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Office of the Chief Accountant: Application of the Commission's Rules on Auditor Independence

May 12, 2017

Frequently Asked Questions

Updated as of June 27, 2019

The answers to these frequently asked questions represent the views of the staff in the Office of the Chief Accountant. They are not rules, regulations or statements of the Securities and Exchange Commission. Further, the Commission has neither approved nor disapproved them.

The questions and answers follow the structure of the Commission’s rules that define (or that relate to) auditor independence, including Rules 2-01 and 2-07 of Regulation S-X and Schedule 14A, Item 9 of the Securities Exchange Act of 1934 (the “Exchange Act”).

The parenthetical date(s) associated with each question and answer represents the date(s) the question or answer was added or changed. Dates are not added when changes are considered to be non-substantive on the point of the question and answer.

Questions and answers are removed from the list of FAQs when they are no longer relevant.

We encourage consultations regarding the auditor independence requirements. Guidance for consulting is available at https://www.sec.gov/page/oca-form-delivery-and-content-correspondence-oca-consultations. Additional questions on auditor independence issues should be directed to Vassilios Karapanos karapanosv@sec.gov, (202) 551-5328, Michael Husich husichm@sec.gov, (202) 551-5319, Jenifer Minke-Girard minke-girardj@sec.gov, (202) 551-5351, or the general phone number (202) 551-5300, all in the Office of the Chief Accountant. Please copy OCA-Independence@sec.gov on questions and consultation requests.

INDEX

A. General standard of independence [2-01(b)]

B. Financial relationships [2-01(c)(1)]

C. Employment relationships [2-01(c)(2)]

D. Business relationships [2-01(c)(3)]

E. Non-audit services [2-01(c)(4)]

F. Contingent fees [2-01(c)(5)] [Reserved]

G. Partner rotation [2-01(c)(6)]

H. Audit committee administration of the engagement [2-01(c)(7)]

I. Compensation [2-01(c)(8)] [Reserved]

J. Quality controls [2-01(d)] [Reserved]

K. Definitions [2-01(f)]

L. Audit committee communications [2-07]

M. Disclosure required in proxy statements [Schedule 14A, Item 9]

N. Broker dealer and investment advisers

O. Other independence

A. General standard of independence [2-01(b)]

Question 1 (issued December 13, 2004)

Q: Has there been any change in the Commission's long standing view (Financial Reporting Policies — Section 600 — 602.02.f.i. "Indemnification by Client") that when an accountant[1] enters into an indemnity agreement with the issuer,[2] the accountant’s independence would come into question?

A: No. When an accountant and the audit client, directly or through an affiliate, enter into an agreement of indemnity which seeks to provide the accountant immunity from liability for their own negligent acts, whether of omission or commission, the accountant is not independent. Further, including in engagement letters a clause that an issuer would release, indemnify or hold harmless from any liability and costs resulting from knowing misrepresentations by management would also impair the firm's independence.

Question 2 (issued June 27, 2019)

Q: How do unpaid prior professional fees affect auditor independence?

A: Generally, prior year audit and other unpaid professional fees should be paid before a current audit engagement is commenced in order for the accountant to be deemed independent with respect to the current audit. However, normally a question would not be raised in such situations if, at the time the current audit engagement is commenced, a definite commitment is made by the client to pay the prior professional fees before the current year audit report is issued, or an arrangement is agreed upon for periodic payments to settle the delinquent fees and there is reasonable assurance that the current audit fee will be paid before the audit of the ensuing year begins. But, if audit and other professional services fees are owed to an accountant for an extended period of time and become material in relation to the fee expected to be charged for a current audit, there may be a question concerning the accountant’s independence with regard to the current audit because the accountant may appear to have a direct interest in the results of operations of the client.

Question 3 (June 27, 2019)

Q: Is the giving or acceptance of gifts or entertainment to or from an audit client considered an issue in relation to the “general standard” of auditor independence in Rule 2-01(b)?

A: Rule 2-01(b) provides the “general standard” of auditor independence, which all accountants must meet even if their conduct does not fall within one of the specific prohibitions in Rule 2-01(c). Under the general standard:

“[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 on all issues encompassed within the accountant’s engagement. In determining whether an accountant is independent, the Commission will consider all relevant circumstances, including all relationships between the accountant and the audit client and not just those relating to reports filed with the Commission.” [Emphasis added.]

The staff would consider all relevant facts and circumstances associated with the giving or acceptance of gifts or entertainment from an audit client in assessing whether the accountant will—or will not—be deemed independent under the general standard. The nature and frequency of the activities may reflect a close personal relationship that could be independence impairing. See, e.g., Release No. 34-78872 (Sept. 19, 2016), In the Matter of Ernst & Young LLP and Gregory S. Bednar; and Release No. 78873 (Sept. 19, 2016), In the Matter of Ernst & Young LLP, Robert J. Brehl, CPA, Pamela J. Hartford, CPA, and Michael T. Kamienski, CPA.

B. Financial relationships [2-01(c)(1)]

Question 1 (issued August 6, 2007)

Q: Mortgages secured by the borrower's primary residence that are obtained from a financial institution under its normal lending procedures, terms and requirements and obtained while not a covered person in the firm meet the loans/debtor-creditor relationship exception in Rule 2-01(c)(1)(ii)(A)(4). Are second mortgages, home improvement loans, equity lines of credit and similar obligations collateralized by a primary residence generally treated in the same manner?

A: Yes. In Release No. 33-7919 (November 21, 2000), Final Rule: Revision of the Commission’s Auditor Independence Requirements, the Commission clarified that the rationale for the stated exception focuses on the status of the covered person at the time of the loan origination.

The staff believes that the same focus should apply to second mortgages, home improvement loans, equity lines of credit and similar mortgage obligations collateralized by a primary residence obtained from a financial institution under its normal lending procedures, terms and requirements and while not a covered person in the firm.

Further, if there is a change in the ownership of the loan and, as a result, the borrower becomes a covered person, the staff would not object to the auditor's independence based solely on the existence of that loan, provided there is no modification in the original terms or conditions of the loan or obligation after the borrower becomes, or in contemplation of the borrower becoming, a covered person.

C. Employment relationships [2-01(c)(2)]

Question 1 (issued August 13, 2003)

Q: The "cooling off" period states that the accounting firm is no longer independent when a member of the audit engagement team commences employment with the issuer in a financial reporting oversight role within the one-year period preceding the date of the commencement of audit procedures. For purposes of applying this provision, is the term "issuer" restricted to the legal entity (typically the parent company) that issues the securities?

