Code of Professional Conduct, ET sec. 102,
``Integrity and Objectivity''.
---------------------------------------------------------------------------

    Two firms suggested that Rule 3520, as proposed, might have the
effect of precluding use of exceptions in the SEC's existing
independence rules and asked the Board to avoid that result. Other than
creating a requirement in a Board rule to comply with existing and
applicable independence requirements, it does not add to, or detract
from, the scope and substantive effect of these existing requirements
in any respect.
    The Board has, however, as suggested by a commenter, added
``associated persons'' to the rule. While the independence requirements
added to the Board's rules through this rulemaking apply to the firm,
other independence requirements covered by Rule 3520 are directed to
individual accountants within auditing firms. Most notably, certain of
the SEC's independence rules impose independence requirements directly
on individual accountants.\16\ Accordingly, the Board believes it is
appropriate for the rule to apply to associated persons, as well as
registered firms themselves. At the same time, the Board has added a
new note to the rule to make clear that the rule applies only to those
associated persons of a registered public accounting firm that are
required to be independent of the firm's audit client by standards,
rules, or regulations of the Commission or other applicable
independence criteria.\17\ Accordingly, the rule does not impose
independence requirements on persons not already subject to them, and
does not impose new independence requirements on any associated person.
Rather, Rule 3520 only requires associated persons who are otherwise
subject to independence requirements to comply, as an ethical
obligation, with those requirements.
---------------------------------------------------------------------------

    \16\ See, e.g., Rule 2-01(c)(1), 17 CFR 210.2-01(c)(1). See also
PCAOB Rule 3600T.
    \17\ Other applicable independence criteria include any rules of
the PCAOB, other than Rule 3520, that contain independence
requirements directly applicable to associated persons of the firm,
such as Rule 3600T.
---------------------------------------------------------------------------

Rule 3521--Contingent Fees
    The Board also has determined to adopt Rule 3521 as proposed. There
was widespread support among commenters for the Board's view, expressed
in the proposal, that certain fee arrangements used for the provision
of tax services create per se conflicts of interest that impair
auditors' independence from their audit clients. As discussed more
fully in the proposing release, when an accounting firm provides a
service to an audit client for a contingent fee, the firm's economic
interests become

aligned with the interests of its audit client in a manner that is
inconsistent with the firm's role as independent auditor. The Board's
rule was adapted from the SEC's rule prohibiting contingent fee
arrangements \18\ and thus treats registered firms as not independent
if they enter into contingent fee arrangements with audit clients.
---------------------------------------------------------------------------

    \18\ See 17 CFR 210.2-01(c)(5).
---------------------------------------------------------------------------

    Specifically, Rule 3521 provides that a registered public
accounting firm is not independent of its audit client \19\ if the
firm, or any affiliate of the firm,\20\ during the audit and
professional engagement period,\21\ provides any service or product to
the audit client for a contingent fee or a commission, or receives from
the audit client, directly or indirectly, a contingent fee or
commission. The Board's definition of a contingent fee is ``any fee
established for the sale of a product or the performance of any service
pursuant to an arrangement in which no fee will be charged unless a
specified finding or result is attained, or in which the amount of the
fee is otherwise dependent upon the finding or result of such product
or service.'' \22\
---------------------------------------------------------------------------

    \19\ Rule 3501(a)(iv) defines ``audit client'' as ``the entity
whose financial statements or other information is being audited,
reviewed, or attested and any affiliates of the audit client.''
    \20\ Rule 3501(a)(ii) defines ``affiliate of the accounting
firm'' as ``the accounting firm's parents; subsidiaries; pension,
retirement, investment or similar plans; and any associated entities
of the firm, as that term is used in Rule 2-01 of the Commission's
Regulation S-X, 17 CFR 210.2-01(f)(2).''
    \21\ Rule 3501(a)(iii) adapts the definition of ``audit and
professional engagement period'' from the definition of that term in
the Rule 2-01 of the SEC's Regulation S-X, which includes both the
period covered by the financial statements under audit or review and
the period beginning when a registered public accounting firm signs
an initial engagement letter (or when such a firm begins audit,
review or attest procedures, whichever is earlier) and ends when the
audit client notifies the SEC that the engagement has ceased. See 17
CFR 210.2-01(f)(5).
    \22\ Rule 3501(c)(ii). As discussed in the Board's proposing
release, the term ``contingent fee'' includes the aggregate amount
of compensation for a service, including any payment, service, or
promise of other value, taking into account any rights to
reimbursements, refunds, or other repayments that could modify the
amount received in a manner that makes it contingent on a finding or
result.
---------------------------------------------------------------------------

    Fees fixed by courts or other public authorities and not dependent
on a finding or result are excluded from this definition to permit
contingencies that do not pose a risk of establishing a mutual interest
between the auditor and the audit client. In the proposing release, the
Board cited, as an example of such a permissible fee, fees approved by
a bankruptcy court, as required under U.S. Federal bankruptcy law.\23\
The Board also sought comment on whether there are courts or other
public authorities that fix fees that are not dependent on a finding or
result, other than bankruptcy courts, such that the term ``courts or
other public authorities'' is necessary.
---------------------------------------------------------------------------

    \23\ 11 U.S.C. 328(a) (providing that, with a court's approval,
a bankruptcy trustee may employ a professional person ``on any
reasonable terms and conditions of employment, including on a
retainer, on a fixed or percentage fee basis, or on a contingent fee
basis'').
---------------------------------------------------------------------------

    In response to this request, several commenters noted that they are
not aware of any such authorities and encouraged the Board to eliminate
the reference to ``other public authorities'' from the proposed rule.
Other commenters suggested that the Board retain the phrase, even
though they did not identify other contexts in which fees that are not
contingent on a result of a ``product or service'' are nevertheless
subject to approval by a court or other public authority.\24\ After
considering these comments, the Board has decided to retain the
exception for fees that require approval of ``courts or other public
authorities.'' The Board envisions that there may be fee approval
schemes outside the U.S. that are analogous to U.S. bankruptcy law.
---------------------------------------------------------------------------

    \24\ One commenter suggested that arbitration panels should be
captured in the final rule as an example of ``courts or other public
authorities'' that may approve auditor fees. The Board is not aware,
and the commenter did not appear to suggest, that any arbitration
panels currently have authority, by contract or law, to approve the
payment of fees to accountants. Therefore, the Board has not
expanded the exception to include fees fixed by arbitration panels.
Nevertheless, if an arbitration panel were by contract given the
authority to approve accountants' fees, such fees would be
permissible under the Board's rule so long as the determination of
the fee was not contingent on the result of a product or service.
---------------------------------------------------------------------------

    Although Rule 3521 and the related definition of ``contingent fee''
are modeled on the SEC's independence rules, as discussed in the
Board's proposing release, they differ from those rules in that the
Board's rules do not include the SEC's exception for fees ``in tax
matters, if determined based on the results of judicial proceedings or
the findings of governmental agencies.'' \25\ As discussed in the
Board's proposing release, this exception may have been misinterpreted
in the past and is largely redundant of the exception for fees fixed by
courts or other public authorities.\26\ For these reasons, proposed
Rule 3521 would eliminate this exception. The few commenters who
addressed this issue agreed with the Board's reasoning and the
elimination of this exception. Therefore, the Board's final rule does
not include an exception for tax matters in which an auditor's fee
agreement is based on the results of judicial proceedings or the
findings of governmental agencies.
---------------------------------------------------------------------------

    \25\ 17 CFR 210.2-01(f)(10). By eliminating this exception from
its rule, the Board expresses no view on any firm's compliance with
Rule 2-01 of the Commission's Regulation S-X. See 17 CFR 210.2-
01(c)(5).
    \26\ As the SEC Chief Accountant has stated, the SEC's ``tax
matters'' exception only permits fee arrangements where the
determination of the fee is ``taken out of the hands of the
accounting firm and its audit client * * *., with the result that
the accounting firm and client are less likely to share a mutual
financial interest in the outcome of the firm's advice or service.''
Letter from Donald T. Nicolaisen, Chief Accountant, U.S. Securities
and Exchange Commission, to Bruce P. Webb, Professional Ethics
Executive Committee Chair, American Institute of Certified Public
Accountants (May 21, 2004), available at http://www.sec.gov/info/accountants/staffletters/webb052104.htm
 (hereinafter ``Nicolaisen

