Office of the Chief Accountant:
Application of Revised Ruleson Auditor Independence - Frequently Asked Questions
May 12, 2017
January 16, 2001
Since the adoption of the Commission's Revised Rules on Auditor Independence, the SEC staff has received questions regarding the implementation and interpretation of the rules. We encourage these questions and related correspondence regarding auditor independence. They should be directed to the Assistant Chief Accountant (currently Sam Burke or Esmeralda Rodriguez) in the Office of the Chief Accountant, Mail Stop 1103, 450 Fifth Street, N.W., Washington, D.C. 20549; telephone: (202) 942-4400. Questions regarding disclosure in proxy statements should be directed to the Office of Chief Counsel in the Division of Corporation Finance at (202) 942-2900. The staff's responses to certain questions received to date are as follows:
Q: What fees should be included in the category of "Audit Fees," pursuant to Item 9(e)(1) of Schedule 14A?
A: This category should include only fees for financial statement audit and review services performed by the auditor that are customary under generally accepted auditing standards or that are customary for the purpose of rendering an opinion or review report on the financial statements.
Examples of professional services, the fees for which should be included in this category include:
- Attendance at audit committee meetings at which matters related to the audits or reviews are discussed.
- Consultations on audit or accounting matters that arise during or as a result of an audit or review.
- Preparation of a "management letter."
- Time incurred in connection with the audit of the income tax accrual.
Examples of professional services, the fees for which should not be included in this category include:
- Work performed in connection with registration statements such as due diligence procedures or issuance of comfort letters.
- Due diligence procedures performed in connection with merger and acquisition procedures.
- Income tax services other than those directly related to the audit of the income tax accrual.
- Internal control advisory services outside of the scope of the audit.
- Risk management advisory services.
- Internal audit services.
- Audits of employee benefit plans.
Q: Should "out-of-pocket" costs incurred in connection with providing the professional service and billed to the registrant be included in the fee disclosures required by Items 9(e)(1) – (e)(3) of Schedule 14A?
A: Yes. These costs should be included as part of the aggregate fee for the service to which they apply.
Q: In determining fees that are disclosed pursuant to Items 9(e)(1) – (e)(3) of Schedule 14A, should the disclosure be based on when the service was performed, the period to which the service applies, or when the bill for the service is received?
A: Fees to be disclosed in response to Item 9(e)(1) of Schedule 14A should be those billed or expected to be billed for the audit of the registrant's financial statements for the most recently completed fiscal year and the review of financial statements for any interim period within that year. If the registrant has not received the bill for such audit services prior to filing with the Commission its definitive proxy statement, then the registrant should ask the auditor for the amount that will be billed for such services, and include that amount in the disclosure. Amounts disclosed pursuant to Items 9(e)(2) and (e)(3) should include amounts billed for services that were rendered during the most recent fiscal year, even if the auditor did not bill the registrant for those services until after year-end.
Q: Should fees for one-time information technology consulting projects that do not affect the financial statements be included in the fees disclosed for "Financial Information Systems Design and Implementation" or "All Other"?
A: They should be included in the "All Other" category. Only fees incurred for services described in Rule 2-01(c)(4)(ii) should be included in Item 9(e)(2) of Schedule 14A (Financial Information Systems Design and Implementation). These services include designing or implementing a hardware or software system that aggregates source data underlying the financial statements or generates information that is significant to the audit client's financial statements taken as a whole.
Q: Can the disclosure of fees made pursuant to Item 9(e)(3) of Schedule 14A include additional detail regarding the services rendered?
A: Yes, provided that the total of the fees is clearly stated.
Q: Should the fees billed in prior years be disclosed so investors may compare trends in audit, information technology and other non-audit fees?
A: The rule does not require comparative disclosures. Registrants may include such information voluntarily.
Q: In situations where other auditors are involved in the delivery of services, to what extent should the fees from the other auditors be included in the required fee disclosures?
A: Only the fees billed by the principal accountant need to be disclosed. See Question 8 regarding the definition of "principal accountant." If the principal accountant's billings or expected billings include fees for the work performed by others (such as where the principal accountant hires someone else to perform part of the work), then such fees should be included in the fees disclosed for the principal accountant.