A: No. The rule prohibits a member of the audit engagement team from commencing employment in a "financial reporting oversight role" with the issuer if the auditor is to remain independent. The Commission's rules define a financial reporting oversight role as "a role in which a person is in a position to or does exercise influence over the contents of the financial statements or anyone who prepares them…"

The issuer is required to prepare consolidated financial statements to include in filings with the Commission. Therefore, a financial reporting oversight role can extend to the issuer and its subsidiaries. In determining whether an individual is in a financial reporting oversight role with the issuer, consideration should be given to the role the individual is playing, such as his or her involvement in the financial reporting process of the issuer, and the impact of his or her role on the consolidated financial statements.

Question 2 (issued August 13, 2003, revised 2007)

Q: Assume that an accounting firm has been providing audit services to a non-public client. The company now wishes to file an IPO and, in doing so, will become an issuer. The IPO filing will include three years of audited financial statements. Do the "cooling off" rules at 2-01(c)(2)(iii)(B)(1) apply to all audited periods included in the filing or just to the periods after the company becomes an issuer?

A: The Commission's rules require that the accountant be independent in each period for which an audit report will be issued.[3]

Thus, the accountant will need to consider his or her relationship with the audit client both prior to and after the time that the client becomes an issuer. If the filing for an IPO contains an audit report that covers three years of financial statements, the "cooling off" rules, likewise, would apply to all three years.

In applying the “cooling off” period rules for periods prior to the filing for an IPO, the day after the audit report release date (rather than the day after the periodic report is filed with the Commission) is deemed to constitute the commencement of audit procedures.

D. Business relationships [2-01(c)(3)]

Question 1 (issued January 16, 2001, revised 2004)

Q: What is the Commission's guidance with respect to business relationships?

A: The basic standard of the Commission's guidance is codified in the rules 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 also 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.”

E. Non-audit services [2-01(c)(4)]

Question 1 (issued January 16, 2001, revised 2019)

Q: Does Rule 2-01(c)(4)(i) (bookkeeping services) preclude an auditor from assisting an audit client in preparing its financial statements?

A: Yes. Also, 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."

The staff would also consider participating closely with an audit client to include providing accounting and financial statement templates for the audit client’s use in its financial reporting process.

Question 2 (issued August 13, 2003)

Q: A firm was not independent with respect to Company A for Year 1 because the firm performed bookkeeping or other prohibited services for Company A during the audit and professional engagement period of Year 1. For Year 2, however, the firm is independent with respect to Company A. The firm is auditing the Year 2 financial statements. In the course of conducting the audit for Year 2, the firm becomes aware that there will be restatements of the Year 1 financial statements. Can the accounting firm re-audit the Year 1 financial statements?

A: Rule 2-01 contains a specific "cure" if an independence issue relates to a prohibited financial relationship in the prior period. However, in this question, the independence issue is caused by having performed prohibited services in that prior period. There is not a cure for prohibited services. The firm's independence would be impaired in relation to Year 1. Thus, the accounting firm would not be qualified to serve as the accountant to re-audit the Year 1 financial statements.

Question 3 (issued August 13, 2003)

Q: The rules for five of the prohibited services (bookkeeping, internal audit outsourcing, valuation services, actuarial services, financial information system design and implementation) allow the services to an audit client when "it is reasonable to conclude that the results of these services will not be subject to audit procedures during an audit of the audit client's financial statements."

Release No. 33-8183 (January 28, 2003),Strengthening the Commission’s Requirements Regarding Auditor Independence, indicates that there is a rebuttable presumption that the services will be subject to audit procedures. Is materiality a basis for determining that it is reasonable to conclude that the services will not be subject to audit procedures? For example, could the audit firm provide bookkeeping services for a subsidiary that is immaterial to the consolidated financial statements?

A: No, as to both questions. There is a rebuttable presumption that the prohibited services will be subject to audit procedures. Determining whether a subsidiary, division, or other unit of the consolidated entity is material is a matter of audit judgment. The development of the basis for the judgment is, in and of itself, an audit procedure relating to the determination of whether to apply detailed audit procedures to a unit of the consolidated entity. Therefore, materiality is not a basis upon which to overcome the presumption in making a determination that “it is reasonable to conclude that the results of the services will not be subject to audit procedures.”

Question 4 (issued August 06, 2007, revised 2019)

Q: The rules for five of the prohibited services (bookkeeping, internal audit outsourcing, valuation services, actuarial services, financial information system design and implementation) allow the services to an audit client when "it is reasonable to conclude that the results of these services will not be subject to audit procedures during an audit of the audit client's financial statements."

Would a successor auditor's independence be impaired, in the current period, if the successor auditor provided these types of services relating to the financial statements of a prior period audited by a predecessor auditor?

A: No, as long as the services (i) relate solely to the prior period audited by the predecessor auditor and (ii) were performed before the successor auditor was engaged to audit the current audit period. However, it would be independence impairing if the successor auditor was engaged to help design a financial system in the prior period, which was not implemented until the current period.

Question 5 (issued June 27, 2019)

Q: The rules for five of the prohibited services (bookkeeping, internal audit outsourcing, valuation services, actuarial services, financial information system design and implementation) allow the services to an audit client when "it is reasonable to conclude that the results of these services will not be subject to audit procedures during an audit of the audit client's financial statements."

Would it be acceptable for the accountant to apply the “not subject to audit” exception to the prohibited services if the prohibited services are provided to separate entities that are under common control with the audit client?

A: If the separate entities under common control have autonomous financial and business operations, and the audit firm audits one of the entities, that audit firm may be able to apply the “not subject to audit” exception to entities that it does not audit. For example, the staff has not objected to the “not subject to audit” exception as applied in a private equity group context under similar circumstances.

However, the “not subject to audit exception” might not apply in other contexts, such as a traditional corporate entity or an investment company complex, based on the facts and circumstances. For example, there could be intercompany transactions and overlaps of corporate governance, management, personnel, or systems; therefore, the financial and business operations would not be autonomous.

Question 6 (issued August 06, 2007)

Q: Regulation S-T Rule 306 and Exchange Act Rule 12b-12(d) require foreign private issuers to provide all filings, related exhibits and all documents under the cover of Form 6-K using the English language. In connection with Commission filings, is an accountant independent if at any point during the audit and professional engagement period the accountant provides translation services to its SEC audit clients that are foreign private issuers or US issuers with foreign operations?