Letter'').
---------------------------------------------------------------------------

    In addition, Rule 3521 treats a firm as not independent of an audit
client if it receives a contingent fee or commission from that client
``directly or indirectly.'' The rule's use of the term ``indirectly''
is meant to prevent arrangements for a fee from any person that is
contingent on a finding or result attained by the audit client. The
Board's determination to include such fees within the prohibition is
based on the principle that, regardless of who pays the contingent fee,
such a contingency gives an auditor a stake in the audit client
attaining the finding or result. Accordingly, under Rule 3521, it does
not matter who pays the contingent fee, if it is contingent on a
finding or result attained by the audit client or otherwise related to
the firm's services for the audit client. That is, while use of an
intermediary to disguise an audit client's agreement to a contingent
fee is certainly prohibited, the rule is not limited to circumstances
in which a contingent fee may be traced (e.g., through an intermediary)
to an agreement or payment by an audit client.
    Comparable to the SEC's independence rules, proposed Rule 3521
treats contingent fee arrangements between a registered firm's
affiliates and the registered firm's audit clients as relevant to the
firm's independence.\27\

The inclusion of such affiliates within the scope of those persons
whose activities may impair the independence of a firm from an audit
client is intended to prevent frustration of the rule's purpose through
the use of firm subsidiaries and other affiliates.\28\ The rule is not
intended to, and does not, impose any requirements on affiliates of
firms per se. Nonetheless, the conduct of an affiliate of the firm can
cause the registered firm not to be independent in the situations
specified in the rules.
---------------------------------------------------------------------------

    \27\ The rule does so by providing that the firm is not
independent if it ``or any affiliate of the firm * * * provides any
service or product to the audit client for a contingent fee or a
commission, or receives from the audit client, directly or
indirectly, a contingent fee or commission.'' The scope of the rule
is intended to be the same as the scope of the Commission's rule,
which defines the terms ``accountant'' and ``accounting firm'' to
include such affiliates. Because registration with the Board is the
basis for the Board's authority over an accountant, the rules would
treat those persons that are related to a registered public
accounting firm and satisfy the Commission's definition of
``accounting firm,'' but are not registered firms themselves, as
``affiliates of the accounting firm.'' Thus, Rule 3501(a)(i) would
adapt the Commission's definition of the term ``accounting firm'' to
define the term ``affiliate of the accounting firm'' as ``the
accounting firm's parents, subsidiaries, pension, retirement,
investment or similar plans, and any associated entities of the
firm, as that term is used in Rule 2-01 of the Commission's
Regulation S-X, 17 CFR 210.2-01(f)(2).''
    \28\ See, e.g., In re PricewaterhouseCoopers LLP, &
PricewaterhouseCoopers Securities LLC, Exchange Act Release No.
46216 (July 17, 2002), available at http://www.sec.gov/litigation/admin/34-46216.htm
 (finding an auditing firm and an affiliate under

the control of the firm in violation of Commission requirements
because the affiliate performed investment banking services for the
firm's audit clients for contingent fees); In KPMG, LLP v.
Securities & Exch. Comm'n, 289 F.3d 109 (D.C. Cir. 2002), the D.C.
Circuit Court declined to find KPMG in violation of the AICPA's rule
against contingent fees, where KPMG only indirectly received a
contingent royalty from an audit client, through an associated
entity of the firm. The Board's rules should be understood, however,
to treat such an arrangement as an impairment of a registered firm's
independence.
---------------------------------------------------------------------------

    Finally, one accounting firm commented that Rule 3521 should
prohibit value-added fees because such fees could be used in lieu of
contingent fees to achieve a similar effect as contingent fees. Fees
that function as contingent fee arrangements are already prohibited
under the SEC's rule against contingent fees,\29\ and thus under the
Board's final rule as well, whether such fees are labeled contingent
fees, value-added fees, or otherwise. The SEC has indicated that it
will closely monitor the use of value-added fees ``to determine whether
a fee labeled a ``value added'' fee is in fact a contingent fee, such
as where there are side letters or other evidence that ties the fee to
the success of the services rendered,'' \30\ and the Board intends to
do so as well before, if necessary, considering additional rulemaking.
---------------------------------------------------------------------------

    \29\ See Revision of the Commission's Auditor Independence
Requirements, SEC Release No. 33-7919, Sec.  IV.D.5 (Nov. 21, 2000),
17 CFR parts 210 and 240. Indeed, the SEC staff has cautioned audit
committees against approving-- any agreement `` from a direct
contract provision to ``a wink and a nod''--that provides for the
possible additional payment of a `value added' fee based on the
results of an accounting firm's performance of a tax or other
service [that] would be viewed as impairing the firm's independence.
In addition, an audit committee should consider carefully the impact
on an accounting firm's independence of the possibility of even a
completely voluntary payment of a ``value added'' fee by an audit
client to the firm.
    Nicolaisen Letter, supra note 25.
    \30\ See Revision of the Commission's Auditor Independence
Requirements, SEC Release No. 33-7919, Sec.  IV.D.5 (Nov. 21, 2000),
17 CFR parts 210 and 240.
---------------------------------------------------------------------------

Rule 3522--Aggressive Tax Positions
    Rule 3522 is intended to describe a class of tax-motivated
transactions that present an unacceptable risk of impairing an
auditor's independence if the auditor markets, plans, or opines in
favor of, such a transaction. As discussed in the Board's proposing
release, such conduct has seriously damaged investors' confidence in
the judgment, objectivity, and ethics of firms that engage in such
transactions. Further, aggressive tax positions carry a high risk that
taxing authorities will not allow the position taken by the auditor and
the audit client. As the SEC Chief Accountant noted in the context of
contingent fees, ``the fact that a government agency might challenge
the amount of the client's tax savings * * * heightens * * * the
mutuality of interest between the firm and client.'' \31\
---------------------------------------------------------------------------

    \31\ Nicolaisen Letter, supra 25.
---------------------------------------------------------------------------

    As proposed, Rule 3522 treated a firm as not independent of its
audit client if the firm, or an affiliate of the firm, provided
services related to planning, or opining on the tax consequences of a
transaction that is a listed or confidential transaction under U.S.
Department of Treasury (``Treasury'') regulations or that promoted an
interpretation of applicable tax laws for which there is inadequate
support. In order to describe such transactions in a manner that is
clear and consistent with existing constructs for analyzing tax-
oriented transactions, the rule is adapted from certain Treasury
regulations and from the SEC's release accompanying its 2003
independence rules.
    Commenters generally supported the notion that auditors should not
provide tax services involving aggressive tax positions to their audit
clients. They also supported the scope of Rule 3522, which as proposed
covered listed transactions, confidential transactions, and other
aggressive transactions. A number of commenters made suggestions to
make the rule text clearer, however, and after considering such
comments the Board has modified the rule in several respects.
    First, several commenters suggested that the rule should make clear
that it does not prohibit auditors from advising audit clients not to
engage in an aggressive transaction. Rule 3522 was not intended to
prevent such advice, so in response to these comments the Board has
modified the rule to make clear the prohibition on opining on
aggressive transactions is limited to ``opining in favor of the tax
treatment of'' such transactions (emphasis added). Thus, auditors are
permitted to advise against an audit client's execution of an
aggressive tax transaction.\32\ However, Rule 3522 prohibits an opinion
that a transaction does not satisfy the more-likely-than-not standard
but does satisfy a lower standard of confidence. Similarly, the rule
prohibits advice that an audit client will ``probably'' lose an
argument in favor of a tax treatment, because such advice can imply up
to a 49-percent chance of success.
---------------------------------------------------------------------------

