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US Securities and Exchange Commission

Accounting Firms Urge SEC to Approve PCAOB’s Auditor Independence Rule Changes Opposed by Investors

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 5 minute read

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 5 minute read

The SEC will soon decide whether to approve the PCAOB’s revised auditor independence rules. As part of its oversight activities, the commission must sign off on the PCAOB’s major decisions, including changes to its standards and annual budget.

While almost likely to be a futile attempt, investor advocates are banding together to urge the commission not to approve the PCAOB’s Release No. 2020-003Amendments to PCAOB Interim Independence Standards and PCAOB Rules to Align with Amendments to Rule 2-01 of Regulation S-X, published in November.

This was to adopt changes to its auditor independence rules so they better align with the SEC’s recent revisions to Rule 2-01Qualifications of Accountants, in Regulation S-X. (See PCAOB Revises Auditor Independence Rules to Align with SEC’s Rule Changes in the November 20, 2020, edition of Accounting & Compliance Alert.)

The PCAOB in practice does not move forward with a vote if it knows that the SEC will ultimately reject it.

Investors are strongly opposed to the SEC’s and consequently PCAOB’s plans that effectively give more discretion to auditors when assessing whether they are independent of their clients.

The market regulator on November 20 published the PCAOB’s rule changes for public comment in Release No. 34-90473Notice of Filing of Proposed Rules on Amendments to PCAOB Interim Independence Standards and PCAOB Rules to Align with Amendments to Rule 2-01 of Regulation S-X. Comments were due by December 18, 2020.

The SEC has 45 days to act after publishing the board’s rule for public comment in the register under Section 19(b)(2)(A) of the Securities Exchange Act of 1934. The provision allows the SEC to extend the period by an additional 45 days if the agency determines that a longer period is appropriate.

Auditors had been pushing for the rule changes at the SEC, and Big Four accounting firms in comment letters to the commission want the PCAOB revisions to become effective as well.

For example, “Absent these proposed amendments, elements of the Commission’s amendments to Rule 2-01 of Regulation S-X would conflict with the PCAOB’s existing ethics and independence standards,” Ernst & Young LLP wrote in its comment letter.

“Rule 2-01 of Regulation S-X improve the relevance of the Commission’s auditor independence standards in light of existing market conditions by more effectively focusing the independence analysis on those relationships or services that are more likely to threaten an auditor’s objectivity and impartiality,” EY wrote. “The PCAOB’s proposed conforming amendments provide greater regulatory clarity that enhance both investor protection and market integrity, which, in turn, will facilitate capital formation.”

Last-Minute Effort by Investor Groups

However, investor protection advocates disagree. A coalition of several investor groups spearheaded by Barbara Roper, director of investor protection of Consumer Federation of America, wrote in a comment letter that “like the SEC rules on which they are based, these changes would weaken auditor independence standards, further undermining investors’ faith in the reliability of financial disclosures and putting the integrity of our capital markets at risk.”

They believe the rules should be strengthened rather than weakened.

Moreover, they said that the PCAOB’s decision to skip the notice-and-comment step in adopting the rules is “a gross abuse of process.”

“They are now being hurried through the approval process at the SEC under an artificially short timeframe,” Roper wrote.

Some of the other organizations that signed the letter are Alliance of Concerned Investors, New York City Comptroller’s Office, AFL-CIO, AFR Education Fund, Better Markets, and Public Citizen.

The Council of Institutional Investors (CII), which wrote a separate comment letter, said it was also troubled by the PCAOB’s revisions.

CII General Counsel Jeffrey Mahoney said that the SEC’s final narrowed the definition of “audit client” to exclude certain affiliated entities within a private equity structure or investment complex. The commission did so in part adopting a materiality qualifier and the concept of dual materiality. The CII had opposed it when the SEC proposed it.

“We note that there is evidence that auditors vary widely in how they assess materiality for financial reporting purposes,” CII wrote in its previous comment letter. “If auditors similarly vary widely in how they assess the materiality requirement as proposed there is a risk the determination of independence may exclude from the consideration sister entities whose relationships with or services from an auditor would impair the auditor’s objectivity and impartiality to the audit client.”

Moreover, in an unusual move, PCAOB member Jay Brown, who has voted against Release No. 2020-003, submitted his statement of dissent expressed during the board’s meeting to the SEC.

“Congress expected the PCAOB to use its authority to set standards, to examine audit firms’ compliance with rules and standards, and to investigate and bring disciplinary action for matters relating to independence and the integrity of the audit,” Brown said. “Today, however, the Board is rolling back the auditor independence rules of the PCAOB without conducting its own economic or policy analysis. The approach effectively cedes away much of the PCAOB’s distinct and separate authority over independence standards.”

Brown’s wife is SEC Commissioner Allison Herren Lee, and she is expected to recuse herself on matters dealing with the PCAOB at the commission.


This article was originally published on December 23, 2020, in Accounting & Compliance Alert available on Checkpoint Edge.

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