A: No. Translation services require the accountant to make decisions and judgments on behalf of the client's management on the selection and application of words, phrases, and specific accounting, business and industry terms, in order to convey the meanings as expressed by management in the original language. This might create a mutual or conflicting interest between the accountant and the audit client and might put the accountant in a position of auditing its own work.

Question 7 (issued January 16, 2001)

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 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 No. 33-7919 (November 21, 2000), Final Rule: Revision of the Commission’s Auditor Independence Requirements, some firms may be providing legal services outside of the United States to issuers 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.

Question 8 (issued August 13, 2003)

Q: Some accounting firms have developed their own proprietary income tax preparation software. The software is used to facilitate the preparation of company income tax returns for various tax jurisdictions. Can an accounting firm license or sell its proprietary income tax preparation software to an audit client?

A: Licensing or selling income tax preparation software to an audit client would be subject to audit committee pre-approval requirements for permissible tax services. To the extent that the audit client's audit committee pre-approves the acquisition of the income tax preparation software from the accounting firm, it would be permissible for the accounting firm to license or sell its income tax preparation software to an audit client, so long as the functionality is, indeed, limited to preparation of returns for filing of tax returns. If the software performs additional functions, each function should be evaluated for its potential effect on the auditor's independence.

Question 9 (issued August 13, 2003)

Q: Some accounting firms have developed software modules which extend the functionality of the proprietary income tax preparation software. One of the additional software modules that has been developed by some firms takes the information used in preparing the tax return and generates some or all of the information needed to prepare the tax accrual and disclosures related to income taxes that will appear in the company's financial statements. Can the accounting firm license or sell this type of module to an audit client either concurrently with or subsequent to the licensing or sale of its income tax preparation software?

A: No. Since the purpose of the module is to develop the information needed to prepare a significant element of the company's financial statements, licensing or selling the module to an audit client would constitute the design and implementation of a financial information system, which is a prohibited non-audit service. It should be noted that the prohibition exists whether or not the module is integrated with, linked to, feeds the company's general ledger system, or otherwise prepares entries on behalf of the audit client (even if those entries are required to be manually recorded by client personnel). The output of the module aggregates source data or generates information that can be significant to the company's financial statements taken as a whole.

Question 10 (issued August 06, 2007)

Q: Is the independence of an auditor of an employee benefit plan, Form 11-K filer, impaired if the accountant provides prohibited non-audit services to the non-audit client sponsor of the employee benefit plan?

A: It depends on the type of prohibited non-audit services provided. The employee benefit plan, while a separate issuer, is considered to be an affiliate of the sponsor to the plan, and therefore subject to the Commission's rules regarding prohibited non-audit services. However, because the accountant is auditing the employee benefit plan (and not the plan sponsor) such services would be permissible as long as: (i) such services are limited to those prohibited non-audit services [at Rule 2-01(c)(4)(i.-v.)] which contain the modifier "…unless it is reasonable to conclude that the results of these services will not be subject to audit procedures during an audit of the audit client's financial statements;" and (ii) the auditor does not provide any services that would affect the financial statements of the plan or the benefit plan audit.

Question 11 (issued June 27, 2019)

Q: Rule 2-01(c)(4) prohibits accountants from providing certain non-audit services to their audit clients during the audit and professional engagement period. Is an auditor precluded from, prior to its dismissal, proposing on prohibited non-audit services, to be provided or entered into after the completion of the audit and professional engagement period?

A: An audit firm could impair its independence under the general standard of Rule 2-01(b) if it were to propose on prohibited non-audit services before the end of the audit and professional engagement period. For instance, proposing on prohibited non-audit services while the firm is still the auditor heightens the threat, both in fact and in appearance, of audit team members acquiescing to management in order to increase the firm’s chance of winning the prohibited non-audit services engagement. Management and the audit committee should consider the facts and circumstances before pursuing any discussion with its auditor about proposing on any prohibited non-audit service while the auditor is performing audit procedures to issue its final audit report.

F. Contingent fees [2-01(c)(5)] [Reserved]

G. Partner rotation [2-01(c)(6)]

Question 1 (issued August 13, 2003)

Q: What are the rotation requirements for the "relationship" partner who is not the "lead" or "concurring" partner?[4]

A: The "relationship" partner meets the definition of an "audit partner" and, therefore, is subject to the partner rotation requirements. "Lead" and "concurring" partners are required to rotate off an engagement after a maximum of five years in either capacity[5] and, upon rotation, must be off the engagement for five years. Other "audit partners" are subject to rotation after seven years on the engagement and must be off the engagement for two years. A "relationship" partner who is not the "lead" or "concurring" partner would, therefore, be subject to the rotation requirement of seven years of service followed by a two year time out period.

Question 2 (issued August 13, 2003)

Q: The same partners at an accounting firm have served on the audit of a non-public audit client for more than three years. The non-public audit client is now going through an IPO. Should some or all of the service time of the audit firm partners prior to the IPO count towards the rotation requirements?

A: Since the company has become an issuer through the IPO process, the partners are now subject to the rotation requirements.

The specific rotation requirements would be established by the number of years of audited financial statements that are included in the filing. Some filings would include three years of audited financial statements while others (e.g., certain filings by emerging growth companies) would include two years of audited financial statements. Those prior years count as prior service in determining the rotation requirements. Accordingly, both the "lead" and "concurring" partners would have either two or three additional years before having to rotate off the engagement, depending on the number of years of audited financial statements that are included in the filing. The same conclusion would apply for determining the service time under the rotation requirements for partners other than the "lead" and "concurring" partners.

The same analysis also would apply to foreign companies that become issuers. As above, some foreign issuer filings include three years of audited financial statements while others may include two years of audited financial statements. The same conclusions regarding the partner rotation requirements would apply to these foreign companies at the time they become issuers.

Question 3 (issued August 13, 2003)

Q: An accounting firm accepts a new audit client that had previously been audited by another firm. In the course of auditing the current period's financial statements, it was determined that the prior two years should be re-audited by the newly-engaged firm. For purposes of the partner rotation provisions of the independence rules, does this engagement constitute one year or three years of service by the audit partners?

A: This constitutes one year for purposes of determining when the partners would need to rotate. This is a different situation from the IPO situation (see Question 2, in this section). In the IPO situation, the firm and its partners had an established relationship with the client for more than three years before the company became an issuer. In this situation, there is no previous relationship with the client.