    \32\ In addition, a number of commenters asked for clarification
of the scope of Rule 3522's prohibition against ``opining'' on an
aggressive transaction. The Board does not intend the rule to
encompass the auditor's opinion on the fairness of financial
statements that reflect the accounting for a transaction that an
audit client has executed. Rather, Rule 3522 is intended to prevent
auditors from facilitating clients' execution of aggressive
transactions by, among other things, providing auditors' written tax
opinions that protect the audit client from the assertion of
penalties by tax authorities or courts.
---------------------------------------------------------------------------

    In addition, as recommended by one commenter, given recent concerns
about accounting firms establishing marketing centers to sell tax
shelter products, the Board has added the term ``marketing'' to the
list of activities that compromise an auditor's independence. That is,
under Rule 3522, as adopted, an auditor may not market an aggressive
tax transaction to an audit client, in addition to being prohibited
from ``planning, or opining in favor of the tax treatment of,'' such a
transaction.
    Finally, proposed Rule 3522(a)'s prohibition on auditors'
involvement in listed transactions has been moved to become a part of
the prohibition on involvement in aggressive tax position transactions,
in light of the overlap of the two provisions and also in light of
questions regarding whether the prohibition on listed transactions
could apply in the context of a non-U.S. tax regime. Accordingly, Rule
3522 now provides for two categories of prohibitions related to
aggressive tax transactions, whereas, as proposed, it had provided for
three such categories. These two categories, as well as modifications
of their proposed versions, are discussed below.
Rule 3522(b)--Aggressive Tax Position Transactions \33\
---------------------------------------------------------------------------

    \33\ As proposed, this provision was entitled ``aggressive tax
positions.'' One commenter questioned whether this title was
intended to expand the scope of this provision beyond transactions.
In addition, the commenter noted that the term ``transaction'' was
consistent with Treasury regulations. In response to this comment,
the Board has re-titled this provision to be ``aggressive tax
position transactions.''
---------------------------------------------------------------------------

    Rule 3522(b) would treat a registered firm as not independent if
the firm, or

an affiliate of the firm, provided an audit client any service related
to marketing, planning, or opining in favor of the tax treatment of, a
transaction that satisfies three criteria--
     The transaction was initially recommended, directly or
indirectly, by the firm;
     A significant purpose of the transaction is tax avoidance;
and
     The proposed tax treatment of the transaction is not at
least more likely than not to be allowed under applicable tax laws.
    Rule 3522(b) is adapted from the SEC's guidance to audit committees
in its release accompanying its 2003 independence rules, which
cautioned that audit committees should ``scrutinize carefully'' the
retention of the auditor ``in a transaction initially recommended by
the accountant, the sole business purpose of which may be tax avoidance
and the tax treatment of which may be not supported in the Internal
Revenue Code and related regulations.'' \34\ The rule builds on this
guidance from the perspective of the auditor, by providing that a
registered firm is not independent of its audit client if the firm, or
an affiliate of the firm, participates in such a transaction.
---------------------------------------------------------------------------

    \34\ Strengthening the Commission's Requirements Regarding
Auditor Independence, at Sec.  II.B.11 (Jan. 28, 2003).
---------------------------------------------------------------------------

    The first prong of the rule's test looks for transactions that the
auditing firm--directly or indirectly, e.g., through an affiliate,
through or with another tax advisor with which the firm has an
arrangement, or otherwise--initially recommended to the audit client.
In this manner, the rule excludes from its scope those transactions
that the audit client itself, or a party other than a tax advisor with
which the firm has an arrangement \35\ (e.g., an acquiring
corporation), initiated. The term ``initially recommended'' is intended
to be a test based on fact. Thus, the prong would be satisfied,
notwithstanding a representation from the audit client that the audit
client initiated the development of the transaction,\36\ if the auditor
had knowledge that the auditor, its affiliate, or another tax advisor
with which the firm has an arrangement, initially recommended it. As
proposed, the rule would have looked for transactions that were
``initially recommended by the registered public accounting firm or
another tax advisor.'' Some commenters expressed concern that an
auditor might not be in a position to know whether another tax advisor
with no relationship to the auditor had recommended a transaction. In
response to these comments, the Board has modified the first prong of
Rule 3522(b) to make clear that auditors are only responsible for
ascertaining whether the firm, one of its affiliates, or another tax
advisor with which the firm has a formal agreement or other arrangement
related to the promotion of such a transaction, initially recommended
the transaction.\37\
---------------------------------------------------------------------------

    \35\ The term ``tax advisor'' is not intended to denote a group
with a certain license or professional status, but rather to cover
any person, other than the client, that recommends a tax transaction
to the client.
    \36\ Two commenters indicated that, as they interpreted the term
``transaction,'' an auditor's tax services in connection with, for
example, a merger transaction that was initiated by the client or
another company, would not come within the ambit of Rule 3522(b),
because the auditor would not have recommended the merger
transaction itself. This is not a fair interpretation of the rule
and indeed would thwart its purpose.
    \37\ See Rule 3522(b), Note 2. The term ``formal agreement or
other arrangement'' in Note 2 relates only to relationships a
registered firm may have with a tax advisor that is not already an
affiliate of the firm.
---------------------------------------------------------------------------

    The second and third prongs of Rule 3522(b) incorporate concepts
that have existing meaning and relevance to tax advisors. The second
prong of the test set forth in Rule 3522(b) uses the phrase
``significant purpose of which is tax avoidance,'' adapted from the
Internal Revenue Code.\38\ The term ``tax avoidance'' should be
understood to include acceleration of deductions into earlier taxable
years and deferral of income to later taxable years. A few commenters
noted that the test whether a significant purpose of a transaction is
tax avoidance appears to be a low threshold that could encompass any
plan to reduce taxes, and some of those commenters suggested that the
Board raise that threshold. The Board intends for the threshold to be
low, however, and therefore has not used terms that might seem to
establish a higher threshold, such as requiring an evaluation of
whether the ``sole purpose'' of a transaction is tax avoidance.
---------------------------------------------------------------------------

    \38\ The Internal Revenue Code treats transactions with respect
to which a ``significant purpose * * * is the avoidance or evasion
of Federal income tax'' as tax shelters, for purposes of determining
whether an adequate disclosure defense is available for the
substantial understatement penalty. See 26 U.S.C. 6662(d)(2)(C)
(amended by the Jobs Act; see also 26 U.S.C. 6662A(b)(2)(B)
(imposing 20-percent penalty on understatements of tax in connection
with ``any reportable transaction (other than a listed transaction)
if a significant purpose of such transaction is the avoidance or
evasion of Federal income tax'').
---------------------------------------------------------------------------

    In addition, the rule uses the term ``more likely than not to be
allowable under applicable tax laws,'' which is the standard certain
taxpayers must meet, under Treasury regulations, to avoid penalties for
substantial understatement of income tax in connection with a tax
shelter.\39\ This test is based, in part, on the Board's observation of
some firms' policies that rely on the ``more likely than not'' standard
to approve the firm's involvement in providing tax services relating to
a transaction initiated by the firm. The rule also uses this standard
because a tax treatment that is not ``more likely than not'' to be
allowed poses a significantly higher risk of being challenged by taxing
authorities, such that a mutuality of interest between the auditor and
the audit client could arise.\40\ Moreover, the rule uses this
standard, as opposed to a higher standard, in recognition of the fact
that tax laws may often be complex and subject to differing good faith
interpretations.\41\
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    \39\ See 26 CFR 1.6664-4(f).
    \40\ Some commenters noted that, while the term ``more likely
than not'' is well-understood in the context of evaluating U.S. tax
advice, it has not been used in non-U.S. contexts. One of these
commenters also noted that this standard may be hard to judge in
jurisdictions in which the rule of law does not always prevail.
After considering these comments, the Board has determined to
maintain the ``more likely than not standard,'' because it is an
objective standard that may be applied in contexts outside the U.S.
even where it has not applied to-date. Further, the Board notes that
foreign private issuers ordinarily file U.S. tax returns and
therefore are already expected to comply--and be familiar with--U.S.
tax laws and regulations.
    \41\ A few commenters recommended that the Board use a standard
higher than ``more likely than not,'' on the ground that there is
some evidence that some accounting firms that used the ``more likely
than not'' standard in the past have not adhered to it. While the
Board is concerned about the record on this issue, the Board has
determined not to use a higher standard at this time. The Board
intends to monitor compliance with the rule through its inspections
of registered public accounting firms and will consider revising the
rule in the future, if that monitoring or other evidence reveals
that the rule is not achieving its intended purpose.
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    In order to satisfy Rule 3522(b)'s ``more likely than not''
standard, a registered public accounting firm must establish, based on
an analysis of the pertinent facts and authorities, that there is a
greater than 50-percent likelihood that the tax treatment of the
transaction would, if challenged, be upheld.\42\ To satisfy this test,
an auditor's analysis must be objectively reasonable and well-founded
at the time the analysis is conducted. The Board would not, however,
treat an auditor as

