SEC proposes to relax long-standing auditor independence rules

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The Securities and Exchange Commission is proposing a set of amendments to the auditor independence rules that have been in place since the early 2000s, allowing firms more leeway in determining conflicts of interest and shortening the lookback period for clients planning to go public.

The auditor independence rules were originally adopted in 2000 and then revised in 2003 after a wave of accounting and auditing scandals involving companies like Enron and WorldCom. Under the rules, an auditor generally must be independent for the entire engagement period and the period covered by the financial statements being audited, but once the relationship is terminated, there is no continuing requirement for the auditor to remain independent.

The SEC gives the example of an audit firm that has an audit partner based in Atlanta who continues to pay his student loans taken to attend college before starting a career at the audit firm. If a different audit partner in Atlanta audits the lender that provided the student loan, under the current rules, the student loan of the audit partner who isn’t part of the audit would still lead to an independence violation for the audit engagement of the lender.

The proposed amendments would update several aspects of the old auditor independence rules and analysis so relationships and services that generally wouldn’t pose a threat to an auditor’s objectivity and impartiality wouldn’t trigger non-substantive rule breaches or lengthy audit committee reviews of non-substantive matters.

“The proposed amendments are based on years of Commission staff experience in applying our auditor independence rule set and respond to recent and longer term feedback received from a wide range of market participants,” said SEC Chairman Jay Clayton (pictured) in a statement Monday. “The proposal is consistent with the Commission’s long-recognized view that an audit by an objective, impartial, and skilled professional enhances both investor protection and market integrity, and, in turn, facilitates capital formation. In practice, the proposed amendments also would increase the number of qualified audit firms an issuer could choose from and permit audit committees and Commission staff to better focus on relationships that could impair an auditor’s objectivity and impartiality.”

The proposed amendments, if they were adopted, would amend the definitions of the affiliate of the audit client to address certain affiliate relationships, including entities under common control. They would also amend the definition of the audit and professional engagement period to shorten the lookback period, for domestic first-time filers in assessing compliance with the independence requirements; and amend the rules to add certain student loans and de minimis consumer loans to the categorical exclusions from independence-impairing lending relationships. They would also amend a rule to replace the reference to “substantial stockholders” in the business relationship rule with the concept of beneficial owners with significant influence. In addition they would replace the transition and grandfathering provision in Rule 2-01(e) with a new rule to introduce a transition framework to address inadvertent independence violations that only arise as a result of merger and acquisition transactions, as well as make some other miscellaneous updates. The amendments will be open for a comment period of 60 days after the proposal is published in the Federal Register.

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Audits Audit standards SEC SEC regulations Jay Clayton