A Pathology of the Independence Standards Board's Conceptual Framework Project

Abstract

ISB to cease operations after making major contributions to resolution of difficult and longstanding auditor independence issues. (AICPA 2001b) With that headline, Independence Standards Board (ISB or Board) announced that it was closing its doors. Why did Board dissolve before officially adopting its largely completed conceptual framework? What does Board's demise mean for future of independence rule making? This commentary is a pathology--which dictionary defines as the scientific study of nature of disease, its causes, processes, development, and consequences (1) -- of ISB's conceptual framework project, which ultimately affected Board's ability to survive. FORMATION AND OPERATION OF THE ISB The Securities and Exchange Commission (SEC) is responsible for developing rules to ensure independence of auditors of public entities. The SEC, American Institute of Certified Public Accountants (AICPA), and largest auditing firms agreed in June 1997 to form an. independent, private body to establish independence standards applicable to auditors of SEC registrants (SEC 1998, Sec. II). Funded by accounting profession, that body--the ISB--consisted of four well-known and highly respected public members, one of whom was elected chair, and four members from accounting profession--three CEOs from Big 5 and CEO of AICPA. The SEC's Chief Accountant, or his/her designee, had observer status at Board meetings. An Executive Director and a small staff coordinated Board's operations (which began in October 1997), helped inform public about ISB's activities, and ensured regular communications with SEC, AICPA, and regulators and standard setters outside U.S. (2) In addition to issuing three independence standards, Board started a project to develop a framework to serve as a conceptual foundation for its future work. The ISB retained us as project directors and appointed a task force composed of auditors, audit committee members, academics, state board of accountancy representatives, analysts and other financial statement users, corporate executives, representatives from international standard setters, AICPA chair, and SEC observer. The Board also retained a business ethicist to assist in project, and a group of three Board members monitored framework project. To stimulate public debate about conceptual issues, in February 2000 Board issued Discussion Memorandum (DM) 00-1, A Conceptual Framework for Auditor Independence (ISB 2000a). After considering comments received during exposure period from individuals and groups in academic, auditing, standard-setting, and investor communities, Board directed staff and consultants, assisted by project task force, to develop an Exposure Draft (ED) of a proposed Statement of Independence Concepts. That ED was issued in November 2000 (ISB 2000b). Based on additional public comments and further assistance from project task force members, Board's oversight task force, and others, staff and consultants revised ED and prepared a final draft of a conceptual framework for Board's review. (3) CONTROVERSIAL ISSUES IN THE FRAMEWORK PROJECT The most significant debates among parties involved in framework's development concerned role of independence in appearance and appropriateness of a threats and safeguards approach. The nature of those debates provides important insights into future of auditor independence regulation. Independence in Appearance The appearance of independence has long been part of auditors' ethical standards. (4) Nevertheless, how to incorporate investors' and other financial statement users' perceptions into a conceptual framework for independence was extremely controversial. (5) There was little disagreement among project's participants that improving financial statement credibility and enhancing user confidence are important outcomes of an audit and an auditor who appears to be independent contributes to those outcomes. …