As noted in the independence Release No. 33-8183 (January 28, 2003),Strengthening the Commission’s Requirements Regarding Auditor Independence, one of the objectives of partner rotation is for the firm to have a "fresh look" at the company. In this situation, there has not been an ongoing relationship with management or the company. Therefore, the fact that multiple periods were audited does not create a need to accelerate the "fresh look." The same would be true for a company preparing its IPO where it had never had its previous financial statements audited and the auditor concurrently audited all three periods included in the IPO.

Question 4 (issued August 13, 2003, revised 2019)

Q: Assume that Partner A is an audit partner with Audit Firm Z. Partner A has served as the "lead" partner on the audit of Company E for three years. Partner A leaves Audit Firm Z to join Audit Firm Y. The Audit Committee of Company E engages Audit Firm Y and Partner A becomes the “lead” partner on Company E. After joining Audit Firm Y, how many additional years may Partner A serve as the "lead" partner for Company E before Partner A must rotate off the engagement?

A: The rotation requirement is, in part, directed towards the need to have a fresh look with respect to the audit client. Since Partner A has a continuing relationship with Company E, the prior service would count in the determination of the partner rotation requirement. As a consequence, Partner A would be able to serve as the "lead" partner on Company E's audit for two additional years (thus, serving the client for five consecutive years) upon joining Audit Firm Y. At that point, Partner A would be required to rotate off the engagement for the required five-year time-out period.

Question 5 (issued August 13, 2003)

Q: Assume that a client changes its fiscal year-end. As a consequence, in the year of the change, its "annual" financial statements would cover less than 12 months. How would this "stub" period be counted in determining when the "audit partners" should rotate?

A: The filing for a “stub” period is referred to as a “transition report.” A transition report on Form 10-K for a period of six months or longer must be audited. A transition period of less than six months may be unaudited and filed on Form 10-Q. The required audit for a transition report on Form 10-K for a period of six months or longer counts as one year for purposes of the partner rotation requirements. If, however, the issuer is not required to file a separate transition report on Form 10-K, then the "stub" period does not constitute a "year" for purposes of the partner rotation requirements.

Question 6 (issued December 13, 2004)

Q: When a registered public accounting firm accepts its fifth audit client that is an issuer (as defined in section 10A(f) of the Exchange Act) or its tenth partner, the exemption to the partner rotation rules as described in Rule 2-01(c)(6)(ii) no longer applies. After the exemption no longer applies, is there a transition period before the lead, concurring, and other partners are required to rotate? In this situation, how do you determine the years of service for the lead, concurring and other partners as defined in Rule 2-01(f)(7)(ii) for purposes of partner rotation?

A: Rule 2-01(e)(1)(v) provides a transition period with respect to the auditor rotation rules for the lead, concurring, and other partners. In a similar manner, a transition period is appropriate when a firm no longer qualifies for the small firm exemption.

A firm should determine annually whether the firm qualifies for the small firm exemption; this determination should be made each year as of the end of the calendar year. Once a determination has been made that the exemption no longer applies the lead partner may continue to serve a client through the first annual audit period ending after the exemption is no longer applicable, regardless of whether that partner has served the client for more than five consecutive years; the concurring review partner may continue to serve a client through two annual audit periods ending after the exemption is no longer applicable, regardless of whether that partner has served the client for more than five consecutive years; audit partners, other than the "lead' and "concurring" partner, receive a "fresh clock" and may continue to serve a client through seven annual audit periods ending after the exemption is no longer applicable.

Question 7 (issued December 13, 2004, revised 2019)

Q: After a lead or concurring partner rotates off an audit engagement may that partner provide services to the issuer in a specialty partner capacity (i.e., providing tax services or national office/technical services) and still have this period continue to be considered part of the partner's rotation-off the audit engagement?

A: Any time providing services to, or continuing the direct service relationship with, the issuer would not be considered as time off the audit engagement. See question 10 in this section for further details of permissible interactions after the partner rotates off the audit engagement.

Question 8 (issued December 13, 2004)

Q: A principal auditor's report on an issuer's financial statement refers to and places reliance on the auditor of a subsidiary or equity method investee of the issuer. The audit report of the subsidiary or investee auditor is required to be included in the SEC filing. Are the audit partner rotation requirements applicable to the auditors of these entities, even if these entities are not issuers as defined by the Sarbanes Oxley Act of 2002?

A: Yes. The entire audit of an issuer must be conducted by independent auditors. For the principal auditor to rely on and make reference to the auditor of a subsidiary or equity method investee, such auditor must be independent under the SEC independence rules. The principal auditor is primarily responsible for determining and confirming compliance with those rules.

Question 9 (issued December 13, 2004)

Q: In an integrated audit of the financial statements and internal control over financial reporting, how would the rotation requirements affect a partner who is primarily responsible for the audit of internal control over financial reporting? Does that person meet the definition of audit partner?

A: Yes. Such a person meets the definition of audit partner.

Question 10 (issued August 13, 2003, revised 2019)

Q: The 20X1 audit of a calendar year client will be the last audit of that client for the person currently serving as the "lead" partner. The Commission's rules specify that, as of the beginning of the next year (e.g., January 1, 20X2), the firm is not independent when the "lead" partner has served for more than five years. How does the staff believe that the transition to the next partner should be applied?

A: The intention of the rules is to allow a "lead" partner to finish the current audit (e.g., the calendar 20X1 audit). The "lead" partner could complete the current audit even though work would extend beyond January 1, 20X2, without impairing the firm's independence. However, care must be taken that the partner is not involved in work that may be performed with respect to the first quarter of the 20X2 reporting period. Since some of this work may be performed simultaneously with the year-end audit, auditors will need to carefully monitor the transition for compliance with the rotation requirements. Limited discussions solely between the audit engagement team and a rotated-off partner generally would be considered as time off the audit engagement. Such discussions should be limited to historical accounting and auditing issues. This question also applies to concurring and other audit partners discussed in Rule 2-01(c)(6).

Question 11 (issued June 27, 2019)

Q: Would independence be impaired if, after serving the maximum period permitted under Rule 2-01(c)(6) the partner continues to serve on the engagement in a capacity outlined in Rule 2-01(c)(6) by performing quarterly review services in the subsequent year?

A: Yes. The partner rotation rules provide that an accountant is not independent of an audit client if an audit partner serves as a lead audit or concurring partner for more than five consecutive years or an audit partner as defined in Rule 2-01(f)(7)(ii) provides one or more services defined in Rule 2-01(f)(7)(ii)(C) and (D) for more than seven consecutive years. If a partner performs review procedures in a capacity outlined in Rule 2-01(c)(6) after the maximum terms in one or more of the quarters in the subsequent audit period, it would impair the accountant’s independence.

