On Friday, the SEC announced amendments to the auditor independence requirements set forth in Rule 2-01 of Regulation S-X. The amendments are intended to update the independence rules to address recurring fact patterns that triggered technical independence rule violations without necessarily impairing the auditor’s objectivity and impartiality.
Among other things, the amendments address independence issues that arise when sister companies with a common PE fund owner have engaged an audit firm to provide non-audit services that could impair the independence of the audit firm with respect to another sibling company. The amendments also shorten the look-back period for auditor independence from three years to one year for first time filers, which will provide increased flexibility for IPO companies to address potential disqualifying relationships with their audit firms.
The SEC’s press release summarizes the changes implemented by the amendments and provides a couple of examples of how they will work. According to the release, the amendments will:
– Amend the definitions of “affiliate of the audit client,” in Rule 2-01(f)(4), and “investment company complex,” in Rule 2-01(f)(14), to address certain affiliate relationships, including entities under common control;
– Amend the definition of “audit and professional engagement period,” specifically Rule 2-01(f)(5)(iii), to shorten the look-back period, for domestic first time filers in assessing compliance with the independence requirements;
– Amend Rule 2-01(c)(1)(ii)(A)(1) and (E) to add certain student loans and de minimis consumer loans to the categorical exclusions from independence-impairing lending relationships;
– Amend Rule 2-01(c)(3) to replace the reference to “substantial stockholders” in the business relationships rule with the concept of beneficial owners with significant influence;
– Replace the outdated transition provision in Rule 2-01(e) with a new Rule 2-01(e) to introduce a transition framework to address inadvertent independence violations that only arise as a result of a merger or acquisition transactions; and
– Make certain other miscellaneous updates.
I’ll give you three guesses how the SEC’s vote on this went down — and the first two don’t count. Read Chair Clayton’s statement on the adoption of the amendments and the customary dissenting statement from Commissioners Lee and Crenshaw. The dissenters expressed concern with the increased discretion provided to audit firms when assessing their own independence and the lack of any mechanism to provide visibility into how auditors are exercising this discretion. We’ll be posting memos in our “Auditor Independence” Practice Area.
-John Jenkins, TheCorporateCounsel.net October 19, 2020