not independent if the law changed after the service was provided or if
the tax treatment simply turned out to be not allowed, despite the
auditor's reasonable judgment before the ultimate resolution of a tax
claim or other dispute.
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    \42\ Cf. 26 CFR 1.6664-4(f)(2)(i)(B)(1) (incorporating by
reference methodology set forth in 26 CFR 1.6662-4(d)(3)(ii) for
analysis of whether a tax treatment has ``substantial authority''
or, in the case of tax shelters, is ``more likely than not'' the
proper treatment, for purposes of determining whether a penalty may
be due on a substantial understatement of income tax).
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    Rule 3522(b) does not require a registered public accounting firm
to obtain a third-party opinion that a tax treatment is ``more likely
than not'' to be allowed under applicable tax laws. On the contrary,
while a firm may decide for its own reasons to obtain a third-party
opinion, such an opinion would not relieve the firm of its obligation
to form its own judgment on the likelihood of a proposed tax treatment
to be allowed.\43\
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    \43\ Treasury regulations permit corporations to avoid penalties
for substantial understatement of income taxes in connection with
tax shelters if they ``reasonably rel[y] in good faith on the
opinion of a professional tax advisor, if the opinion is based on
the tax advisor's analysis of the pertinent facts and authorities *
* * and unambiguously states that the tax advisor concludes that
there is a greater than 50-percent likelihood that the tax treatment
of the item will be upheld if challenged by the Internal Revenue
Service.'' 20 CFR 1.6664-4(f)(2)(i)(B)(2). Rule 3522(b) would not
permit registered public accounting firms, who themselves serve as
tax advisors, to rely on other tax advisors to satisfy the rule's
standard because registered firms that provide tax services are
themselves in a position to perform such an analysis.
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    Finally, although the SEC's release accompanying its 2003
independence rules cautioned audit committees to scrutinize situations
in which a proposed tax treatment might not be supported ``in the
Internal Revenue Code and related regulations,'' the proposed rule
would use the term ``applicable tax laws'' in recognition of the
variety of tax laws and regulations, including Federal, state, local,
foreign, and other tax laws, that may be the subject of tax services.
For this reason, and in response to questions from several commenters,
the Board also incorporated its proposed prohibition on auditors
providing tax services in connection with transactions that are listed
by the IRS into Rule 3522(b). That is, IRS listing is one example of
aggressive tax transactions covered by the rule.
    Accordingly, the prohibition on advising in favor of listed
transactions, which was proposed as Rule 3522(a), has been moved to a
note to what is now Rule 3522(b). Specifically, Note 1 to Rule 3522(b)
treats a registered public accounting firm as not independent of its
audit client if the firm, or any affiliate of the firm, provided
services related to marketing, planning, or opining in favor of the tax
treatment of, a listed transaction. Under Treasury regulations, a
listed transaction is ``a transaction that is the same as or
substantially similar to one of the types of transactions that the IRS
has determined to be a tax avoidance transaction and identified by
notice, regulation, or other form of published guidance as a listed
transaction.'' \44\ The IRS uses its listing process to identify and
publish a list of transactions that tax promoters and advisors have
developed and sold to clients but that, in the IRS's view, do not
comply with applicable laws. Thus, the Treasury's regulation on
``listed transactions'' identifies a class of transactions that, in the
Board's view, carries an unacceptable risk of disallowance, which in
turn create an unacceptable risk of establishing a mutuality of
interest between the auditor and the audit client if the auditor
participated in marketing, planning, or opining in favor of the tax
treatment of a transaction that impairs independence. By referring to
this class of transactions, Note 1 to Rule 3522(b) incorporates an
existing framework that auditors who serve as tax advisors already
follow in their tax practices and that is highly likely to remain
current since the Treasury and the IRS regularly update guidance
related to listed transactions.\45\
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    \44\ See, e.g., 26 CFR 1.6011-4(b)(2).
    \45\ The IRS updates the list of listed transactions by issuing
a listing notice, both adding to and removing transactions from the
list of listed transactions. See, e.g., IRS Notice No. 2004-67,
2004-41 I.R.B. 600. Some commenters questioned whether the Board
should effectively incorporate the IRS's changes to its list into
the Board's rule on aggressive transactions. This is, indeed, the
Board's intention. To freeze the IRS's list as of the date of the
Board's final rule, or to establish a system of reviewing the IRS's
list as it is updated, might permit auditors to provide tax services
in favor of listed transactions notwithstanding that the IRS had
identified those transactions as potentially abusive. Such a system
would thwart the underlying intent of the Board's rule.
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    As discussed above, the Board's proposed prohibition on auditor
involvement in transactions that are ``listed'' by the IRS has been
moved to a note to Rule 3522(b). By definition, a listed transaction is
not ``more likely than not to be allowable under applicable tax laws''
at the time the auditor advises on it. Because the risk of IRS or other
scrutiny of listed transactions, including transactions that are
substantially similar to listed transactions,\46\ is high, tax advisors
and taxpayers tend not to enter into such transactions once they are
listed. In light of this fact, when it proposed this rule, the Board
sought comment on whether the rule should treat an auditor as not
independent if a transaction planned or opined on by the auditor
subsequently became listed. In general, commenters recommended against
adopting a per se rule that subsequent listing of such a transaction
impaired an auditor's independence with respect to either the period in
which the transaction was executed or in subsequent periods. The Board
agrees that such a per se rule would not be appropriate, but as
discussed below, firms should nevertheless be cautious in participating
in transactions that they believe could become listed.
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    \46\ By its terms, the Treasury regulation requiring reporting
of listed transactions makes clear that the definition of ``listed
transaction'' includes transactions that have been listed by the IRS
as well as transactions that are ``substantially similar'' to such
transactions. By expressly referring to the Treasury's regulation on
listed transactions, the Board intends Rule 3522(b) to encompass
such substantially similar transactions that are included in the
Treasury's regulation.
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    Even if a firm were independent at the time a transaction was
executed, because it reasonably and correctly concluded the transaction
was not the same as, or substantially similar to, a listed transaction,
once a transaction is actually listed (or a substantially similar
transaction becomes listed), a firm that has participated in the
transaction may find its independence impaired due to the mutuality of
interest caused by the listing. That is, depending on the
circumstances, a firm's independence may become impaired in some cases
after a transaction planned or opined on by the firm becomes listed. In
such cases, the auditor should carefully consider the potential
impairment of its independence with the audit committee of its audit
client.\47\ For example, once a transaction is listed, either the audit
client or the firm, or both, may be required to defend the tax
treatment of the transaction and, in some cases, pay penalties. In
addition, the firm may face liability to the audit client related to
the firm's tax advice. The auditor's judgment regarding appropriate
financial reporting and disclosure concerning a transaction that
becomes listed could become biased by the auditor's vested interests in
defending its tax advice.
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    \47\ According to ISB Standard No. 1, which is incorporated in
the Board's Rule 3600T interim independence standards, at least
annually, an auditor must ``disclose to the audit committee of the
company (or the board of directors if there is no audit committee),
in writing, 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
independence.''
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    Some auditors commented that they would prefer a bright-line rule
providing that, so long as a transaction recommended by the firm was
not listed at the time it was executed, subsequent listing cannot
impair an auditor's independence later in time, when the auditor is
called on to defend its earlier