Question 12 (issued June 27, 2019)

Q: Rule 2-01(c)(6)(ii), has an exception to Rule 2-01(c)(6)(i) when the audit firm has less than five audit clients that are issuers and less than ten partners, provided the PCAOB conducts a review at least once every three years of each of these audit client engagements. Are all equity partners such as tax partners, consulting partners, firm shareholders, and principals and directors that have partner equivalent responsibility considered “partners” in applying this provision of the small firm exception?

A: Yes. An individual who is a proprietor, partner, principal, or shareholder of the accounting firm and other positions with equivalent responsibility are considered partners in evaluating partner rotation.

Question 13 (issued June 27, 2019)

Q: A private operating company becomes an issuer through a reverse merger with a non-operating shell issuer. The surviving public operating company establishes new governance, management, operations, and accounting policies and procedures. Would the lead audit (or concurring) partner of the pre-transaction shell company be allowed to serve as the lead (or concurring) audit partner for the audit of the new operating company for the first five years after the transaction?

A: Generally, yes. However, this answer would not apply to a circumstance in which the new operating company carried over the former non-operating shell company’s board of directors, management, or accounting policies and procedures, because those elements would have been previously subject to audit by the lead (or concurring) audit partner.

Question 14 (issued June 27, 2019)

Q: In 20X4, a private company submitted a confidential draft submission, i.e., a draft registration statement that included audited financial statements for the years 20X1, 20X2 and 20X3. During the staff review process the company was required to update its confidential draft registration statement to include the years 20X2, 20X3 and 20X4. The company’s auditor has been auditing the company for many years and the same lead audit or concurring partner, as defined in Rule 2-01(f)(7)(ii), provided services for years 20X1 through 20X4. How many years should count toward partner rotation if the registration statement that was declared effective included audited financial statements for 20X2, 20X3, and 20X4?

A: The lead audit or concurring partner would have served four years, 20X1-20X4. All years included in the confidential draft submission and effective registration statement count towards partner rotation, including for foreign private issuers. Further, the audit firm must also be independent in accordance with all other SEC and PCAOB rules for all years included in the confidential draft submission and effective registration statement, except for foreign private issuers.[6]

H. Audit committee administration of the engagement [2-01(c)(7)]

Question 1 (issued August 13, 2003)

Q: An issuer has wholly-owned subsidiaries that also are issuers. The parent company has an audit committee. The wholly-owned subsidiaries do not have audit committees. Can the audit committee of the parent company function as the audit committee of the wholly-owned subsidiaries for purposes of satisfying the pre-approval requirements?

A: Yes. It is appropriate for the audit committee of the parent company to, in effect, serve as the audit committee of the parent company and the wholly-owned subsidiaries. In this situation, the subsidiary's disclosure should include the pre-approval policies and procedures of the subsidiary and, also should include the pre-approval policies and procedures of the parent company. It should be noted that this view does not extend to the fund industry in a manner that would permit an adviser's audit committee to pre-approve non-audit work on behalf of the funds. For more information, see Release No. 33-8220 (April 9, 2003), Standards Related to Listed Company Audit Committees.

Question 2 (issued August 13, 2003)

Q: An issuer that is a listed company has foreign subsidiaries that are consolidated. The issuer's "principal" auditor is a member firm of a network of international accounting firms. Some of the foreign subsidiaries have statutory audits performed and, in some cases (depending upon location, size, etc.), the statutory auditor may be a firm outside the member firm's network. Any statutory audits performed by member firms are subject to audit committee pre-approval requirements. Do the issuer's pre-approval requirements run to the statutory non-network auditors for the foreign subsidiaries or should the issuer's pre-approval requirements run just to the "principal" audit firm?

A: The Commission's rules relating to listed company audit committees (see Release No. 33-8220 (April 9, 2003), Standards Related to Listed Company Audit Committees) require audit committees to approve all audit services provided to the company, whether provided by the principal auditor or other firms. Therefore, the issuer's pre-approval requirements run to the statutory auditors for the foreign subsidiaries. However, failure of the audit committee to pre-approve audit services to be provided by another non-network auditor would not affect the independence of the principal auditor. See also question 1 under definitions.

Question 3 (issued August 13, 2003)

Q: The Commission's rules require the audit committee to pre-approve all services provided by the independent auditor. In doing so, the audit committee can pre-approve services using pre-approval policies and procedures. Can the audit committee use monetary limits as the sole basis for establishing its pre-approval policies and procedures?

A: Monetary limits cannot be the sole basis for the pre-approval policies and procedures. The establishment of monetary limits would not, alone, constitute policies that are detailed as to the particular services to be provided and would not, alone, allow for the audit committee to be informed about each service.

The Commission's rules include three requirements that must be followed in the audit committee's use of pre-approval through policies and procedures. First, the policies and procedures must be detailed as to the particular services to be provided. Second, the audit committee must be informed about each service. Third, the policies and procedures cannot result in the delegation of the audit committee's authority to management. The Commission’s rules require compliance with all three of these requirements.

Question 4 (issued August 13, 2003)

Q: Can the audit committee's pre-approval policies and procedures provide for broad, categorical approvals (e.g., tax compliance services)?

A: No. The Commission's rules require that the pre-approval policies be detailed as to the particular services to be provided. Use of broad, categorical approvals would not meet the requirement that the policies must be detailed as to the particular services to be provided.

Question 5 (issued August 13, 2003)

Q: How detailed do the pre-approval policies need to be?

A: The determination of the appropriate level of detail for the pre-approval policies will differ depending upon the facts and circumstances of the issuer. However, a key requirement is that the policies cannot result in a delegation of the audit committee's responsibility to management. As such, if a member of management is called upon to make a judgment as to whether a proposed service fits within the pre-approved services, then the pre-approval policy would not be sufficiently detailed as to the particular services to be provided. Similarly, pre-approval policies must be designed such that the audit committee knows what services it is being asked to pre-approve so that it can make a well-reasoned assessment of the impact of the service on the auditor's independence. For example, if the audit committee is presented with a schedule or cover sheet describing services to be pre-approved, that schedule or cover sheet must be accompanied by detailed back-up documentation regarding the specific services to be provided.

Question 6 (issued August 06, 2007)

Q: Does the audit committee of the plan sponsor of an employee benefit plan have to pre-approve the audit of the plan?

