SEC Planning to Loosen Auditor Independence Rules

On Monday, the SEC proposed changing the rules to keep auditor committees and auditors from spending time on "non-substantive" rule breaches.
Vincent RyanJanuary 2, 2020

SEC Chair Jay Clayton

Auditor independence rules appear to be headed in opposite directions in the United States and the United Kingdom.

At a time when auditors in the U.K. are still under fire for the meltdown of  Carillion, U.S. auditors may be getting a break on some of the rules governing impartiality and objectivity.

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On Monday, the Securities and Exchange Commission proposed loosening some of the restrictions around whether an auditor’s objectivity and impartiality are compromised because it has nonaudit ties to a client.

The rule changes 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,” said SEC Chair Jay Clayton, and avoid “spending time on potentially time-consuming audit committee review of non-substantive matters.”

One of the proposals would change how an affiliate of an audit client is defined. Currently, if a firm audits a portfolio company in a private fund, the independence rules restrict its relationships with other portfolio companies controlled by the same fund. The new rules would provide a materiality exception. If the auditor determines that a portfolio company is not material to the fund, it can provide nonaudit services to that company without violating independence standards.

Other changes include:

  • Amending the definition of the audit and professional engagement period to shorten the look-back period to one year from three years for domestic first-time filers in assessing compliance with the independence requirements;
  • Adding certain student loans and de minimis consumer loans to the categorical exclusions from independence-impairing lending relationships;
  • Replacing the reference to “substantial stockholders” in the business relationship rule with the concept of beneficial owners with significant influence; and
  • Introducing a transition framework to address inadvertent independence violations that only arise as a result of merger and acquisition transactions.

The proposed amendments, said the SEC, primarily focus on “fact patterns” presented to commission staff through consultations. Those consultations often involve a relationship with, or services provided to, an entity that has little or no relationship with the entity under audit, and no relationship to the engagement team conducting the audit.

In these scenarios, “the SEC staff regularly observes that the audit firm is objective and impartial and, as a result, [the SEC] does not object to their continuing the audit relationship with the audit client.”

Most large auditing firms have policies, systems, and controls to try to avoid independence violations. They require certain internal approvals and reviews of transactions and services that have independence implications.

After the speedy collapse of the U.K. government contractor Carillion in 2018, U.K. regulators have debated how to avoid auditor conflicts of interest through regulation.

The current auditor independence framework in the United States was adopted in 2000 and underwent revisions in 2003.

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