tax advice. Such a bright-line rule, however, would do little to
address circumstances in which, because of IRS scrutiny after execution
of the transaction, the auditor's interest in the client's successful
defense of the transaction becomes heightened to the point where the
auditor can no longer be impartial about the financial statement
presentation of the transaction. That said, as some commenters noted,
existing independence requirements address these kinds of
circumstances, and thus the Board has determined not to expand Rule
3522(b) either to retroactively deem an auditor not independent upon
subsequent listing of a transaction or to deem an auditor not
independent per se in the period in which such a transaction becomes
listed.
Rule 3522(a)--Confidential Transactions
    The Treasury has identified transactions with tax-advisor imposed
conditions of confidentiality as potentially abusive. By regulation,
the Treasury requires taxpayers to disclose to the IRS transactions in
which a tax advisor ``places a limitation on disclosure by the taxpayer
of the tax treatment or tax structure of the transaction and the
limitation on disclosure protects the confidentiality of that advisor's
tax strategies.'' \48\ Tax-advisor imposed confidentiality may also be
indicative of a tax product that a tax advisor intends to market to
multiple customers, thus necessitating commitments by customers to
treat the tax treatment or structure of the advisor's product as
confidential.
---------------------------------------------------------------------------

    \48\ 26 CFR 1.6011-4(b)(3)(ii).
---------------------------------------------------------------------------

    As discussed in the proposing release, the Board is concerned that
marketing, planning, or opining in favor of tax products that require
confidentiality in order that they may be offered to multiple clients
contributes to the erosion of public confidence in the ethics and
integrity of such firms. A reasonable investor easily could infer that
the auditor has a vested interest in advocating to the IRS the tax
treatment it promoted, or helped to promote, to multiple clients and
perpetuating that treatment in the audit client's financial statements.
Based on these concerns, Rule 3522(a) treats a registered public
accounting firm as not independent of its audit client if the firm, or
an affiliate of the firm, provided services related to marketing,
planning, or opining in favor of the tax treatment of a transaction for
an audit client under terms that satisfy the definition of
``confidential transaction,'' as defined by Rule 3501(c)(i), which is
adapted from the Treasury's regulation requiring tax advisors to report
confidential transactions.\49\
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    \49\ 26 CFR 1.6011-4(b)(3) (2005). The proposed version of this
rule incorporated the Treasury's definition of the term
``confidential transaction'' by reference. A number of commenters
noted generally that incorporation of this Treasury regulation by
reference could lead to unintended changes to the Board's rules if
the Treasury amends those regulations (or the IRS amends its list of
listed transactions). As discussed above, the Board intends for its
prohibition on auditors' involvement as tax advisors in audit
clients' execution of listed transactions to be kept current by
changes to the IRS's list. Upon further consideration, unlike the
Board's prohibition on listed transactions, the Board has determined
that it may not be appropriate for any changes the Treasury may make
to its definition of ``confidential transaction'' to automatically
be reflected in the Board's prohibition on auditors' involvement in
such a transaction. The definition of ``confidential transaction''
in Rule 3501(c)(i) is intended to be the same as the current
Treasury regulation, except for the minimum fee requirement.
    The proposed version of the rule did not incorporate the
Treasury's minimum fee exception to its regulation on confidential
transactions. That is, Treasury Regulation 1.6011-4(b)(3)(i)
provides that ``a confidential transaction is a transaction that is
offered to a taxpayer under conditions of confidentiality and for
which the taxpayer has paid an advisor a minimum fee.'' 26 CFR
1.6011-4(b)(3) (2005). Under the regulation, the ``minimum fee'' is
$250,000 for corporate taxpayers (and partnerships and trusts in
which all of the owners or beneficiaries are corporations) and
$50,000 for all other transactions. Id. 26 CFR 1.6011-4(b)(3)(iii).
Although some commenters suggested that the Board should adopt the
minimum fee exception, the Board understands the IRS disclosure
rules to serve a different purpose than Rule 3522(a). Accordingly,
the Board has not adopted a minimum fee exception in its final rule
either.
---------------------------------------------------------------------------

    It should be noted that, Rule 3501(c)(i) defines confidential
transactions in terms of confidentiality restrictions imposed by tax
advisors generally, not specifically auditors. Therefore, whereas under
Rule 3522(b) a transaction that is initially recommended by a tax
advisor other than the auditor or an affiliate of the auditor unless
the tax advisor has an arrangement with the auditor does not fall
within the first prong of the rule, Rule 3522(a) prohibits an auditor
from marketing, planning, or opining in favor of a confidential
transaction whether the applicable terms of confidentiality are imposed
by the auditor or by another tax advisor, acting independently of the
auditor.
    Commenters generally supported the Board's proposed prohibition on
confidential transactions. Although some commenters expressed the view
that tax advisors might impose conditions of confidentiality for
reasons other than the ability to market the proposed transaction to
multiple clients, other commenters agreed that auditors should not
become involved in transactions subject to tax-advisor imposed
confidentiality restrictions. One accounting firm commenter also noted
that, even if a transaction were not potentially abusive, the fact that
there is a disclosure limitation is likely to create a negative
impression concerning the objectivity of the auditor.
    In addition, a few commenters suggested that the rule be limited to
circumstances in which terms of confidentiality are imposed with
respect to the U.S. tax treatment of a transaction. After carefully
considering these comments, the Board has determined not to modify the
scope of the rule. Tax-advisor imposed conditions of confidentiality
facilitate aggressive selling of novel tax ideas that pose too great a
risk of impairing the objectivity of auditors who market, plan, or
opine in favor of them. Further, the rule continues to permit audit
clients themselves to impose conditions of confidentiality in
connection with transactions on which auditors may provide tax advice,
and this fact appears to adequately serve audit clients' needs to
maintain appropriate confidentiality. Finally, there does not appear to
be a reasoned basis to limit the prohibition on confidential
transactions to proposed tax treatments under U.S. tax laws.
Rule 3523--Tax Services for Persons in Financial Reporting Oversight
Roles
    Rule 3523 provides that a registered public accounting firm is not
independent of an audit client if the firm, or any affiliate of the
firm, during the audit and professional engagement period, provides any
tax service to a member of management in a financial reporting
oversight role at the audit client.\50\ As discussed in the Board's
proposing release, this rule addresses concerns that performing tax
services for certain individuals involved in the financial reporting
processes of an audit client creates an appearance of a mutual

interest between the auditor and those individuals.
---------------------------------------------------------------------------

    \50\ The rule's use of the term ``financial reporting oversight
role'' is based on the Commission's definition of ``financial
reporting oversight role,'' which includes any person who has direct
responsibility for oversight over those who prepare the issuer's
financial statements and related information (for example,
management's discussion and analysis) that are included in filings
with the Commission. See Strengthening the Commission's Requirements
Regarding Auditor Independence, at Sec.  II.A. The Commission uses
the term ``financial reporting oversight role'' to describe those
positions that are covered by the Act's ``cooling off'' period,
during which a public company would not be independent from its
audit firm if a member of the engagement team for the audit of that
company assumed such a position. See Sarbanes-Oxley Act of 2002,
Sec.  206, 17 CFR 210.2-01(f)(3)(ii). The term ``financial reporting
oversight role'' as defined in Rule 3501(f)(i) mirrors verbatim the
SEC's definition of the same term in Rule 2-01 of Regulation S-X. 17
CFR 210.2-01(f)(3)(ii).
---------------------------------------------------------------------------