In some foreign jurisdictions a registrant may be required to have a joint audit requiring both accountants to issue an audit report for the same fiscal year. In these circumstances, fees for each accountant should be separately disclosed as they are both "principal accountants."
Q: Does the term "principal accountant" in Item 9(e) of Schedule 14A include associated or affiliated organizations?
A: Yes. "Principal accountant" has the meaning given to it in the auditing literature. In determining what services rendered by the principal accountant must be disclosed, all entities that comprise the accountant, as defined in Rule 2-01(f)(1) of Regulation S-X, should be included. This term includes not only the person or entity that furnishes reports or other documents that the registrant files with the Commission, but also all of the person's or entity's departments, divisions, parents, subsidiaries, and associated entities, including those located outside of the United States.
Q: To what extent should audit as well as non-audit fees billed to subsidiaries and investees of the registrant by the principal accountant be included in the disclosures required by Item 9 of Schedule 14A?
A: In all cases, audit fees billed pursuant to the engagement letter for the performance of the audit of the consolidated financial statements as well as non-audit fees billed to entities that are consolidated entities should be included as part of the parent company's proxy disclosures.
Q: Where in the proxy materials should the disclosures required pursuant to Item 9(e) of Schedule 14A appear? For example, can registrants include the disclosures in the audit committee report?
A: Like other Items in Schedule 14A, Item 9(e) does not specify where in the proxy statement the disclosures must appear. We think it is certainly appropriate for the disclosures to accompany the disclosures required by Item 7(e) and Items 9(a)-(d) of Schedule 14A. Registrants can include the disclosures in the audit committee report, but we remind registrants that the safe harbor in Item 7(e)(3)(v) of Schedule 14A applies only to information required to be disclosed under Item 7(e)(3) and the safe harbor in Item 306(c) of Regulation S-K applies only to information required to be disclosed by Items 306(a) and (b) of Regulation S-K and, therefore, neither safe harbor would cover disclosures required by Item 9(e) but included in the audit committee report.
Q: Can the audit fee, information technology consulting fee and all other services fee amounts specified in Items 9(e)(1), (2) and (3) of Schedule 14A be provided in tabular format?
A: Yes. Items 9(e)(1), (2) and (3) require that each of these amounts be provided under a specified caption. One way to satisfy this requirement is to provide a table consisting of two columns or rows, the first listing the three captions and the second listing the three amounts. Any further breakdown of the amounts is optional and could be included in the table itself, in a footnote to the table or in narrative disclosure in proximity to the table.
Q: What disclosures should be provided under Item 9(e)(4) of Schedule 14A if the audit committee did not consider whether the provision of financial information systems design and implementation services and all other services specified in Items 9(e)(2) and (3) of Schedule 14A is compatible with maintaining the principal accountant's independence?
A: Registrants may state that the audit committee did not consider whether the provision of financial information systems design and implementation services and other non-audit services is compatible with the principal accountant's independence.
Q: Does Item 9(e)(4) of Schedule 14A require disclosure of a conclusion by the audit committee or of factors considered by the audit committee in the assessment of independence?
A: No. Voluntary disclosures describing conclusions reached and factors considered are permitted.
Q: When there has been a change in accountants during the year, should fees paid to both the predecessor and successor auditor be disclosed pursuant to Item 9(e) of Schedule 14A?
A: No. The fee disclosure should only be made for the accountant who renders an audit opinion on the most recent year's financial statements.
Q: Does the restriction on the independent accountant providing legal services to an audit client apply only to litigation services?
A: No. The Commission's rule provides that an auditor's and firm's independence would be impaired if an auditor provides to its audit client a service for which the person providing the service must be admitted to practice before the courts of a U.S. jurisdiction. This standard includes all legal services. The rule does not apply only to appearance in court or solely to litigators. The only circumstances excluded by the rule are those in which local U.S. law allows certain limited activities without admission to the bar (generally confined to advice concerning the law of foreign jurisdictions). Additionally, as discussed in the adopting release, some firms may be providing legal services outside of the United States to registrants when those services are not precluded by local law and are routine and ministerial or relate to matters that are not material to the consolidated financial statements. Such services raise serious independence concerns under circumstances other than those meeting at least those minimum criteria.
Q: Does Rule 2-01(c)(4)(i) (bookkeeping services) preclude an auditor from assisting an audit client in preparing its financial statements?
