SEC Aims to Fix Auditor Independence Rule by Next Fall

December 17, 2018

Addressing complaints that the current loan provision under its auditor independence rule is outdated, the Securities and Exchange Commission (“SEC”) expects to finalize planned changes to the rule by September 2019. The final rule will likely be based on Release No. 33-10491, Auditor Independence With Respect to Certain Loans or Debtor-Creditor Relationships. Issued in May, the proposal addresses practical challenges in deciding whether an auditor complies with independence Rule 2-01 of Regulation S-X when engaged in a lending relationship with its audit clients’ shareholders.

To finance its business operations, an accounting firm may borrow from a bank or acquire funds by distributing debt. The proposed rule concerns circumstances commonly experienced in the fund industry. If the changes are approved, the fund industry said the independence review will focus on such relationships that could hinder an auditor’s impartiality and objectivity without being slowed by insignificant matters.

Specific changes include four amendments to Rule 2-01. When establishing independence, auditors would only review the beneficial ownership and not the current obligation to examine record and beneficial ownership. The proposal would introduce a significant influence test to replace the 10 percent bright-line shareholder ownership test.

Additionally, the proposal would introduce a “known through reasonable inquiry” standard in recognizing beneficial owners of an audit client’s securities. The proposal would also update the “audit client” definition for a fund under audit to omit funds that otherwise would be deemed associates of the audit client.

If the proposed amendments are finalized, groups like the Center for Audit Quality and several accounting firms said the new guidance would appropriately focus on circumstances when auditor independence might be compromised.