    The Board received varied comments on Rule 3523. Some commenters,
including groups representing investors and issuers, as well as several
large accounting firms, supported the proposed rule on the ground that
it is necessary to preserve the objectivity, and the appearance of
objectivity, of auditors. Other commenters, however, including a number
of smaller accounting firms, accounting associations, and a few
issuers, claimed that the rule is not necessary, that these services
have long been provided, and that auditors should be allowed to provide
senior financial management of issuers with the same types of tax
services the auditor may provide the issuer. After carefully
considering these comments, the Board has determined to adopt the rule,
with a few modifications. The Board continues to believe that the
provision of tax services by the auditor to the senior management
responsible for the audit client's financial reporting creates an
unacceptable appearance of the auditor and such senior management
having a mutual interest.
    The Board also received a number of comments on specific aspects of
the proposed rule. For example, some commenters expressed confusion as
to whether Rule 3523 is intended to apply to directors, in part because
the definition of ``financial reporting oversight role'' includes
directors. In response to these comments, the Board has modified the
rule to exclude directors more explicitly. Thus, the rule no longer
uses the term ``officer''--which is how the proposed rule narrowed the
scope to exclude directors--and instead includes an explicit exception
for any person who serves in a financial reporting oversight role
``only because he or she serves as a member of the board of directors
or similar management or governing body of the audit client.'' \51\
---------------------------------------------------------------------------

    \51\ Rule 3523(a).
---------------------------------------------------------------------------

    The Board also included a second exception in Rule 3523(b) in
response to comments regarding whether the rule should apply to persons
who serve in a financial reporting oversight role at an affiliate of an
issuer. After considering these comments, the Board has determined not
to restrict auditors' provision of tax services to employees in a
financial reporting oversight role at an affiliate of an audit client,
so long as the financial statements of the affiliate are not material
to the financial statements of the audit client or are audited by an
auditor other than the firm or an associated person of the firm. This
exception is intended to exclude executives of affiliates that do not
contribute to the consolidated financial statements of the audit
client. The Board does not believe that auditors' relationships with
executives of immaterial affiliates, or affiliates whose financial
statements are audited by an auditor other than the firm or an
associated person of the firm, pose as great a risk to auditors'
impartiality regarding an audit clients' consolidated financial
statements as do auditors' provision of tax services to executives
involved in the consolidated financial reporting of the client.
    The first part of this exception, Rule 3523(b)(i), excludes persons
in a financial reporting oversight role at immaterial affiliates of the
entity being audited. This exception would encompass, among others,
executives of most affiliates within the same investment company
complex as the audited entity and executives of up-stream affiliates of
the audited entity. The second part of this exception, Rule
3523(b)(ii), excludes executives in financial reporting oversight roles
of a subsidiary of an audit client that is not audited by the firm or
any firm that is an associated person of the firm, as defined by PCAOB
Rule 1001. On the other hand, executives in financial reporting
oversight roles at a material subsidiary whose financial statements are
audited by a firm that is an associated person of the registered firm
would be subject to Rule 3523. For purposes of Rule 3523(b)(ii), the
term ``audited'' should be understood to include audit procedures that
contribute to the firm's preparation or issuance of an audit report on
an audit client's consolidated financial statements, whether or not
such procedures result in an audit opinion on the affiliate's financial
statements.
    Some commenters also expressed concern that the rule could impose
an undue hardship on persons who become subject to the rule because
they are hired or promoted into a financial reporting oversight role at
an audit client. To address that concern, the Board determined to
create a time-limited exception to the rule to cover such situations.
Specifically, the Board has determined to add a new exception to the
rule that applies to a person who was not in a financial reporting
oversight role at the audit client before a hiring, promotion, or other
change in employment event, when the tax services are both: (1)
Provided pursuant to an engagement that was 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.\52\ The Board will treat engagements as ``in process'' if an
engagement letter has been executed and substantive work on the
engagement has commenced; the Board will not treat engagements as ``in
process'' during negotiations on the scope and fee for a service.
---------------------------------------------------------------------------

    \52\ Rule 3523(c).
---------------------------------------------------------------------------

    Some commenters also suggested that, as proposed, Rule 3523 could
invite persons subject to the rule to evade the rule by using the
auditor's tax services through an immediate family member or through an
entity controlled by the person. In response to this comment, the Board
has added to the scope of the rule immediate family members of persons
who are covered by the rule.\53\
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    \53\ The Board also has added a definition of ``immediate family
member,'' adapted from the SEC's definition in its independence
rules. Compare Rule 3501(i)(i) with 17 CFR 210.2-01(f)(13). The
Board has not included entities controlled by persons in financial
reporting oversight roles, such as trusts and investment
partnerships. The Board notes, however, that an auditor who provides
services to an entity controlled by a person in a financial
reporting oversight role of an audit client should consider whether,
under ISB Standard No. 1, it is necessary to notify the client's
audit committee of such services.
---------------------------------------------------------------------------

    In addition, some commenters suggested that the rule be expanded to
cover all non-audit services, such as services involving investment,
personal financial planning, and executive compensation, on the ground
that any such services provided to those in a financial reporting
oversight role create a perception of a mutuality of interest between
auditors and those members of management who receive such services.\54\
Other commenters suggested that the rule be expanded to include persons
who do not play a financial reporting oversight role but nevertheless
play a key role in operations, such as vice presidents of sales.\55\
Other

commenters recommended the rule cover audit committee members. Still
other commenters, however, disagreed with these commenters and noted
that applying the rule to audit committee members might serve as a
practical disincentive to audit committee service.
---------------------------------------------------------------------------

    \54\ Some commenters asked for clarification of whether persons
in a financial reporting oversight role could seek the assistance of
the registered public accounting firm that prepared the original tax
return to assist them in responding to an IRS or other governmental
agency examination regarding that specific tax return after Rule
3523 becomes effective. If a registered firm prepared such a tax
return before the rule's effective date, the rule does not operate
to prohibit that person from answering questions and providing
assistance when that tax return is under examination by a taxing
authority after the rule's effective date, Such assistance, of
course, must be otherwise consistent with Board and SEC auditor
independence rules, including the requirement the auditor not become
an advocate for its audit client.
    \55\ A few commenters suggested that the Board use the list of
officers in section 16 of the Exchange Act, rather than relying on
the defined term ``financial reporting oversight role.'' The
``financial reporting oversight role'' term, however, includes those
individuals at an audit client that, because of their oversight of
the company's financial reporting process, raise special concerns
when they have certain relationships with the auditor. For this
reason, the Board continues to believe this is the appropriate group
to include in this rule.
---------------------------------------------------------------------------

    The Board has determined not to expand the final rule to include
all non-audit services, directors or persons outside the definition of
``financial reporting oversight role.'' To date, the concerns that have
arisen in this area have related to auditors' provision of tax services
to executives of public companies. Accordingly, the Board believes it
is appropriate, at this time, to limit the rule to address this
problem. The Board intends to monitor implementation of the rule,
however. In addition, to the extent that issuers pay for non-audit
services provided to any individuals, audit committees can and should
be scrutinizing the potential effects on the auditor's independence due
to such services. Further, as discussed in the proposing release,
although accounting firms are not now required to seek pre-approval for
executive tax services paid directly by the employee, auditors should
consider under Independence Standards Board (``ISB'') Standard No. 1
whether it is necessary to notify the audit committee of these services
\56\ or whether it is otherwise advisable to inform audit committees of
such services.\57\ In this regard, while the Board is reluctant to
establish a per se prohibition on auditors' provision of tax services
to directors of their audit clients, the Board notes that firms can--
and some have--adopted procedures to notify the audit committee of such
services so it may evaluate the potential effect of such services on
the auditor's independence.\58\
---------------------------------------------------------------------------

    \56\ See ISB Standard No. 1; see also Memorandum from Scott A.
Taub, Deputy Chief Accountant, Office of the Chief Accountant, U.S.
Securities and Exchange Commission to William H. Donaldson,
Chairman, Securities and Exchange Commission at 5 (June 24, 2003)
(attached to letter from Chairman William H. Donaldson, U.S.
Securities and Exchange Commission, to Five Consumer Groups) (July
11, 2003), available at http://www.sec.gov/info/accountants/staffletters/taub071103.pdf
 (hereinafter ``Taub Memo'').