A: "Assistance" can take many forms. As a general matter, Rule 2-01(c)(4)(i) sets forth in rule form the Commission's previous guidance on this subject. In particular, the Codification of Financial Reporting Policies provides that: "It is the Commission's position that an accounting firm cannot be deemed independent with regard to auditing financial statements of a client if it has participated closely, either manually or through its computer services, in maintenance of basic accounting records and preparation of financial statements, or if the firm performs other accounting services through which it participates with management in operational decisions."
Q: The final rule did not define an affiliate of an accounting firm. Does the lack of a definition signal a change in the Commission's approach to this issue?
A: No. The final rule's definition of an "accounting firm" includes the accounting firm's "associated entities." As noted in the adopting release, the Commission used this phrase to reflect the staff's current practice of addressing these questions in light of all relevant facts and circumstances, and by looking to the factors identified in our previous guidance on this subject. Much of this guidance is cited in footnotes 489 and 491 of the adopting release. The staff is available for consultations on this issue.
Q: Did the final rule change the Commission's guidance with respect to business relationships?
A: No. The final rule is consistent with the Commission's prior guidance on business relationships. The basic standard of the Commission's prior guidance has now been codified in the rule. In addition, as the adopting release notes, much of the Commission's previous guidance has been retained and continues to apply. For example, joint ventures, limited partnerships, investments in supplier or customer companies, certain leasing interest and sales by the accountant of items other than professional services are examples of business relationships that may impair an accountant's independence. In a 1989 letter to Arthur Andersen, the Commission stated:
The Commission has recognized that certain situations, including those in which accountants and their audit clients have joined together in a profit-sharing venture, create a unity of interest between the accountant and client. In such cases, both the revenue accruing to each party ...and the existence of the relationship itself create a situation in which to some degree the auditor's interest is wedded to that of its client. That interdependence impairs the auditor's independence, irrespective of whether the audit was in fact performed in an objective, critical fashion. Where such a unity of interests exists, there is an appearance that the auditor has lost the objectivity and skepticism necessary to take a critical second look at management's representations in the financial statements. The consequence is a loss of confidence in the integrity of the financial statements.
Q: May an auditor provide a fairness opinion on a transaction that is not material to the financial statements and still be considered independent?
A: As the Commission stated in the adopting release, "Fairness opinions are opinions that an accounting firm provides on the adequacy of consideration in a transaction. [I]f an audit firm provides these services to an audit client, when it is time to audit the financial statements the accountant could well end up reviewing his or her own work, including key assumptions or variables suggested by his or her firm that underlie an entry in the financial statements. [W]e are limiting application of the rule to the provision of appraisals, valuations or services involving a fairness opinion where it is reasonably likely that the results individually or in the aggregate, would be material to the audit client's financial statements or where the results would be audited by the auditor. As a general matter, auditors would be auditing the results when they perform a GAAS audit." Under this rule, the "results" of a fairness opinion refers to the financial effects of the transaction that is the subject of the fairness opinion.
Q: Is an accountant's independence always impaired if it renders a report characterized as a "fairness opinion" when that report is mandated by a foreign jurisdiction?
A: The Commission stated in the adopting release, "The Commission is sensitive to those issues and in the past has worked with foreign regulators and companies to reach an acceptable resolution. We will continue our practice of determining whether to accept such reports on a case-by-case basis." For example, the staff has agreed to an engagement whereby the auditor performs specified procedures as set forth in a letter to the Italian Consob, which is on our website at www.sec.gov/info/accountants/noaction/italyaud.htm.
Q: The new rule permits the auditor to continue to provide certain internal audit and financial information systems design and implementation services provided certain criteria are met. Do these criteria for internal audit apply to all internal audit engagements? What are the responsibilities of management pursuant to these criteria?
A: The six criteria for internal audit services apply to all internal audit services the auditor provides to its audit client, including those services related to operational audits or for companies with less than $200 million in assets.
All of the specified criteria must be met for both internal audit and financial information systems design and implementation to ensure that management not only takes responsibility for the services and projects performed by the auditor, but also makes the required management decisions. An audit client that merely signs a letter acknowledging responsibility for the services or project, without actually meeting each of the specified conditions, is not sufficient to ensure the auditor's independence.