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Introduction

Good morning.  It is an honor to have the privilege to speak at this conference about auditor independence. 

The independence requirement serves two related, but distinct, public policy goals.  One goal is to foster high quality audits by minimizing the possibility that any external factors will influence an auditor's judgments.… The other related goal is to promote investor confidence in the financial statements of public companies. [1]

For those reasons the Commission and the SEC staff continue to consider the importance of the auditor independence rules.   OCA staff is available for consultations with auditors, management, and audit committees in applying and interpreting the independence rule requirements.  This year, in addition to responding to consultations, the OCA independence group was active in independence-related rulemaking and updating our staff independence FAQs.  I will provide updates on these projects and also discuss how auditors and audit clients can coordinate in considering the auditor independence rules.

Auditor Independence With Respect to Certain Loans or Debtor-Creditor Relationships

The financial relationships section of the independence rule addresses, among other things, lending relationships between an auditor and its audit client.  Over the past few years through auditor independence consultations, the staff had become aware of a number of significant practical challenges with the restriction on lending relationships with record or beneficial owners of equity securities of the audit client as prescribed in Rule 2-01(c)(1)(ii)(A) (the “Loan Provision”).  For example, previously, the Loan Provision in certain situations would have been triggered by a ten percent bright-line shareholder ownership test, even where a lender to an auditor would not have been able to assert any influence over the audit client whose shares it owned, such as where the lender held the securities as a custodian or an omnibus account holder for its customers without having beneficial ownership.  For investment companies, the Loan Provision broadly applied not only to entities that the audit firm was auditing, but also to each entity in the investment company complex, regardless of which entity was being audited.  The Commission approved a final release in June 2019 amending the Loan Provision to more effectively identify debtor-creditor relationships that could impair an auditor’s objectivity and impartiality.^[2]

The final amendments to the Loan Provision did the following:

• Focused the analysis only on beneficial ownership rather than on both record and beneficial ownership;
• Replaced the existing ten percent bright-line shareholder ownership test with a “significant influence” test; 
• Added a “known through reasonable inquiry” standard with respect to identifying beneficial owners of the audit client’s equity securities; and
• Amended the definition of “audit client” for a fund under audit to exclude any other funds that otherwise would be considered affiliates of the audit client.  This amendment limiting the definition of audit client for funds to the fund under audit is only applicable to the Loan Provision.

The amended Loan Provision addressed some of the practical compliance challenges associated with the rule, such as those experienced in the asset management industry, without compromising the objective of preventing shareholders who have a “special and influential role” with the issuer from having lending relationships with the auditor.  The amendments became effective on October 3, 2019.   

Independence FAQ’s

During 2019, SEC staff reviewed and updated the staff’s auditor independence FAQs as follows:^[3] 

• Reorganized the presentation of the FAQs to match the structure of the independence rules;
• Removed FAQs issued to aid in transition to the 2003 amendments to the auditor independence rules as they are no longer relevant;
• Updated references and made other minor changes; and 
• Added ten new FAQs and made substantive changes to certain existing FAQs in response to trends observed from OCA staff consultation activity. 

For example  FAQ E. #5 addresses that the “not subject to audit exception” provided for certain prohibited services^[4] may be applicable when these services are performed to commonly controlled entities^[5] on a facts and circumstances basis.  As another example, FAQ G. #14 indicates that all years included in a confidential draft submission and effective registration statement count towards partner rotation.

  Audit firm coordination with its audit client

The staff has regularly emphasized that auditor independence is a shared responsibility.^[6]  It is very important and most effective when management, audit committees, and audit firms work together in considering the auditor’s compliance with the independence rules.  The following are some examples where instituting the shared responsibility concept can help prevent independence violations from occurring:   

• Issuers and their audit committees may want to consider having their own policies and procedures to identify, consider, and monitor the provision of services and relationships with the issuer’s independent accountant, which may help supplement the audit firm’s system of quality control;
• Auditors and their audit clients may want to work together to identify and consider maintaining a list of company affiliates based on the affiliate of the audit client definition in the independence rule.  Management could assist and notify the auditor in a timely manner of changes in its list of affiliates in order to prevent independence violations from occurring, such as by notifying an auditor of acquisitions before the closing date; and
• Management should consider communicating to auditors as early as possible the intent by private companies to file a registration statement in order for the SEC and PCAOB independence rules to be considered in advance.    

Thank you.