    \57\ For example, the SEC staff has recommended that audit
committees scrutinize audit firms' provision of these services--The
provision of tax services to the executives of an audit client is
not expressly addressed in the Act or in the Commission's rules.
Nonetheless, an audit committee should review the provision of those
services to assure that reasonable investors would conclude that the
auditor, when providing such services, is capable of exercising
objective and impartial judgment on all issues within the audit
engagement.
    Taub Memo, supra note 55, at 5.
    \58\ See, e.g., Remarks of Scott Bayless, Deloitte & Touche LLP,
Auditor Independence Roundtable on Tax Services (July 14, 2004) at
152 (indicating that even when ``the company does not pay for those
services * * * there is a notification procedure to ensure that the
audit committee has the ability to take control of that relationship
if they so desire'').
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Rule 3524--The Auditor's Responsibilities in Connection With Audit
Committee Pre-approval of Tax Services
    Under Section 10A(h) of the Exchange Act, as amended by Section 202
of the Sarbanes-Oxley Act, all non-audit services that the auditor
proposes to perform for an issuer client ``shall be pre-approved by the
audit committee of the issuer.'' The SEC's 2003 independence rules
implemented the Act's pre-approval requirement by adopting a provision
on audit committee administration of the engagement.\59\ Rule 3524
implements the Act's pre-approval requirement further by strengthening
the auditor's responsibilities in seeking audit committee pre-approval
of tax services. Specifically, Rule 3524 requires a registered public
accounting firm that seeks pre-approval of an issuer audit client's
audit committee \60\ to perform tax services that are not otherwise
prohibited by the Act or the rules of the SEC or the Board to--
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    \59\ See 17 CFR 210.2-01(c)(7).
    \60\ Proposed Rule 3524 used the term ``audit committee of the
audit client,'' which some commenters interpreted to mean that the
rule would require auditors to make the required communications in
connection with proposed tax services for affiliates of an audit
client that are not consolidated as subsidiaries with the audit
client for financial statement purposes. One commenter noted that
the Commission's Rule 2-01(c)(7) requires only that ``[b]efore the
accountant is engaged by the issuer or its subsidiaries, or the
registered investment company or its subsidiaries, to render audit
or non-audit services, the engagement [be] approved by the issuer's
or registered investment company's audit committee.'' By using the
phrase ``in connection with seeking audit committee pre-approval,''
the Board intends Rule 3524 to apply only when the SEC's Rule 2-
01(c)(7) requires such approval. Accordingly, the rule does not
require registered firms to make the specified communications or to
seek audit committee pre-approval in any situations in which audit
committee pre-approval is not already required by the SEC's rules.
Nor should the rule be understood to require pre-approval by any
committee other than the committee required to provide pre-approval
by the SEC's rules. To clarify this issue, the Board has also
modified Rule 3524 to more clearly track the language of section
10A(h) of the Exchange Act and the SEC's Rule 2-01(c)(7).
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     Describe, in writing, to the audit committee the nature
and scope of the proposed tax service;
     Discuss with the audit committee the potential effects on
the firm's independence that could be caused by the firm's performance
of the proposed tax service; and
     Document the firm's discussion with the audit committee.
    These requirements are intended to buttress the pre-approval
processes established by the Act and the Commission's rules. Whether an
audit committee pre-approves a non-audit service on an ad hoc basis or
on the basis of policies and procedures, the Commission staff has
stated that ``detailed backup documentation that spells out the terms
of each non-audit service to be provided by the auditor'' should be
provided to the audit committee.\61\ Indeed, the SEC staff has
indicated ``[s]uch documentation should be so detailed that there
should never be any doubt as to whether any particular service was
brought to the audit committee's attention and was considered and pre-
approved by that committee.'' \62\
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    \61\ Taub Memo, supra note 55, at 3; see also SEC Office of the
Chief Accountant: Application of Commission's Rules on Auditor
Independence Frequently Asked Questions, Audit Committee Pre-
approval, Question 5, (issued August 13, 2003), available at http://www.sec.gov/info/accountants/ocafaqaudind121304.htm
 (hereinafter

``FAQs'').
    \62\ Taub Memo, supra note 55, at 3; see also FAQs, supra note
60, Audit Committee Pre-approval, Question 5 (issued August 13,
2003). The SEC staff FAQ answer states that (``[p]re-approval
policies must be designed to ensure that the audit committee knows
precisely what services it is being asked to pre-approve so that it
can make a well-reasoned assessment of the impact of the service on
the auditor's independence. For example, if the audit committee is
presented with a schedule or cover sheet describing services to be
pre-approved, that schedule or cover sheet must be accompanied by
detailed back-up documentation regarding the specific services to be
provided'').
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    Rule 3524 implements the Act's pre-approval requirement further by
requiring that registered firms provide the audit committee of an
issuer audit client a description of proposed tax services engagements
that includes descriptions of the scope of any tax service under review
and the fee structure for the engagement.\63\ Some commenters suggested
significant changes to the scope of the proposed rule. One group of
commenters recommended that the rule be broadened to apply to all non-
audit services, rather than only tax services. Other commenters
expressed concern that the rule appeared to impose restrictions on
audit committee pre-approval in excess of the SEC's requirements and,
for that reason,

recommended that the Board narrow or eliminate the rule. The Board has
determined not to change the scope of the rule in response to these
comments. While auditors and audit committees may find the procedures
in Rule 3524 to be useful for purposes of considering non-audit
services generally, the Board adopts these rules only after having
engaged in a substantial effort to obtain facts and views of interested
persons on appropriate procedures for considering proposed tax
services. Before considering broadening the rule, the Board would seek
additional information, based, among other things, on experience with
this rule, inspections of registered firms, and additional public
input. On the other hand, notwithstanding the concerns of some
commenters that Rule 3524 requires more than the parallel SEC rule, the
Board has determined not to narrow or eliminate the rule. The Board
continues to believe that the rule is an appropriate complement to the
SEC's pre-approval rule. Rule 3524 supports the procedure under the SEC
rule, by requiring the auditor--who is in the best position to describe
a proposed engagement--to gather the information required to be
presented to the audit committee by the SEC rule. Indeed, it is the SEC
rule and staff interpretations of what information audit committees
need that have informed the Board's development of the rule.
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    \63\ See Rule 3524(a)(1). Audit committees may ask auditors for
other materials not identified in the rule, to assist them in their
determinations whether to pre-approve proposed tax services. Rule
3524 should not be understood to limit the information or materials
that an audit committee may request, or that a registered firm may
decide to provide, in connection with the pre-approval of tax
services.
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    The Board has made certain modifications to the proposed rule,
however. As proposed, the rule would have required auditors to provide
audit committees copies of all engagement letters for proposed tax
services. While some commenters supported this proposal as a way to
ensure that audit committees received adequate information on which to
base their judgments, other commenters expressed concern that the rule
could result in audit committees being provided voluminous stacks of
engagement letters--some in foreign languages--that would obscure
rather than elucidate the nature of the tax services proposed. On the
basis of this information, and because the underlying purpose of the
proposed requirement was to establish a manageable collection of
information on which audit committees could make their determinations
to pre-approve tax services, the Board has determined to eliminate the
proposed rule's requirement to supply the audit committee a copy of
each tax service engagement letter. Instead, the rule requires auditors
to describe for audit committees, in writing, the scope of the proposed
service, the proposed fee structure for the service, and the potential
effect of the service on the auditor's independence. The Board believes
requiring such a description of a proposed service better meets the
Board's goal to improve the quality of information auditors provide
audit committees about proposed tax services.
    The rule also requires the auditor to describe for the audit
committee any amendment to the engagement letter or any other agreement
relating to the service (whether oral, written, or otherwise) between
the firm and the audit client.\64\ While the Board does not expect or
encourage auditors to enter into side agreements relating to tax
services, the Board understands that, in the past, some accounting
firms have entered into such agreements.\65\ To the extent firms do so,
they must disclose those agreements to the audit committee.
---------------------------------------------------------------------------