A: No. Rule 2-01(c)(7) requires pre-approval of services provided to the issuer and the issuer's subsidiaries, but not pre-approval of services provided to other affiliates of the issuer that are not subsidiaries. Therefore, the independence rules do not require the audit committee of the plan sponsor to pre-approve audits of the employee benefit plans. Audit committees are not precluded, however, from establishing policies to do so.

Question 7 (issued August 06, 2007)

Q: Are audit committees required to pre-approve services provided by the issuer's principal accountant to variable interest entities that are consolidated under FASB ASC 810 Consolidation (ASC 810)?

A: Yes. Rule 2-01 requires the issuer's audit committee to approve or establish pre-approval policies and procedures with respect to services provided by the accountant to the issuer or its subsidiaries. An entity that the issuer is required to consolidate under ASC 810 is subject to the pre-approval requirements.

I. Compensation [2-01(c)(8)] [Reserved]

J. Quality controls [2-01(d)] [Reserved]

K. Definitions [2-01(f)]

Question 1 (issued January 16, 2001, revised 2004)

Q: The rules do not define an affiliate of an accounting firm. What is the staff's approach to this issue?

A: The definition of an "accounting firm" includes the accounting firm's "associated entities." The Commission uses 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 was cited in footnotes 489 and 491 of Release No. 33-7919 (November 21, 2000), Final Rule: Revision of the Commission’s Auditor Independence Requirements.

Question 2 (issued August 06, 2007, revised 2019)

Q: ASC 810 provides guidance for the preparation of consolidated financial statements. Consolidated financial statements present the financial position, results of operations, and cash flows of a parent and all its subsidiaries as a single reporting entity. Must auditors of the consolidated financial statements be independent of the entities that are included within the consolidated group?

A: Yes. The accountant is required to be independent of all entities that are included within the meaning of "audit client" and "affiliate of the audit client," as defined in Rule 2-01(f).

The definition of "affiliate of the audit client" includes an entity that has control over the audit client, or over which the audit client has control, or which is under common control with the audit client, including the audit client's parents and subsidiaries. The term "control" is defined in Rule 1-02(g) and means, "the possession, direct or indirect, of the power to direct or cause the direction of the management of the policies of a person, whether through the ownership of voting shares, by contract, or otherwise."

The condition for consolidation of an entity under ASC 810 is a direct or indirect controlling financial interest in the other entity, which may arise through the ownership of voting shares, by contract, or otherwise. As a result, entities in the consolidated group would be considered within the definition of an “audit client” or an “affiliate of the audit client.”

Question 3 (issued December 13, 2011)

Q: The definition of “audit and professional engagement period” in Rule 2-01(f)(5) provides that the professional engagement period ends when the audit client or the accountant notifies the Commission that the client is no longer that accountant’s audit client. How is the end date affected if the notification of termination of the engagement period is not effective until some future date or event? For example, where the client notifies the accountant that the relationship terminates with the conclusion of the engagement for the current fiscal year, when does the “audit and professional engagement period” end?

A: In this situation (absent any subsequent notice of termination), the professional engagement period ends with the issuance of the accountant’s report for that particular engagement. It is important to note, however, that even where the termination of the professional engagement period is not effective until a future date or event, the obligation to make a filing under Commission regulations (e.g., on Form 8-K, Form ADV-E, or pursuant to Rule 17a-5 of the Exchange Act, as applicable) upon notification is not affected.

Question 4 (issued August 13, 2003)

Q: Generally, a tax or other specialty partner is not included within the definition of "audit partner." Are there circumstances where a tax or other specialty partner would be included within the definition of "audit partner?" If so, what are the consequences?

A: The term "audit partner" is significant in that it establishes the partners who are subject to the partner rotation requirements and the partner compensation requirements. The discussion of "audit partner" in Release No. 33-8183 (January 28, 2003),Strengthening the Commission’s Requirements Regarding Auditor Independence, text states:

"the term audit partner would include the 'lead' and 'concurring' partners, partners such as ”relationship” partners who serve the client at the issuer or parent level."

"Relationship" partners have a high level of contact with management and the audit committee of the issuer. Therefore, a tax or other specialty partner who serves as the "relationship" partner would be included within the scope of the definition of "audit partner."

L. Audit committee communications [2-07]

Question 1 (issued August 13, 2003)

Q: Would the requirement to communicate with audit committees apply to situations where the auditor is providing a consent (e.g., related to a 1933 Act filing)? If so, what information should be communicated to the audit committee?

A: Yes. In that situation, the audit report is deemed to be filed. As a result, the auditor would be required to communicate the relevant information to the audit committee under Rule 2-07. Since the auditor would have communicated the relevant information when the audit report was originally filed, this communication at the time of the consent may properly be restricted to updating the audit committee. However, if in the process of applying audit procedures required by PCAOB AS 4101, Responsibilities Regarding Filings Under Federal Securities Statutes, matters come to the auditor's attention that would or could have affected the financial statements or the auditor's report that was previously filed, all relevant information should be communicated to the audit committee.

Question 2 (issued August 13, 2003)

Q: The rules require that auditors communicate to the audit committee alternative applications of GAAP relating to material items that have been discussed with management. Does this require that auditors discuss with audit committees transactions where there are alternative applications of GAAP that occurred subsequent to the balance sheet date that are not reflected in the financial statements (including the related notes) subject to audit?

A: No. Because the rules require the auditor to communicate alternative applications of GAAP that are material and that the communications occur before the audit report is filed with the Commission, the rules relate to items that are material to the financial statements on which the auditor is expressing an opinion. Therefore, such transactions that have occurred subsequent to the balance sheet date and which are not required to be reflected in the financial statements or the related notes are not required to be communicated to the audit committee until the period in which the transactions affect the financial statements. It should be noted, however, that Release No. 33-8183 (January 28, 2003),Strengthening the Commission’s Requirements Regarding Auditor Independence, text indicates that over time these communications should occur on a "real time" basis and, thus, the auditor is strongly advised to consider communicating the matters to the audit committee at the first opportunity after the matters arise.

Question 3 (issued August 13, 2003)

Q: Assume that the issuer's filing contains the report of a successor audit firm and a predecessor audit firm. Each of the audit firms will be required to provide a consent. Must each of the audit firms provide the communications with the audit committee?

A: No. When there is a predecessor-successor auditor relationship, only the successor auditor is required to communicate with the audit committee. Prior to providing its consent, however, the predecessor is required to perform the audit procedures specified in PCAOB AS 4101, Responsibilities Regarding Filings Under Federal Securities Statutes.

