OCA oversees the resolution of auditor and preparer independence … Also assume that two of Audit Firm A’s global network affiliates provide the services discussed below to two separate portfolio companies of Fund F, Company Y and Company Z. Company X has its own separate governance structure that is unrelated to Company Y or Z, and Company Y and Z are not material to Fund F. Amend the definitions of “affiliate of the audit client,” in Rule 2-01(f)(4), and “investment company complex,” in Rule 2-01(f)(14), to address certain affiliate relationships, including entities under common control; Amend the definition of “audit and professional engagement period,” specifically Rule 2-01(f)(5)(iii), to shorten the look-back period, for domestic first time filers in assessing compliance with the independence requirements; Amend Rule 2-01(c)(1)(ii)(A)(1) and (E) to add certain student loans and de minimis consumer loans to the categorical exclusions from independence-impairing lending relationships; Amend Rule 2-01(c)(3) to replace the reference to “substantial stockholders” in the business relationships rule with the concept of beneficial owners with significant influence; Replace the outdated transition provision in Rule 2-01(e) with a new Rule 2-01(e) to introduce a transition framework to address inadvertent independence violations that only arise as a result of a merger or acquisition transactions; and. Thus, the entities and their auditors would have to grapple with independence issues if the parent company’s audit firm has provided prohibited services, such as bookkeeping, to remote, immaterial entities. Taking into account comments the SEC received, the final rule went a step further and adopted a dual materiality threshold, meaning that for the audit client to include a sister entity, both the entity under audit and the sister entity must be material to the common entity. The SEC has repeatedly emphasized that “maintaining the independence of auditors is crucial to the credibility of financial reporting.” As such, auditors and audit committees constantly—both before and during an engagement—must be vigilant against impairment of their independence and devote substantial resources to verifying and maintaining that independence. Such issues include situations where the entity under audit is under common control with other entities, which frequently is an issue for operating and portfolio companies, investment companies, and investment advisers and sponsors. Under the rules as amended, Company X would be able to engage Audit Firm A for audit services. Underlying the positions historically taken by the SEC and its staff is Rule 2-01(c)(4)(i)(B) of its Regulation S-X, which prohibits an auditor of a client that is subject to the SEC independence rules from preparing, or substantially assisting in the preparation of, the audit … Finally, the SEC has given relief to auditors and entities that inadvertently violate the independence requirements as a result of corporate events such as mergers and acquisitions or IPOs. The following examples, based, in part, on the SEC staff’s consultation experience, help to illustrate some of the concerns with the prior rules that today’s amendments address. The final amendments respond to recent changes in capital market conditions, reflect the Commission staff’s experience administering the independence requirements, and incorporate both recent and long-term feedback. These relationships either triggered non-substantive rule breaches or required potentially time-consuming audit committee review of non-substantive matters, thereby diverting time, attention, and other resources of audit clients, auditors, and audit committees from other investor protection efforts. The amendments will be effective 180 days after publication in the Federal Register. Difficult analytical problems often arise in assessing independence issues with respect to affiliates of the audit client. Independence Requirements. The requirements set out a nonexclusive list of circumstances (including, for example, prohibited services or lending relationships) that would be inconsistent with independence with respect to the audit client. The SEC has made only limited modifications to its auditor independence requirements in the 20 years since their adoption. www.icai.org June/2012/1,000 (Reprint) The Institute of Chartered Accountants of India (Set up by an Act of Parliament) New Delhi ISBN : 978-81-88437-52-8 According to SEC rules, the general standard of auditor independence is that it is impaired if a reasonable, fully informed investor would conclude that the auditor is not capable of exercising … The hypothetical scenario described above is based directly on SEC staff’s experience over the past decade. Five Threats to Auditor Independence. A public company must wait at least a year before it can hire certain individuals formerly employed by its audit … Voluntary early compliance is permitted after the amendments are published in the Federal Register in advance of the effective date provided that the final amendments are applied in their entirety from the date of early compliance. Additionally, in the May 2018 Proposing Release for Auditor Independence with Respect to Certain Loans or Creditor/Debtor Relationships, the Commission solicited suggestions for other revisions to the independence requirements. In June 2019, the agency amended the requirements regarding certain debtor-creditor relationships, with the intent of focusing on relationships most likely to impact an auditor’s objectivity and impartiality. An Australian affiliate of Audit Firm A provides limited staffing services to Company Y –– a healthcare portfolio company based in Australia –– for a short-period of time to meet a resource need. Regulation of … All members are required to apply ICAEW’s Code of Ethics (‘the Code’) in all of their professional and business activities. Assume Company X is a U.S.