PwC and Thomson Reuters: Too Close For Comfort

A few days ago I reported at Forbes.com on a new business alliance between PwC China and Thompson Reuters, a PwC audit client. The three-year agreement is a license to use Thomson Reuters tax software exclusively – in an ironic twist of fate the software was originally developed by Deloitte – for client service in China. PwC UK already uses the software for its clients.

PwC US is also a “Certified Implementer” (CIP) of Thomson Reuters One Source software. The deal was signed just this past August. That means PwC consulting professionals implement Thomson Reuters for third-parties, perhaps at times in joint engagements with Thomson Reuters. Are there incentives paid? There must be a joint marketing and training arrangement at least. Oh, there is…

Through the CIP, Thomson Reuters will provide PwC US with training and technical support that PwC will use to work with clients who use Thomson Reuters software solutions in their corporate tax and accounting departments.

There is a certainly a shared benefit to teaming up to sell software and consulting services. You can agree or disagree whether such arrangements should be prohibited, but under existing rules in the UK and for US listed audit clients of the global firms, they are prohibited.

Why isn’t the SEC and PCAOB enforcing auditor independence rules prohibiting business alliances between auditors and their audit clients?

PwC and Thomson Reuters would not comment for Forbes.com.

Professor Paul Gillis, a PCAOB SAG member and author of the China Accounting Blog, thinks I “jumped the shark” with this one.

Here’s the thing… According to the SEC’s Final Rule: Revision of the Commission’s Auditor Independence Requirements effective February 5, 2001, the perception of auditor independence is as important, or maybe even more important, than the fact of auditor independence.

This is not new.

The independence requirement serves two related, but distinct, public policy goals. One goal is to foster high quality audits by minimizing the possibility that any external factors will influence an auditor’s judgments. The auditor must approach each audit with professional skepticism and must have the capacity and the willingness to decide issues in an unbiased and objective manner, even when the auditor’s decisions may be against the interests of management of the audit client or against the interests of the auditor’s own accounting firm.

The other related goal is to promote investor confidence in the financial statements of public companies. Investor confidence in the integrity of publicly available financial information is the cornerstone of our securities markets. Capital formation depends on the willingness of investors to invest in the securities of public companies. Investors are more likely to invest, and pricing is more likely to be efficient, the greater the assurance that the financial information disclosed by issuers is reliable. The federal securities laws contemplate that that assurance will flow from knowledge that the financial information has been subjected to rigorous examination by competent and objective auditors.

The two goals — objective audits and investor confidence that the audits are objective — overlap substantially but are not identical. Because objectivity rarely can be observed directly, investor confidence in auditor independence rests in large measure on investor perception. For this reason, the professional literature, such as the AICPA’s Statement on Auditing Standards (SAS) No. 1, has long emphasized that auditors “should not only be independent in fact; they should also avoid situations that may lead outsiders to doubt their independence.” The Supreme Court has emphasized the importance of the connection between investor confidence and the appearance of independence:

The SEC requires the filing of audited financial statements in order to obviate the fear of loss from reliance on inaccurate information, thereby encouraging public investment in the Nation’s industries. It is therefore not enough that financial statements be accurate; the public must also perceivethem as being accurate. Public faith in the reliability of a corporation’s financial statements depends upon the public perception of the outside auditor as an independent professional. . . . If investors were to view the auditor as an advocate for the corporate client, the value of the audit function itself might well be lost.

Here’s my column at Forbes.com.

Apparently, PwC and Thomson Reuters believe what happens in China stays in China.

Thomson Reuters announced it signed a three-year contract with PwC, the company’s auditor, to provide use of the Thomson Reuters ONESOURCE Corporate Tax solution for China. PwC U.K. also uses this Thomson Reuters software for its tax clients. Business alliances between a company and its auditor are prohibited under U.S. law and U.K. auditor regulations. Thomson Reuters, headquartered in New York, has its shares listed on the Toronto and New York Stock Exchanges.

Rule 2-01(b) of Regulation S-X (17 CFR 210.2-01.), amended under the Sarbanes-Oxley Act of 2002 to enhance auditor independence after the Enron and Arthur Andersen failures, provides the standard used to judge a business relationship between a company and its auditor or services provided to an audit client:

• Does the relationship create a mutual or conflicting interest between the accountant and the audit client?
• Does the relationship place the accountant in the position of auditing his or her own work?
• Does the relationship result in the accountant acting as management or an employee of the audit client?
• Does the relationship place the accountant in a position of being an advocate for the audit client?

For business relationships specifically, the law allows contracts between an auditor and its client only if the auditor is a consumer in the normal course of business and receives no incentives, special pricing or other advantage that other customers would not receive.

Business relationships. An accountant is not independent if, at any point during the audit and professional engagement period, the accounting firm or any covered person in the firm has any direct or material indirect business relationship with an audit client…The relationships described in this paragraph do not include a relationship in which the accounting firm or covered person in the firm provides professional services to an audit client or is a consumer in the ordinary course of business.

The Financial Reporting Council (FRC) is the U.K.’s lead audit regulator. APB Ethical Standard 2, Financial, Employment and Personal Relationships, states:

Audit firms, persons in a position to influence the conduct and outcome of the audit and immediate family members of such persons shall not enter into business relationships with an audited entity, its management or its affiliates except where they involve the purchase of goods and services from the audit firm or the audited entity in the ordinary course of business and on an arm’s length basis and which are not material to either party or are clearly inconsequential to either party.

Business relationships, says the FRC, may create self-interest, advocacy or intimidation threats to the auditor’s objectivity and perceived loss of independence.

Examples of prohibited business relationships in the U.K. include “arrangements to combine one or more services or products of the audit firm with one or more services or products of the audited entity and to market the package with reference to both parties or distribution or marketing arrangements under which the audit firm acts as a distributor or marketer of any of the audited entity’s products or services, or the audited entity acts as the distributor or marketer of any of the products or services of the audit firm.”

It’s not known if PwC receives any financial incentives or special considerations for its exclusive use of Thomson Reuters software to provide tax services to its clients in China and the U.K. PwC did provide a significant amount of tax services to Thomson Reuters as part of its audit. (Did PwC use Thomson Reuters software?) Thomson Reuters spent $8.6 million with PwC out of a total of $45.8 million for tax services in 2011 and $9.2 million out of total fees of $33.2 million to its auditor in 2010.

PwC also prepares a quarterly study of venture capital investment activity in the United States called Money Tree that’s co-branded with the National Venture Capital Association based on data from Thomson Reuters.

Thomson Reuters and PricewaterhouseCoopers have not yet provided a response to my request for comment this morning.