SEC makes auditor independence requirements more flexible

The Securities and Exchange Commission (SEC) has announced it is to relax some of its auditor independence requirements in a bid to reduce the number of technical rule violations and increase the pool of audit firms from which companies can select

The US regulator said the move was in response to years of consultations showing that certain relationships and services triggered technical independence rule violations without necessarily impairing an auditor’s objectivity and impartiality. 

These relationships either triggered non-substantive rule breaches or required potentially time-consuming audit committee review of non-substantive matters, which the SEC said took away time, attention, and other resources of audit clients, auditors, and audit committees from other investor protection efforts.

Its amendments are intended to introduce auditor independence requirements that will be used to evaluate specific relationships and services.

Jay Clayton, SEC chair, said: ‘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. 

‘They also will improve competition and audit quality by increasing the number of qualified audit firms from which an issuer can choose.’

The SEC has provided some examples of how its changes to rule 2-01 of regulation S-X will work in practice. 

In the first example, an audit firm has an audit partner who continues to pay her student loans taken to attend college before starting her career.  A different audit partner in the same office of the same firm audits the lender that provided the student loan, a large student loan company that originates thousands of student loans.

Under the rules prior to the 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.  Under the amended rules, that student loan would no longer result in an independence violation for the audit engagement of the lender.

The second example covers US-based portfolio companies which may invest in multiple companies around the world, in situations where the audit firm of the principal company has network affiliates who may be auditing some of the companies in which they invest.

The SEC said the issue of the independence rule set affecting auditor choice is brought home by this example and has increased significantly as the asset management industry has grown, investments have become more global and the global audit services ecosystem has consolidated and become more specialized.

Under current rules, some relationships would be barred for up to three years.

The regulator’s amendments will amend the definitions of ‘affiliate of the audit client’, and ‘investment company complex’, to address certain affiliate relationships, including entities under common control.

They also amend the definition of ‘audit and professional engagement period’, to shorten the look-back period, for domestic first time filers in assessing compliance with the independence requirements.

In addition, certain student loans and de minimis consumer loans are added to the categorical exclusions from independence-impairing lending relationships, while the reference to  ‘substantial stockholders’ in the business relationships rule is replaced with the concept of beneficial owners with significant influence.

As well as other minor changes, the amendments also introduce a transition framework to address inadvertent independence violations that only arise as a result of a merger or acquisition transactions.

Further reading:

SEC updated auditor independence requirements

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