Changes to Declarations of Independence

The SEC agrees to the PCAOB's new rules requiring audit firms to disclose possible conflicts of interest before taking on a client.
Sarah JohnsonAugust 26, 2008

Starting this fall, auditing firms will have to disclose to potential corporate clients any possibly conflicting relationships.

A new independence rule approved by the Securities and Exchange Commission requires that auditors, before they are hired, share with audit committees information that has a bearing on their independence.

“The new rule will make sure that audit committees have the relevant independence information in front of them when they select the auditor, not after they have already made the decision and the work has begun,” explained Daniel Goelzer, a member of the Public Company Accounting Oversight Board, after the PCAOB approved of the rule earlier this year.

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The PCAOB — whose rules take effect only after the SEC approves — tweaked its independence rules to clarify how registered public audit firms should demonstrate their independence, to reduce the possibility of conflicts of interest. They are still required annually to inform clients ofany relationships that could have a bearing on their independence status so that any bias is revealed. But under the new Rule 3526, Communication with Audit Committees Concerning Independence, these disclosures must be revealed before the accounting firm accepts a new relationship with a company. Auditors must also now declare in writing that they are independent.

The SEC approved the changes on Friday after a 30-day comment period with the caveat that the PCAOB may have to issue further guidance, depending on how auditors implement the rule. The SEC had received only three letters on the proposals, two of which were from Big Four firms, voicing their support.

However, Ernst & Young cautioned that the rule could slow down initial public offerings, since private companies couldn’t engage an auditor until it completed its independence assessment. The SEC said the PCAOB considered that concern and that the commissioners “do not believe any clarifying commentary is necessary at this time.” The rule therefore goes into effect September 30.

The SEC has also approved the PCAOB’s amendment to another independence rule, which says external auditors cannot work on the personal tax returns of client-companies’ CFOs and their family members during the same time that they are auditing or reviewing financial statements. The amendment excludes from that rule tax services provided during the audit period before the company engages the firm as its auditor.

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