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US Securities and Exchange Commission

SEC Plans to Propose Simplifying Auditor Independence Rule in Coming Months

Thomson Reuters Tax & Accounting  

· 6 minute read

Thomson Reuters Tax & Accounting  

· 6 minute read

By Soyoung Ho

The staff in the SEC’s Office of the Chief Accountant (OCA) is working on a proposal that would simplify certain aspects of the commission’s auditor independence rule, Chairman Jay Clayton and Chief Accountant Sagar Teotia said at an accounting conference.

The SEC plans to consider issuing the proposal by April 2020, according to the latest rulemaking agenda, but some see this as yet another effort to enact business-friendly policies at the expense of investors.

The effort comes as auditors and companies have asked for further changes as the OCA was working on the so-called “loan rule” in the past year.

The SEC in May 2018 issued a proposal in Release No. 33-10491Auditor Independence With Respect to Certain Loans or Debtor-Creditor Relationships, and in June 2019 finalized the proposed rules in Release No. 33-10648Auditor Independence With Respect to Certain Loans or Debtor-Creditor Relationships.

The final rule responded to the complaints by addressing practical challenges in determining whether an auditor is complying with Rule 2-01 of Regulation S-X.

Accounting firms frequently borrow from banks and other lenders or obtain funds by issuing debt to help finance their business operations. The rule deals with situations more commonly found in the fund industry. The SEC said the final rule makes it less difficult to comply with Rule 2-01 by focusing the independence assessment on those relationships that could truly threaten an auditor’s ability to be impartial and objective without being bogged down by inconsequential issues.

The forthcoming proposal will be based on comment letters that dealt with auditor independence issues other than the loan rule. Release No. 33-10491 had asked about other aspects of Rule 2-01 that the SEC should change.

“We asked, ‘hey, what else are people seeing in areas where potentially things can get simplified, but in a matter where investors … won’t be hindered at all.’ And so, we got feedback on that,” Teotia said at the AICPA’s 2019 Conference on Current SEC and PCAOB Developments on December 9 in Washington.

Both Teotia and Clayton emphasized that OCA’s work is also based on 15 years of experience in providing compliance advice to businesses and auditors when they have complex and difficult situations regarding auditor independence but do not want to violate the SEC’s rules.

“Many people have lived it. We get a huge amount of consultation flow in this space, a lot of very challenging consultations that have built up, years and years of knowledge within OCA on independence matters, and we try to use that knowledge,” Teotia said.

Clayton emphasized that auditor independence is critical to give the marketplace confidence in a company’s financial reporting, and the commission is committed to protecting investors. But he said the commission must also address changing conditions.

However, some are skeptical of the commission’s work.

The SEC under Clayton has largely focused on cutting back requirements to encourage more companies to stay and go public at a time when companies pulled back from doing initial public offerings (IPOs). Business groups cited regulatory compliance burdens as one of the factors behind the decline of IPO compared to two decades ago. Clayton also believes that investors are shortchanged when there are fewer companies to invest in public capital markets.

For this rulemaking, former SEC chief accountant Lynn Turner is worried that the commission will only end up eroding auditor independence rules.

“Stage II of the rule making, as Clayton referred to it, is likely to be further loosening of the auditor independence rules,” Turner said. “That would be consistent with recent PCAOB staff guidance.”

Turner was referring to the “grave concerns” some investor and reform groups have regarding the PCAOB’s recent staff guidance on auditor communication with audit committees about independence.

“The faulty interpretation of the rules contained in this staff guidance would both undermine auditor independence and deceive the investing public by permitting firms to claim an audit was independent and conducted in accordance with PCAOB standards even when violations of the auditor independence rules occurred,” the groups led by the Consumer Federation of America said in a letter to Clayton in November. The SEC oversees the PCAOB.

“The PCAOB inspections have found numerous violations by auditors of the independence rules,” Turner said. “As the SEC and PCAOB have noted, the firms have misled the audit committees and investors by not notifying them of the violations. Both the SEC and PCAOB have permitted auditors to continue to state they are independent, notwithstanding the violations. Some of these violations have been violations of SOX.” Congress passed SOX, short for Sarbanes-Oxley Act of 2002, in response to accounting scandals at companies like Enron and WorldCom that cost investors an estimated $85 billion.

In the meantime, among several changes suggested, PricewaterhouseCoopers LLP said the SEC should consider giving the concept of materiality greater prominence in auditor independence rules. This would avoid situations where auditors and audit committees may feel obligated to devote a lot of time to evaluate potential instances of noncompliance on issues that are not likely to affect an auditor’s objectivity, the Big Four firm said.

Grant Thornton LLP said the commission should review the definition of “affiliate” because there are frequent changes in ownership positions today. “The Commission’s definition of ‘affiliate of the audit client’ may result in an entity meeting the affiliate criteria that may not reasonably be viewed to pose an independence threat to the issuer audit client,” GT said. “The Commission could consider modifying the concept of ‘control’ to allow for the focus of accounting firm’s evaluation of relationships that may bear on independence to be directed at the issuer audit client and its downward affiliates.”

In a July comment letter after the SEC adopted the loan rule, the American Investment Council (AIC) also asked for a change in the definition of an affiliate.

“The modifications we are suggesting aim to preserve an independent accountant’s capability to exercise objective and impartial judgment on all issues encompassed within the accountant’s engagement while addressing certain challenges faced by investment funds, including their management entities and general partners,” said AIC, whose members include private equity firms and all Big Four accounting firms.

Turner questioned audit firms’ motivation, however.

“The firms have always pushed for inclusion of a materiality statement and a change to what is considered an affiliate so the firms can do more business with affiliates of companies through affiliates of the audit firm,” he said.


This article originally appeared in the December 13, 2019 edition of Accounting & Compliance Alert, available on Checkpoint.

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