Effect of Sarbanes-Oxley Act of 2002 and SEC Final Rulings on Auditor Independence
By
Hoseoup Lee, PhD, CPA
Assistant Professor, SUNY Institute of Technology
Abstract
Recent final rule on auditor independence by the Securities and Exchange Commission, as
directed by Section 208(a) of the Sarbanes-Oxley Act of 2002, bans the auditors performing
certain types of nonaudit services to audit client, requires the auditors the pre-approval from
audit committee for providing nonaudit services not banned by the SEC rules, mandates the
rotation of in-charge and concurring partners every five years, and requires “time-out” period for
member of audit engagement team before employed by audit client. This study compares the
new rule with the current code of professional conduct and examines the potential impact on
audit profession
Keywords
Auditing, Auditing standards, Auditor independence
1
I. Introduction
With recent accounting scandals, such as Enron, WorldCom, Adelphia, and Global
Crossing to name a few, investors have asked “why the external auditors failed to detect financial
statements fraud?” Independence (or lack of it) of auditor was identified as a biggest culprit of
the recent audit failures. Traditional approach of self-regulation (AICPA enforcing generally
accepted auditing standards (GAAS) and the Code of Professional Conduct) was considered
failed to properly ensure the quality audit provided in such audit failures. Independence has long
been the foundation of audit process, and any erosion of it may create potential dangers to audit
quality and reduce the likelihood that the auditor may detect fraudulent financial reporting.
Instead of the ineffective self-regulation system, politicians and financial regulators (the SEC)
designed a new legislation (Sarbanes-Oxley Act of 2002, or SOA) and a set of corresponding
regulations that impact the accounting profession. The SOA and the SEC regulations
fundamentally change the way public companies do business and how the a