CAQ Provides an Overview of Amendments to the Auditor Independence Rules
In Amendments to SEC Independence Rules, an Alert issued on June 10, the Center for Audit Quality (CAQ) summarizes recent amendments to the SEC’s auditor independence requirements. These changes to SEC Rule 2-01 of Regulation S-X were proposed in December 2019 (see SEC Proposes Changes to the Auditor Independence Rules, January 2020 Update), approved on October 16, 2020, and took effect on June 9, 2021. The Alert provides an overview of the amendments “to assist auditors and other stakeholders with understanding and applying the independence rules and the key changes included in the amendments.”
The Alert consist of two sections and an appendix. Section 1 (“Auditor Independence Is Fundamental to Audit Quality – What Hasn’t Changed”) provides a high-level summary of the basic principles of the SEC’s independence requirements. The recent amendments do not change these basic aspects of independence. Instead, according to the CAQ, the amendments “serve to focus the independence requirements on those relationships and services that are more likely to threaten an auditor’s objectivity and impartiality in light of current market conditions and industry practice.”
Section 2 (“Overview of the Amendments – Key Changes”) discusses five changes resulting from the 2020 amendments:
Definition of an Affiliate. The auditor and its affiliates must be independent of the audit client and its affiliates. The SEC amended the definition of “affiliate of the audit client,” so that the auditor need not necessarily to be independent of sister affiliates of the audit client that are not material to the controlling entity. A similar change was made with respect to entities in an investment company complex.
“Look-back” Period. The amendments changed the definition of “audit and professional engagement period” to shorten the “look-back” period during which a domestic IPO company’s auditor must have been in compliance with the SEC’s independence requirements. This change addresses the fact that the independence rules applicable to private company audits differ somewhat from the SEC’s independence rules.
Student and Consumer Loans. The SEC added certain student loans and de minimis consumer loans to the exclusions from independence-impairing lending relationships between audit personnel and the audit client.
Business Relationship Rule. The amendments limit the scope of the “substantial stockholders” of the company under audit as to which the auditor must be independent. Independence is now required only as to beneficial owners of the company’s shares that have significant influence over the company.
Transition Framework for Mergers & Acquisitions (M&A) Activity. Independence violations sometimes result from mergers and acquisitions, such as where an audit client acquires a company for which the acquiror’s auditor is performing non-audit services that are inconsistent with independence. Under the amended rules, there is a transition framework to address independence violations that arise inadvertently as a result of M&A transactions.
The Appendix to the Alert contains the full text of Rule 2-01, with changes resulting from the recent amendments highlighted in red.
Comment: The Alert notes that compliance with the independence requirements “is a shared responsibility among management, auditors, and audit committees.” While audit committee members need not master the technical intricacies of the independence rules, a general understanding of their requirements is useful. The Alert is a good aid to that understanding.