I hear it all the time – firms struggle with independence compliance. Understanding, applying, and getting it right is not so easy, but there are three key things firms can do to enhance compliance. These can be categorized as:
- Promote awareness.
- Communicate well.
- Create good documentation.
There’s a saying – perhaps more of a warning – that, “You don’t know what you don’t know.” You cannot avoid situations that impair independence if you don’t know what types of situations create, or may create, issues. Sure, sometimes all you need is some good old “common sense” or that gut feeling that makes you uncomfortable. But other situations may seem benign, yet the rules clearly say they impair independence.
Firms should enthusiastically promote awareness of independence requirements to counter this situation by observing the following best practices:
- The firm gives independence the proper priority and importance in firm discussions, communications and decision-making. The best messaging includes examples of situations and how the firm handled them. For example: “Last month, we learned that a client was planning an initial public offering, which would make us subject to Securities and Exchange Commission and Public Company Accounting Oversight Board rules for previous periods included in the SEC filing. Recognizing this, we avoided a potential issue by amending the scope of nonaudit services we planned to provide during the financial statement period.”
- The firm has clear, well-organized independence policies and procedures that are easy to find, tailored to the firm, and spell out the responsibilities of various parties (e.g., the engagement partner, staff, the partner responsible for independence, etc.). Policies provide clear channels of communication to address independence matters promptly, particularly when a breach may have occurred.
- Staff and partners, regardless of practice area and level in the firm, receive periodic training in independence. As in other messaging, the best teaching tools leverage the firm’s actual experiences. These stories instruct whether the outcome was positive (e.g., “Here’s how we avoided an independence violation by being proactive”) or negative (e.g., “We had to resign the audit due to an independence issue and here’s why.”). PCAOB and SEC enforcement actions and PCAOB inspection findings also provide good illustrations. Overall, focus on lessons learned by connecting the rules to real-life scenarios. With this approach, independence training isn’t a boring recitation of the rules but an interactive discussion of recent developments, experiences and how the firm can improve. Less is more here; focus on “red flags” without diving too deeply into the gory details. As long as partners and staff recognize potential issues and know where to go for help, they can address situations. The goal is awareness so that when something happens, the light bulb clicks on; your employees don’t need to become independence experts.
Your staff knows independence is important and is aware of red flags and where to find guidance, which is the critical first step towards good independence compliance. Good communication between firm members will be the next key step.
Here’s an example: An audit client approaches Kayla, an audit senior on the job, about an accounting position at a public company. The audit is almost complete. Kayla is interested. She recalls that this situation raises independence issues and looks up the firm’s policy. Following the policy, Kayla notifies Sandra, the firm’s quality control director, to inform her that she is interested in interviewing with the client.
Here’s another: Brendon, an audit manager on a private company engagement, learns that the client just hired a close friend of his. He recalls that close, personal relationships can threaten independence and reads the policy, which leads him to Sandra. Following the firm’s protocol, Sandra and the audit partner work with Brendon to determine whether significant threats to independence exist, and if so, whether the firm should remove him from the engagement team or apply other safeguards to protect the firm’s independence.
To ace independence, consultation is vital. The firm should designate one or more partners or other management-level individuals, depending on the size and complexity of the firm, to consult on independence matters. If a matter is novel, complex or gray, firms may need additional resources from outside the firm to provide another, independent view. Possible sources include a partner in a peer firm, a regulatory body (including the SEC, PCAOB, or state accountancy board), the AICPA Professional Ethics Division, the local state CPA society, or an outside consultant or attorney. Firms whose internal consultants feel too close to a matter to be objective (especially one that could significantly impact the firm’s personnel or revenues) would be wise to seek an outside view.
Lastly, documenting independence evaluations is important for many reasons – first, firms must evidence their independence to prove that they complied with professional and regulatory requirements. This is important not only from a peer review or inspection perspective but also to protect the firm from legal liability if a claimant alleges the firm lacked independence.
When a firm addresses an independence matter, it’s in the firm’s best interests to carefully record the facts and what, when, how and with whom they considered the matter. If the conclusion is later questioned, it will be far easier to reference a comprehensive written account of the specifics than piece together fragmented memories. Preparing a contemporaneous record of the firm’s assessment also helps ensure that important facts or rules are not overlooked in the process. One more plus: If scrubbed of client names, the documentation can provide a valuable teaching or reference tool on evaluating other, similar matters.
Mind your ABCs
Firms selling assurance services build their reputations on independence. If deeply embedded in a firm’s culture, these basic components – awareness, communications and documentation – lead to excellence in compliance.