Proposed Changes to Auditor Independence Rules

Proposed Changes to Auditor Independence Rules

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Proposed Changes to Auditor Independence Rules

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SEC Proposes Loosening of Auditor Independence Rules

The U.S. Securities and Exchange Commission on Monday proposed changes to auditor independence rules that would relax regulation of audit firms in cases involving affiliates of their clients and preparations for initial public offerings.

The proposed rule, which has been released for public comment over the next 60 days, represents a potential further loosening of regulation following the June approval of softer rules governing auditors’ and funds’ financial ties to the same lender.

The changes proposed Monday would give auditors more discretion in assessing conflicts of interest in their relationships with companies they audit.

The proposal would alter the definition of affiliates of an audit client, which currently states that the independence rules governing an auditor of a portfolio company also extend to any other portfolio company controlled by the same private fund.

The proposal would build a materiality qualifier into the definition, allowing the auditor to determine if another portfolio company under the fund is material to the fund. If the auditor determines no materiality, it can provide non audit services to that company without compromising its independence.

The different ways auditors assess materiality could lead to variation in analyses.

The Big Four accounting firms’ push into consulting to boost revenues has been the subject of scrutiny in recent years. U.K. regulators, for example, have proposed an operational split between accounting firms’ audit and consulting businesses. A parliamentary committee also suggested new legislation that would introduce a structural separation between audit and consulting businesses.

The SEC proposal would also shorten the period during which U.S. companies planning to go public ensure their auditor’s independence before an IPO. The proposal would change the time frame, known as a “look-back” period, from three years to one year for U.S. companies. Non-U.S. companies are currently subject to a one-year requirement for ensuring their auditor’s independence before an IPO.

The proposal would also expand upon the SEC’s recent loan-related changes to auditing rules. Under the proposal, the student loans of certain employees who are involved in or are in a position to influence an audit would no longer be deemed to compromise the independence of the audit firm.

The current rules apply restrictions to those employees who had obtained student loans from an audit client through normal lending procedures before their employment at the firm.

“The proposal is consistent with the Commission’s long-recognized view that an audit by an objective, impartial, and skilled professional enhances both investor protection and market integrity, and, in turn, facilitates capital formation,” SEC Chairman Jay Clayton said in a statement.

The amendments would increase the number of qualified audit firms a company could choose from and permit audit committees and commission staff to better focus on relationships that could impair an auditor’s objectivity and impartiality, Mr. Clayton said.

Mr. Clayton said in December that changes to auditor independence rules were a priority of the regulator in the next year. He also said the audit committee has an especially important role in evaluating independence. The SEC’s office of the chief accountant provided recommendations on additional changes to the auditor-independence rule to the commission.

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The agency previously removed a rule that prevented a firm from auditing a fund while also borrowing money from a lender with a stake above a certain threshold in the same fund. The change replaced the threshold with a squishier form of appraisal known as a “significant influence” test, which seeks to determine whether a beneficial owner or loan relationship may impair the auditor’s independence.

Monday’s proposal covers the potential future changes to auditor independence that were mentioned broadly in the loan amendment document. In the devising of the proposal, the SEC reviewed past comments from audit firms on other changes to existing rules.

The SEC has detected several alleged independence violations in recent years involving large accounting firms.

Proposed Changes to Auditor Independence Rules

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