Question 4 (issued August 13, 2003)

Q: Assume that a portion of the company's consolidated financial statements were audited by a firm other than the principal accountant. Due to the significance of the portion audited by the other firm, the principal accountant decides to make reference to the other accountant. Because reference will be made to the other firm's report, both the audit reports of the principal accountant and the other accountant must be filed. Is the other accountant required to make the specified communications with the issuer's audit committee?

A: Yes. The Commission's rules require that the auditor communicate with the audit committee before the audit report is filed with the Commission. Because, in this situation, the other auditor's report will be filed, the other auditor also is required to provide the required communications with the audit committee.

M. Disclosure required in proxy statements [Schedule 14A, Item 9]

Question 1 (issued January 16, 2001)

Q: Does Item 9(e)(5) 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.

Question 2 (issued January 16, 2001)

Q: Should "out-of-pocket" costs incurred in connection with providing the professional service and billed to the issuer be included in the fee disclosures required by Items 9(e)(1) – (e)(4) of Schedule 14A?

A: Yes. These costs should be included as part of the aggregate fee for the service to which they apply.

Question 3 (issued January 16, 2001, revised 2004)

Q: In determining fees that are disclosed pursuant to Items 9(e)(1) – (e)(4) 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 issuer's financial statements for the two most recently completed fiscal years and the review of financial statements for any interim periods within those years. If the issuer has not received the bill for such audit services prior to filing with the Commission its definitive proxy statement, then the issuer 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) – (e)(4) should include amounts billed for services that were rendered during the most recent fiscal year, even if the auditor did not bill the issuer for those services until after year-end.

Question 4 (issued January 16, 2001)

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 5 of this section 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 an issuer 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."

Question 5 (issued January 16, 2001)

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), should be included. This term includes not only the person or entity that furnishes reports or other documents that the issuer 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.

Question 6 (issued January 16, 2001, revised 2004)

Q: Where in the proxy materials should the disclosures required pursuant to Item 9(e) of Schedule 14A appear? For example, can issuers 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 appropriate for the disclosures to accompany the disclosures required by Item 7(d) and Items 9(a)-(d) of Schedule 14A. Issuers can include the disclosures in the audit committee report, but we remind issuers that the safe harbor in Item 7(d)(3)(v) of Schedule 14A applies only to information required to be disclosed under Item 7(d)(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. The 2003 rules require disclosure of Item 9 (a) – (d) be included in a company's annual report. However, domestic companies are able to incorporate the required disclosure from the proxy or information statement into the annual report. Issuers that do not issue proxy statements are required to include disclosures in their annual filings.

Question 7 (issued January 16, 2001, revised 2004)

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 report on that year's financial statements.

Question 8 (issued August 13, 2003)

Q: What fee disclosure category is appropriate for professional fees in connection with an audit of the financial statements of a carve-out entity in anticipation of a subsequent divestiture?

A: Release No. 33-8183 (January 28, 2003),Strengthening the Commission’s Requirements Regarding Auditor Independence, establishes a new category, "Audit-Related Fees," which enables issuers to present the audit fee relationship with the principal accountant in a more transparent fashion. In general, "Audit-Related Fees" are assurance and related services (e.g., due diligence services) that traditionally are performed by the independent accountant. More specifically, these services would include, among others: employee benefit plan audits, due diligence related to mergers and acquisitions, accounting consultations and audits in connection with acquisitions, internal control reviews, attest services related to financial reporting that are not required by statute or regulation and consultation concerning financial accounting and reporting standards. Fees for the above services would be disclosed under "Audit-Related Fees."

Question 9 (issued August 13, 2003)

Q: Should fees paid to the audit firm for operational audit services be included in "Audit-Related Fees?"

A: No. "Audit-Related Fees" are fees for assurance and related services by the principal accountant that are traditionally performed by the principal accountant and which are "reasonably related to the performance of the audit or review of the issuer's financial statements." Operational audits would not be related to the audit or review of the financial statements and, therefore, the fees for these services should be included in "All Other Fees." As required by the rules, the issuer would need to include a narrative description of the services included in the "All Other Fees" category.

Question 10 (issued August 06, 2007)

Q: Are the fees paid to the principal auditor of a sponsor for the audit of its employee benefit plan, regardless of whether paid by the sponsor or the plan, required to be disclosed in the sponsor's proxy statement?

A: Yes. The Commission's rules (Items 9(e)(1)–(e)(4) of Schedule 14A) require all fees paid to the principal auditor be included in the issuer's fee disclosures. This includes fees related to the audits of any employee benefit plan for which the issuer is the sponsor, regardless of whether or not the issuer paid those fees or the audit committee of the issuer pre-approved those fees. The issuer may elect to identify in their disclosures those fees paid to the accountant that were not paid by the issuer or subject to the pre-approval requirements.

N. Broker dealer and investment advisers

Question 1 (issued August 13, 2003)

Q: Do the partner rotation and compensation requirements apply to auditors of non-issuer brokers and dealers or investment advisers that are non-issuers?

A: The term "audit partner" is intended to apply to an issuer as defined by the Sarbanes-Oxley Act of 2002. Therefore, for brokers and dealers or investment advisers that are not issuers as defined by the Act, the auditors would not be subject to the rotation requirements or the compensation requirements of the Commission's independence rules. However, since the prohibition on non-audit services applies to audit clients, those provisions would apply to auditors of non-issuer brokers and dealers or investment advisers.

Question 2 (issued December 13, 2011)

Q: Pursuant to Rule 206(4)-2 under the Investment Advisers Act of 1940 (the “Custody Rule”), an accountant performing a surprise examination must meet the standards of independence described in Rules 2-01(b) and (c). Rule 2-01(b) provides the general standard of independence. Rule 2-01(c) provides a non-exclusive list of circumstances, including specific relationships and services, which would be inconsistent with the general standard. How should an accountant who performs a surprise examination under the Custody Rule consider the propriety of non-audit services specified in Rule 2-01(c)(4)(i)-(v) if such services are not subject to the accountant’s procedures during the surprise examination?

A: When engaged to issue an audit or attest report to satisfy a requirement in the Custody Rule, the accountant should consider the application of the general standard of independence to such engagements. The Commission’s 2003 adopting release (Release No. 33-8183 (January 28, 2003),Strengthening the Commission’s Requirements Regarding Auditor Independence), states that there is a rebuttable presumption that certain prohibited non-audit services (e.g., bookkeeping, financial information systems design and implementation) will be subject to audit procedures during an audit of the audit client’s financial statements.