-based portfolio company of Fund F. Fund F invests in various companies around the globe, perhaps dozens or even hundreds, including Company X. Independence … In complex organizational structures, there is a significant compliance burden in identifying all such affiliates and making independence determinations. Further, it is often the case that the relationship at issue will not reasonably threaten the auditor’s objectivity and impartiality because of the affiliate’s remoteness, the fact that sister companies have engaged different audit firms, and other factual circumstances surrounding the provision of nonaudit services to such an affiliate. Focusing on Risks to Audit Firm Objectivity and Impartiality. “These modernized auditor independence requirements will increase investor protection by focusing audit clients, audit committees, and auditors on areas that may threaten an auditor’s objectivity and impartiality. Second, such a Company shall have an audit committee that satisfies Rule 5605(c)(3). Under the rules prior to today’s amendments, the student loan of the audit partner who is not part of the audit would still lead to an independence violation for the audit engagement of the lender. AS PROPOSED, THE SEC RULES PUT IN DOUBT whether an auditor … CPA professional conduct: Auditor independence — Harmonized Rule of Professional Conduct (Rule 204) Rule 204 sets out the profession’s standards, ensuring Chartered Professional … Guidance for Auditor Independence. Auditor independence refers to the independence of the internal auditor or of the external auditor from parties that may have a financial interest in the business being audited. This is the case regardless of whether, as the SEC staff has observed in similar situations, these limited services at immaterial portfolio companies (like Companies Y and Z) have no impact on the entity under audit in any way and do not affect the objectivity and impartiality of the auditor in conducting the audit for Company X. The final amendments seek to focus our auditor independence rules on relationships and services that are more likely to jeopardize the objectivity and impartiality of auditors. In June 2019 the Securities and Exchange Commission (“the Commission” or “SEC”) adopted amendments to its auditor independence requirements in Rule 2-01 of Regulation S-X, Qualifications of Accountants, regarding the analysis that must be conducted to determine whether an auditor is independent when the auditor has a lending relationship with certain shareholders of an audit client. The SEC’s Office of Chief Accountant has updated its FAQs regarding auditor independence. In their joint dissent, Commissioners Allison Lee and Caroline Crenshaw set the stage by observing that the auditor independence rules are the central method of addressing and mitigating the inherent conflict of interest that arises as a result of the “issuer pays” model in which companies select and pay for their own watchdogs, their auditing … The previous chapter emphasized the importance of auditor independence and objectivity to internal auditing and noted the challenge to achieve true independence in internal auditing when the auditors … Your email is never published nor shared. The SEC believes this will improve the requirements by making them more clear and less complex. Required fields are marked *, You may use these HTML tags and attributes:
, Posted by Charles F. Smith, Brian V. Breheny, and Andrew J. Fuchs, Skadden, Arps, Slate, Meagher & Flom LLP, on, Harvard Law School Forum on Corporate Governance. SEC Modernizes Auditor Independence Rules – October 28, 2020 by Syed Farooq. 2. (AICPA, PCAOB Standards and Related Rules, Select Rules of the Board), superseded the PCAOB’s interim standard Independence Standards Board Independence Standard No. The final amendments reflect updates based on recurring fact patterns that the Commission staff has observed over years of consultations in which certain relationships and services triggered technical independence rule violations without necessarily impairing an auditor’s objectivity and impartiality. The general standard of auditor independence under the requirements is that an auditor is not independent with respect to the audit client if a reasonable, fully informed investor would conclude that the auditor is not capable of exercising objective and impartial judgment on all issues encompassed within the audit engagement. The SEC also has now recognized that application of the current requirements may be detrimentally restraining competition for audit and nonaudit services by reducing the pool of qualified auditors or service providers based on independence issues that should not reasonably threaten the auditor’s objectivity and impartiality. During a comment period that ended in April 2020, the SEC received approximately 30 comments on those proposals. While strongly backed by accounting firms, investors want the SEC to reject it because the rules weaken auditor independence … On December 30, 2019, the SEC announced proposed amendments to its auditor independence requirements to further focus them on the relationships and services that the SEC believes are most likely to threaten an auditor’s objectivity and impartiality. The SEC has reduced the look-back period to assess auditor independence in an IPO to one year, regardless of the period of financial statements included in the registration statement. Overview of Rule 2-01 of Regulation S-X. Washington D.C., Oct. 16, 2020 —. October 16, 2020. The Commission’s rules, primarily through Regulations S-X, address the qualifications of accountants, including the independence requirements for auditors that issue audit, attestation, and review reports that form the basis for financial statements filed with the Commission. Most significantly: The final rules also include a variety of changes to auditor independence requirements around debtor-creditor relationships, intended to focus on those relationships that more reasonably create a self-interest competing with the auditor’s obligations to serve investors. Rule 2-01 of SEC Regulation S-X is designed to ensure that auditors are qualified and independent of their audit clients. Earlier this month, the Securities and Exchange Commission (SEC) continued its modernization plan and updated rules related to auditor independence requirements. Accordingly, the rule sets forth restrictions on financial, employment, and business relationships between an accountant and an audit client and restrictions on an accountant providing certain non-audit services to an audit client. 