SEC Hearing, July 26, 2000
ORAL STATEMENT

     Chairman Levitt and Commissioners, I am honored to have the
opportunity to participate in today's hearing on the Securities and
Exchange Commission's proposal to revise the rules relating to auditor
independence.  I believe the Commission's proposed rule deserves careful
consideration by all interested parties, and I applaud you for this
initiative.

     In my oral statement, I will focus on some trends we are seeing in
the relationships between external auditors and national banks and my
concerns about those trends.  My written statement includes a broader
discussion of the importance of independent external and internal audits
for the safety and soundness of the banking system.

     It is indisputable that independent auditors play a critical role in
maintaining public trust in our financial markets and in the integrity of
corporate financial statements.  Accordingly, ensuring not only the
independence of external auditors, but also the appearance of
independence, is vitally important for investors and other users of
financial statements, including bank supervisors.

     It is also important to recognize that the factors that influence
independence may be extremely subtle and difficult to identify, and that
the consequences of an impairment of independence may be difficult to
document.  In this sense, independence may really be more of a state of
mind than a legal status. Thus, building safeguards for independence can
present difficult challenges.  In an ideal world, the external auditor
should be free from any extraneous influences and motivations that might
cause it to express anything less than its frank and forthright opinion.

     The Commission's proposed rule would comprehensively modernize and
strengthen the standards for determining independence.  Most relevant to
the OCC's concerns, the proposal would establish the standard that an
external auditor would not be deemed independent if it provided internal
audit services for an audit client or an affiliate of an audit client,
subject to limited exceptions.  This part of the proposal is of great
importance for bank supervisors and we support its adoption.

     Recently, we have seen a growing number of national banks outsource
some or all of their internal audit functions to auditing firms.  This
practice raises concerns that bank management and examiners must carefully
assess.  Specifically, a bank's board of directors and senior management
must understand that these arrangements do not relieve them of their
responsibilities for establishing, maintaining, and operating effective
and independent audit programs.  Management and the board cannot allow
outsourcing arrangements to compromise the integrity or independence of
either a bank's internal or external audit functions.

     When a bank outsources its internal audit function to the same firm
that performs the bank's external financial audit, however, the
possibility for inherent conflicts and impairment of auditor independence
and audit integrity is greatest.  Such arrangements introduce a number of
risks, including, as the Commission has noted, questions about the
independence of the external auditor, both in fact and appearance.  In
addition, these arrangements eliminate the normal checks and balances that
can be expected to operate where the internal and external audit functions
are performed independently, and they deprive management of the ability to
have the bank's external auditors evaluate the quality of internal audit.
Currently, the OCC and the other banking agencies do not impose a blanket
prohibition on a bank's outsourcing internal audit work to the same
external firm that audits its financial statements, because we follow the
SEC's and AICPA's current rules and standards on auditor independence.
However, we discourage this practice and have imposed a number of
safeguards and quality controls to address our supervisory concerns.
Guidance is set forth in a 1998 Interagency Policy Statement as well as
our recently issued handbook on Internal and External Audits.

     The OCC has seen a number of cases in which national banks have
outsourced internal audit to the same firms that provide their external
audits.  Several of these arrangements have involved larger institutions
and have involved extensive planning, coordination and consultation
between the bank's senior management and the auditing firms' senior
partners.

     While these arrangements incorporate the various safeguards outlined
in the agencies' Interagency Policy Statement, and have served to improve
the quality of internal audits, I have strong reservations whether even
these safeguards can sufficiently address the fundamental issue of
external auditor independence. The pressures and influences that may come
to bear on external auditors who also are seeking to perform the internal
audit function may be exceedingly subtle and may not be effectively
addressed by objective safeguards.

     Even more problematic are the outsourcing arrangements that we are
seeing among smaller community banks.   In many of these cases, neither
the bank nor the outside auditors has the staff or resources to institute
the safeguards outlined in the Interagency Policy Statement.  While we
recognize that banks in some smaller communities may have a limited range
of external firms to choose from, the maintenance of independence can be
even more important in banks that lack the resources to manage their
internal audit function effectively.

     Having said that, I do have a concern about the impact of the rule on
smaller banks.  Under banking agency rules, banks with less than $500
million in assets are not required to have independent external opinion
audits -- although a substantial number in fact do.  I would be concerned
if a rigid application of a rule against outsourcing internal audit caused
some smaller institutions to elect to forego such audits, in order to be
able to continue outsourcing internal audit functions to the same firm
they had been using for external opinion audits.  This is an issue we
would like to discuss further with you as your work with the proposal
progresses.

     Given the important and evolving role that external audits and
auditors play in national banks' risk management programs, I believe the
SEC's review of its auditor independence rule is timely and warranted.
This review is consistent with many of the discussions taking place among
bank supervisors, and I applaud the Commission's efforts to address this
important issue in a balanced and careful manner.

     Although I am very interested in the perspectives that other
participants in these hearings and commenters will bring to this
discussion, I believe that the SEC's proposal attempts to strike a
reasonable balance in this area.  In particular, I agree with the SEC's
initial views that a blanket prohibition on providing any consulting or
non-audit services to financial statement audit clients may be unduly
broad, given the considerable expertise that audit firms can provide their
clients.

     With regard to arrangements involving the outsourcing of internal
audit to the external auditor, however, I believe there are serious risks
both that the auditor's independence may be compromised and that banks
will be deprived of the benefits that can flow from having internal and
external audit functions performed independently.  In light of the
importance that we place on the audit functions in the conduct of our
supervisory responsibilities, and given the subtlety of the pressures and
influences that can come to bear in this area, I believe the Commission's
proposal on outsourcing the internal audit to the external auditor is
right on the mark and should be supported.  We look forward to consulting
with you and the other banking agencies on this subject as the Commission
moves forward with this proposal.