Rule 2-01(c)(4) provides that these non-audit services are prohibited unless “it is reasonable to conclude that the results of these services will not be subject to audit procedures during an audit of the audit client’s financial statements.”

Therefore, it is the staff’s position that, subject to Rule 2-01(b), an accountant performing a surprise examination under the Custody Rule would be able to perform certain non-audit services as long as it is reasonable to conclude that: (1) the results of the non-audit service will not be subject to attest procedures which might be performed during the surprise examination; and (2) the results of the non-audit service would not be subject to audit procedures if the accountant had been engaged to perform a financial statement audit. For example, if a pooled investment vehicle is included in the scope of an adviser’s surprise examination under the Custody Rule, the accountant performing the surprise examination would be prohibited from compiling the pooled investment vehicle’s financial statements.

Question 3 (issued December 13, 2011)

Q: Rule 206(4)-2 of the Advisers Act (“Custody Rule”) requires that an accountant performing a surprise examination of an adviser, preparing an internal control report of an adviser’s related person qualified custodian or performing an audit of a pooled investment vehicle’s financial statements for purposes of the adviser’s compliance with the Custody Rule must be an “independent public accountant” and thus comply with the applicable provisions of Rule 2-01, including the term “audit and professional engagement period” as defined in Rule 2-01(f)(5). How should the term “audit and professional engagement period” be applied for accountants performing surprise examinations, preparing internal control reports, and auditing pooled investment vehicles’ financial statements pursuant to Rule 206(4)-2?

A: Under the provisions of Rule 2-01, for a surprise examination, the audit and professional engagement period begins the earliest of: (1) the date the accountant signs an initial written agreement to perform the surprise examination as required by Rule 206(4)-2(a)(4); (2) the date the accountant begins attest procedures; or (3) the beginning of the period subject to the surprise examination.

For the preparation of an internal control report or an audit of a pooled investment vehicle’s financial statements, the audit and professional engagement period begins the earliest of: (1) the date the accountant signs an engagement letter or other agreement to prepare the qualified custodian’s internal control report or audit the pooled investment vehicle’s financial statements; (2) the date the accountant begins attest or audit procedures; or (3) the beginning of the period covered by the internal control report or pooled investment vehicle’s financial statements.

In general, the audit and professional engagement period for the surprise examination ends when the accountant notifies the Commission of its termination pursuant to Rule 206(4)-2(a)(4)(iii). While neither the accountant nor the audit client is required to notify the Commission of a termination of an engagement to prepare an internal control report or to audit a pooled investment vehicle’s financial statements under the Custody Rule, consistent with the provisions of Rule 2-01, the audit and professional engagement period for these engagements ends when the audit client or the accountant, as applicable, notifies the other that the client is no longer the accountant’s client for such engagement.

Question 4 (issued December 13, 2011)

Q: If an accounting firm regularly audits an advisory firm's books or the books of a limited partnership run by the advisory firm, can that accounting firm also be an “independent” public accountant for purposes of performing the surprise examination under the Custody Rule?

A: Yes, provided that the accounting firm meets the definition of “independent public accountant” in section (d)(3) of the rule.

O. Other independence

Question 1 (issued December 13, 2004)

Q: Do the Commission's independence rules apply to auditors whose reports are filed with the Commission on financial statements of entities other than those of the issuer?

A: The Commission's independence rules apply to audits of financial statements required by SEC rules, except for those required by Rules 3-05, 3-14, 8-04, and 8-06 of Regulation S-X.

Question 2 (issued June 27, 2019)

Q: Are financial statements provided to investors in offerings under Rule 506(b) of Regulation D required to be audited by an accountant that is SEC independent?

A: Yes. Financial statements required to be provided to investors in offerings under Rule 506(b) generally must comply with Article 8 of Regulation S-X.[7] Even though Regulation D does not require these financial statements to be filed with the Commission, the auditors of such statements must comply with the SEC independence rules in Rule 2-01. See Question 1 in this section with respect to financial statements required by Rules 8-04 and 8-06.

Question 3 (issued June 27, 2019)

Q: Rule 3-09 of Regulation S-X specifies that under certain conditions separately audited financial statements of an equity investee must be included in the filing. Are these financial statements required to be audited by an accountant that has complied with the Commission’s independence rules?

A: Yes. The accountant must comply with the Commission’s auditor independence rules, even when the accountant is permitted to perform the audit under standards other than the PCAOB’s standards.


[1] For purposes of this document the terms accountant(s) and auditor(s) are used interchangeably.

[2] An issuer is an entity whose securities are registered under section 12 of the Exchange Act or that is required to file reports under section 15(d) or that files or has filed a registration statement that has not yet become effective under the Securities Act of 1933 (the “Securities Act”) and that it has not withdrawn. Therefore, these conclusions would be applicable whether or not the filing has gone effective.

[3] Except for foreign private issuers for which Rule 2-01(f)(5)(iii) provides: For audits of the financial statements of foreign private issuers, the “audit and professional engagement period” does not include periods ended prior to the first day of the last fiscal year before the foreign private issuer first filed, or was required to file, a registration statement or report with the Commission, provided there has been full compliance with home country independence standards in all prior periods covered by any registration statement or report filed with the Commission.

[4] Rule 2-01 uses the terms “concurring partner,” “engagement quality reviewer,” and “engagement quality control reviewer.” These terms are interchangeable.

[5] For example, if a partner served as the "concurring" partner for two years and then began serving as the "lead" partner, he or she could serve for three years as the "lead" partner before reaching the maximum five year period as either the "lead" or "concurring" partner. It should be noted that PCAOB AS 1220, Engagement Quality Review, does not allow someone who served as the lead engagement partner during either of the two audits preceding the audit subject to the engagement quality review to serve as the engagement quality reviewer unless the audit firm qualified for the exemption under Rule 2-01(c)(6)(ii).

[6] See supra note 3.

[7] Regulation D requires an issuer conducting an offering under Rule 506(b) to provide, among other things, certain financial information to any non-accredited investors in that offering.

  • For offerings of up to $2 million, issuers must provide financial statements that comply with Article 8 of Regulation S-X, except that only the issuer's balance sheet, which shall be dated within 120 days of the start of the offering, must be audited.
  • For offerings of up to $7.5 million, the issuer must provide financial statements as would be required in Form S-1 for smaller reporting companies.
  • For offerings over $7.5 million, the issuer must provide financial statements as would be required in a registration statement filed under the Securities Act on the form that the issuer would be entitled to use.
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