1, Independence Discussions with Audit Committees, and its interpretations. These amendments take effect 180 days from their publication in the Federal Register. The amendments in the final rules the SEC has adopted are meant to address some of these issues. Auditors are not permitted to retroactively apply the final amendments to relationships and services in existence prior to the effective date or the early compliance date if selected by an audit firm. In this situation, the parent company and each of the operating subsidiaries would be considered affiliates of each other. Auditor independence —meaning independence of both the firm engaged to perform external audits and the individual auditors who conduct the audits–is a central facet of external auditing. Revised SEC Independence Rules (Part 1): Affiliate of the Audit Client and Investment Company Complex The latest issue of Audit Conduct News highlights significant changes to the Securities and Exchange Commission's (SEC's) Rule … In December 2019, the Commission proposed additional amendments to Rule … This would in some circumstances prevent investment companies advised by related investment advisers from being swept up in the definition of “affiliate.”. The final amendments result in auditor independence requirements that will be used to evaluate specific relationships and services, with a focus on protecting investors against threats to the objectivity and impartiality of auditors. A self-interest threat exists if the auditor holds a … SEC independence rules also prohibit audit firms and auditors from engaging in the following financial relationships with their public audit clients: Employment relationships . Washington D.C., Oct. 16, 2020 —. Audit Firm A is the auditor of Company X. The final rules, adopted on October 16, 2020, principally focus on complications that arise from auditor independence assessments with respect to affiliates of the audit client. Auditor independence is the ability of a person conducting an audit to do so autonomously and with integrity. These rules set forth the independence requirements for the issuance of audit… Recent changes to audit independence rules will impact businesses of all sizes, as the FRC increases the separation of audit and non-audit services and introduces further restrictions. In some situations, the existing audit firm cannot be replaced as a practical matter because all other qualified audit firms have themselves provided services or established other relationships with portfolio companies of Fund F that triggered a breach of our independence rules. We covered auditor independence in a recent post and decided to take a closer look at what has changed among the rules in the US.. are excepted; and excepted consumer loans under the same criteria as credit card balances. Regarding the prohibition against certain business relationships between the auditor and the audit client as well as substantial stockholders of the audit client, the SEC has replaced the reference to “substantial stockholders” with a reference to beneficial owners (known through reasonable inquiry) that have significant influence over the audit client. This might have required a private company to delay its IPO or engage a new auditor to comply with the auditor independence requirements, and also is inconsistent with the more relaxed independence rules applicable to foreign issuers in a U.S. IPO. Make certain other miscellaneous updates. They also will improve competition and audit quality by increasing the number of qualified audit firms from which an issuer can choose.”, FACT SHEET The amended rules would mitigate the need for registrants audit committees and their auditors to seek SEC staff guidance in these scenarios. Since the initial adoption of the current independence requirements in 2000 and amendments adopted in 2003, the Commission and its staff have continued to learn about the application, efficiency, and effectiveness of auditor independence requirements amidst changing capital market conditions. A different audit partner in Atlanta audits the lender that provided the student loan, a large student loan company that originates thousands of student loans. … Further assume that Company Y and Company Z have no relation to each other or to Company X except for the fact that Fund F is invested in each Company. In recent years, the SEC staff conducted a number of consultations in which this fact pattern, or one similar to it, was raised to the SEC staff by the registrant’s audit committee and its auditor, and the SEC staff, under such circumstances, did not object to the auditor’s and the audit committee’s conclusion that the auditor’s objectivity and impartiality would not be impaired. The Securities and Exchange Commission today announced that it adopted final amendments to certain auditor independence requirements in Rule 2-01 of Regulation S-X… Accordingly, this could expand the pool of auditors available to registrants, which would provide more relevant industry expertise, drive down audit costs and improve the quality of financial reporting. Under the amended rules, that student loan would no longer result in an independence violation for the audit engagement of the lender. 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