Acting SEC Chief Accountant Paul Munter has issued a significant statement on auditor independence. See The Critical Importance of the General Standard of Auditor Independence and an Ethical Culture for the Accounting Profession. The statement is a forceful reminder of the Commission’s view that “auditor independence rule is integral to its mandate to protect investors and is fundamental for promoting investor confidence in the quality of financial disclosures.” Mr. Munter focuses particular attention on the independence ramifications of non-audit services and business relationships between the auditor and affiliates of the company being audited.
While aimed primarily at accounting firms, the statement also underscores the SEC’s view that audit committees have a key role in auditor independence. Mr. Munter asserts that the “Commission’s auditor independence requirement is foundational to the credibility of the financial statements, and, as the Commission has consistently noted, it is a shared responsibility among audit committees, management, and their independent accountants.”
The June 8 statement discusses four topics.
The Auditor Independence Framework Under the SEC’s Rules
The general standard of auditor independence is that “[t]he Commission will not recognize an accountant as independent, with respect to an audit client, if the accountant is not, or a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the accountant is not, capable of exercising objective and impartial judgment of all issues encompassed within the accountant’s engagement.” In determining whether an accountant is independent, the Commission takes into consideration “all relevant circumstances, including all relationships between the accountant and the audit client, and not just those relating to reports filed with the Commission.”
The auditor independence rule also contains a non-exclusive list of specific circumstances that are inconsistent with the general standard. “However, we caution that accountants, audit firms, registrants, and their audit committees should never make the mistake of assuming that just because a particular circumstance is not expressly prohibited in, or captured by, * * * [the non-exclusive list], their independence analysis is over. Instead, accountants, audit firms, registrants, and their audit committees must always assess and approach auditor independence for purposes of considering, beginning, or continuing an audit engagement” under the general independence standard.
The Office of the Chief Accountant’s Approach to Auditor Independence Consultations
The SEC’s Office of the Chief Accountant (OCA) will assist accountants, companies, and audit commit-tees with interpretation of the independence rules. “Critical to the effectiveness of the auditor independence consultation process is that any party seeking guidance communicate all relevant circumstances of their specific question to OCA staff.” Mr. Munter also points out that prior staff positions may not necessarily determine the staff’s views on matters raised in the consultation process. “We caution that developments, including risk to investors, may affect the applicability of prior OCA staff positions and note that prior OCA staff positions may not apply to your particular set of facts and circumstances—even if you think they may appear similar.”
Certain Recurring Issues in Recent Auditor Independence Consultations
In Mr. Munter’s view, recent consultations reflect “loosening attitudes” toward the Commission’s general standard of auditor independence. He lists three problem areas.
In some cases, accounting firms, companies, and audit committees treat the auditor independence rule as a “mere checklist of prohibitions” and ignore the general independence standard. He states that this approach “is not conductive to compliance.”
A second area of concern is the provision of non-audit services. “While non-audit services are often not provided directly to the company being audited, OCA staff encounter circumstances in which the extent and magnitude of the non-audit services and business relationships between the accountant and affiliates and non-affiliates of the company being audited would make it difficult for a reasonable investor to conclude that the accountant could exercise objective and impartial judgment in its audit.”
Accounting firms are engaging in “increasingly complex business arrangements and, in some cases, attempting to facilitate these arrangements through restructurings and the use of alternative practice structures. Such arrangements have the potential to undermine auditor independence.”
The Paramount Importance that Accounting Firms Foster an Ethical Culture.
Mr. Munter states that accounting firms should foster a culture of ethical behavior with respect to their professional responsibilities, including auditor independence. He believes however that a “’checklist compliance’ mentality” is becoming more common and that this has led to a deterioration in the ethical culture in some firms. He urges firms to “prioritize auditor independence and a culture of ethical behavior in all professional activities, and where independence on an audit engagement is a close-to-the-line call, the firms must be willing to forego audit and review fees or potentially lucrative restructuring proposals to comply with their independence responsibilities.”
Comment: Mr. Munter’s statement is a strong reminder that auditor independence issues must be approached broadly, from the perspective of a reasonable investor, not technically based on the specific prohibitions in the SEC’s rule. It is important for audit committees to bear this message in mind when independence issues arise. In particular, Mr. Munter’s statement seems to be something of a shot across the bow at accounting firms in response to the growing economic importance of their consulting practices and the tension between the desire to grow those practices and the limitations imposed by the independence rules. Audit committees should bear the SEC staff’s attitude on this issue in mind when confronted with questions regarding whether particular non-audit services offered by their audit firm would impact independence.
The statement is also a powerful reminder that audit committees share responsibility with their audit firm and management for compliance with the independence requirements and that the SEC is prepared to examine the audit committee’s role when independence violations come to light. In this regard, the statement builds on a theme that Mr. Munter has previously expressed. See Acting Chief Accountant Stresses Auditor Independence and Audit Committee Oversight, November -December 2021 Update.