    \64\ Id. One commenter expressed concern that Rule 3524(a)'s
requirement to describe an ``other agreement'' could be understood
to require the auditor to submit to the audit committee
documentation concerning ``essentially every communication with the
audit client.'' The Board believes this comment is misplaced. Rule
3524 does not require that the auditor describe all communications
with the audit client, but rather all agreements with the audit
client that relate to the proposed service.
    \65\ See, e.g., In re PricewaterhouseCoopers LLP, &
PricewaterhouseCoopers Securities LLC, supra note 27 (``through side
letters or oral understandings, the parties created contingent fee
arrangements''). In addition, some commenters have expressed concern
that Rule 3524 requires disclosure to the audit committee of fee
arrangements that are prohibited by Rule 3521 (or by professional
association membership requirements, such as certain referral
agreements and fees). Those commenters have asked the Board to
clarify that Rule 3524 does not operate to permit such fee
structures that are otherwise prohibited by the Board's rules or to
endorse fee structures that are prohibited or discouraged by
professional ethics rules. It is the case that Rule 3524 does not
permit or otherwise endorse such fees.
---------------------------------------------------------------------------

    In addition, to the extent that a firm receives fees or other
consideration from a third party in connection with promoting,
marketing, or recommending a tax transaction, Rule 3524 requires the
firm to disclose those fees or other consideration to the audit
committee. Specifically, Rule 3524(a)(2) requires that the firm
disclose to the audit committee ``any compensation arrangement or other
agreement, such as a referral agreement, a referral fee or fee-sharing
arrangement, between the registered public accounting firm (or an
affiliate of the firm) and any person (other than the audit client)
with respect to the promoting, marketing or recommending of a
transaction covered by the service.'' This provision is adapted from
the IRS's rules of practice, which require tax advisors to disclose
such arrangements to taxpayer clients.\66\
---------------------------------------------------------------------------

    \66\ See 31 CFR 10.35(e)(1) (2005), available at http://www.irs.gov/pub/irs-pdf/pcir230.pdf
.

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    Rule 3524(b) also requires registered public accounting firms to
discuss with audit committees of their issuer audit clients the
potential effects of any proposed tax services on the firm's
independence. Even if a non-audit service does not per se impair an
auditor's independence, the Commission's independence rules
nevertheless deem an auditor not to be 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.\67\
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    \67\ 17 CFR 210.2-01(b).

    Rule 3524(b) is intended to provide audit committees a robust
foundation of information upon which to determine whether to pre-
approve proposed tax services. Some commenters have asked for guidance
as to the scope of the discussions intended by the rule. The Board
intends that the scope of such discussions remain flexible, to address
the matters that are pertinent in the judgment of the audit committee,
as informed by Commission requirements. While the Act's legislative
history makes clear that the Act ``does not require the audit committee
to make a particular finding in order to pre-approve an activity,''
\68\ the Commission's staff expects a robust review of proposed non-
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audit services--

    \68\ S. Rep. No. 107-205, at 19 (2002).

    The audit committee must take its role seriously and perform
diligent analyses and reviews that allow the committee to conclude
that reasonable investors would view the auditor as capable of
exercising objective and impartial judgment on all matters brought
---------------------------------------------------------------------------
to the auditor's attention.\69\

    \69\ Taub Memo, supra note 55, at 7-8; see also FAQs, supra note
60, Audit Committee Pre-approval, Question 5 (issued August 13,
2003).
---------------------------------------------------------------------------

    To be clear, the rule does not prescribe any test for audit
committees or require audit committees to make legal assessments as to
whether proposed services are prohibited or permissible. Nor is the
rule intended to limit an audit committee's discretion to establish its
own more stringent pre-approval procedures. Rather, the rule directs
registered firms to present detailed information and analysis to audit
committees for audit committees' consideration, in their own judgment,
of

the best interests of the issuer and its shareholders.
    In addition, through the discussion required by Rule 3524(b), the
Board expects registered firms to convey to the audit committee
information sufficient to distinguish between tax services that could
have a detrimental effect on the firm's independence and those that
would be unlikely to have a detrimental effect. Some commenters
expressed concern that an example of such a distinction that the Board
provided in the proposing release could be understood to suggest that
audit committees should not permit an auditor to provide any tax
services unless the company had an internal tax department and/or a tax
director who could make sound management decision in the best interest
of the company. The Board did not intend to suggest that particular
functional departments or managers must exist at a company before its
auditor may provide it tax services. Rather, the inquiry the auditor
should engage in when proposing to provide tax services to an audit
client is whether, in the particular case, the company has the capacity
to make its own decisions regarding the proposed tax matter, such that
the auditor would not be in the position of performing management
functions or making management decisions for the company.\70\ The
resolution of this inquiry will vary depending on the nature of the tax
matter at issue and the sophistication of the company, among other
things.
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    \70\ See PCAOB Rule 3600T (adopting AICPA Code of Professional
Conduct, paragraph .05 of ET sec. 101, ``Independence'',
Interpretation No. 101-3, ``Performance of Other Services,'' as of
April 16, 2003) (``care should be taken not to perform management
functions or make management decisions for attest clients the
responsibility for which remains with the client's board of
directors and management.'') (Interpretation No. 101-3 was later
amended by the AICPA in December 2003).
---------------------------------------------------------------------------

    Rule 3524, both as proposed and as adopted, is intentionally silent
as to when a registered public accounting firm should provide the
required information about a proposed tax service to an audit
committee. This is because, under the SEC's 2003 independence rules,
audit committees themselves may have policies that establish a
procedure and schedule for audit committee review of non-audit
services, including tax services.\71\ Some commenters expressed concern
that the rule might favor one approval method (ad hoc) over another
(approval pursuant to policies and procedures). This is not the case.
Similar to the SEC's 2003 independence rules, Rule 3524 does not
dictate, or even express a preference as to, whether the documentation
and discussions required under Rule 3524 should take place pursuant to
an audit committee's policies and procedures on pre-approval or on an
ad hoc basis. Many issuers have adopted policies that provide for pre-
approval in annual audit committee meetings. The Board understands that
such an annual planning process can include as robust a presentation to
the audit committee as a case-by-case pre-approval process, and Rule
3524 is designed to be flexible enough to accommodate either system and
to encourage auditors and audit committees to develop systems tailored
to the needs and attributes of the issuer.
---------------------------------------------------------------------------

    \71\ 17 CFR 210.2-01(c)(7)(i)(B).
---------------------------------------------------------------------------

    The timing and method by which auditors describe for, and discuss
with, audit committees proposed tax services will necessarily vary
depending on different audit committees procedures. For those audit
committees that hold an annual meeting to consider proposed non-audit
services for the upcoming year, often by reviewing a proposed annual
budget for non-audit services, it would be appropriate for auditors to
provide their disclosures pursuant to Rule 3524(a), and hold their
discussions pursuant to Rule 3524(b), about proposed tax services that
are known at the time of the meeting in connection with or at that
meeting. In addition, some audit committees' policies delegate
authority to pre-approve non-audit services to one committee member and
require reporting of any services approved by delegated authority at
the next scheduled audit committee meeting, on a quarterly basis, or
otherwise, in order for the audit committee to review an updated
forecast or other summary of non-audit services. In such cases, it
would be appropriate for auditors to provide the member holding
delegated authority to approve a tax service a description of the
service that complies with Rule 3524(a). Also, although the auditor may
discuss the service with the member holding delegated authority when
the member is considering the service, in order to comply with Rule
3524(b), the auditor ought to discuss the service with the audit
committee as a whole when the audit committee considers the updated
forecast or other summary.
    Finally, Rule 3524(c) requires a registered public accounting firm
to document the substance of its discussion with the audit committee
under subparagraph (b). The few commenters who addressed this provision
supported it.\72\
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    \72\ One commenting auditor suggested that the Board consider
requiring specific forms or occasions for auditor documentation of
audit committee discussion. After considering this suggestion, the
Board has determined that such forms or required timing of
discussions could unnecessarily limit the scope of the discussions
that, in the judgment of the auditor and audit committee, are
appropriate.
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Effective and Transition Dates
    The Board intends that the rules become effective at varying times.
    In light of pre-existing legal and regulatory requirements, Rules
3502 and 3520 do not, in any practical sense, create new criteria for