Remarks Before the 2015 AICPA National Conference on Current SEC and PCAOB Developments
Michael W. Husich, Senior Associate Chief Accountant, Office of the Chief Accountant
Dec. 9, 2015
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues upon the staff of the Commission.
Good morning. Today, I want to share a few thoughts about auditor independence, including our consultation process in the Office of the Chief Accountant (“OCA”) and some reminders that I hope you will find helpful.
OCA Auditor Independence Consultation Process
OCA has an experienced team available to respond to independence consultations. In many cases, the calls we receive can be resolved by directing someone to the relevant Commission or staff guidance. However, we also receive a steady stream of consults that are interpretive in nature, and some may require a much deeper analysis, if the existing guidance is not exactly on-point. Lastly, we also consider self-reported violations or potential violations of the independence rules, which can present a range of questions and potential consequences. Regardless of the nature of the independence question, the staff generally encourages the inquirer to communicate in writing to help us better understand the facts.
It may be difficult for the staff to provide definitive views for certain types of questions. For example, non-audit service questions generally tend to be very fact specific and frequently those facts may be only partially known or still evolving. Moreover, a description of the service by itself may not provide the full picture regarding the manner in which the service may ultimately be performed. However, the staff nonetheless will generally provide feedback or observations with consideration to any written analysis provided by the caller. Lastly, to the extent an independence question is posed to the SEC staff as a result of an ongoing PCAOB inspection, we expect the inquirer to be transparent, as discussions with the PCAOB staff may be warranted in order to determine an appropriate response to the question.
The staff is sometimes asked to consider written submissions when a registrant and/or its accountant determine to self-report independence violations. I would like to clarify that the staff does not have the statutory authority to waive an independence violation because the company and its accountant cannot be relieved of the obligation to file audit reports certified by an independent public accountant.
While there is no requirement under the Commission’s rules for issuers and their accountants to self-report independence violations, the staff expects that any potential violation of the independence rules has been appropriately evaluated by the accountant and the Company and its audit committee, to determine the potential regulatory implications. In addition, the accountant should also consider whether potential improvements to its quality control system are necessary to avoid similar future occurrences. When in doubt, we encourage issuers and accountants to consult with us on these matters.
Auditor Independence is a Shared Responsibility
The staff has previously commented that compliance with the auditor independence rules is a shared responsibility of both the accounting firm and the company and its audit committee. Rule 2-01 has a specific requirement for the audit committee to pre-approve audit and non-audit services to be provided by the Company’s accountant. A company should consider, as appropriate, the extent of its policies and procedures in place to promote compliance by its accountant with SEC and PCAOB independence rules.
For example, the accountant must be independent of its audit client and its affiliates and should have an effective system in place to identify affiliates accurately and in a timely fashion. Thus, regularly monitoring corporate structural changes or other operational events that may result in new affiliates is crucial to effective compliance. Incomplete or inappropriate assessments of a company’s affiliates make it more likely that independence violations will go unidentified. Since management has reasons beyond compliance with auditor independence rules for being aware of the company’s affiliates, management should have its own records concerning affiliates, which the accountant could refer to in determining if its list of affiliates is complete and accurate. We, in OCA, suggest that management and audit committees, along with its accountant, regularly review their current practices in this area.
Another area of the auditor independence rules where issuers can help promote compliance relates to the prohibition on business relationships between the accountant and its audit client, or persons associated with the audit client in a decision making capacity, such as officers, directors, or substantial stockholders. Through the years, there have been several enforcement actions that involved a prohibited business relationship between the accountant and an individual serving on the board and/or the audit committee of the issuer. The issuer is in a position to supplement the accountant’s independence procedures by requiring management, officers and directors to disclose potential conflicts or other relationships with its accountant that could be problematic. The staff in OCA encourages issuers, in consultation with their accountant, to evaluate the sufficiency of their monitoring processes, as appropriate, to reduce the likelihood of entering into prohibited business relationships.
In 2003 the Commission adopted the current partner rotation rules. Shortly thereafter, the staff issued a number of FAQs to help address some common questions it received about the application of the rules. However, it is impractical to address the full range of fact patterns and permutations that could arise in a series of FAQs or other staff guidance. Rather than issue more FAQs or interpretive guidance, the staff would prefer to respond to rotation questions on a case-by-case basis, so that it can give due consideration to the particular facts and circumstances. Thus, the staff continues to encourage your questions in this area. One reminder is that quarterly reviews should not be overlooked in complying with partner rotation requirements. For example, even if a partner only served as the lead partner for one quarterly review during the year, that year would count as one year toward the total number of years which that partner served as the lead partner on the engagement.
Bookkeeping/Financial Statement Preparation
As you may be aware, bookkeeping and/or financial statement preparation services provided to broker dealer audit clients have come to the forefront over the past few years. As reflected in recent SEC/PCAOB enforcement actions, while the AICPA independence rules may be less restrictive in this space, these services, if provided to SEC audit clients, are independence impairing. It is worth a reminder that the same restriction applies to audit or attestation engagements performed to satisfy the requirements of the Investment Adviser Custody Rule, as they are also subject to SEC independence rules.
The Commission’s guidance provides that 1) bookkeeping, 2) financial information systems design and implementation, 3) appraisal, valuation, fairness opinions, or contribution-in-kind reports, 4) actuarial, and 5) internal audit outsourcing, are prohibited “unless it is reasonable to conclude that the results of the services will not be subject to audit procedures during an audit of the audit client’s financial statements.” However, as noted in the Commission’s 2003 rule release, the circumstances for which the provision can be applied are very narrow and there is a rebuttable presumption that the services are subject to audit. More recently, the staff has been asked about the application of this provision to circumstances not addressed in the Commission’s guidance, such as an accountant providing bookkeeping services to an adviser or its private funds where the accountant also performs audits pursuant to the Custody Rule. We suggest that accountants and their audit clients use caution before proceeding with any engagement that is predicated upon the “not subject to audit” exception and consider consulting with the staff, where appropriate.
In conclusion, please note that the prohibitions on bookkeeping and financial statement preparation are not intended to discourage two-way communications between the accountant and its audit client. The Commission addressed this issue from an internal control perspective in its May 2005 statement on implementation of Section 404 of the Act, which encourages frequent and frank dialogue between management, accountants and audit committees. As long as management determines the accounting to be used and does not rely on the accountant to design or implement the controls, we do not believe that the accountant's providing advice or assistance, in itself, constitutes a violation of the Commission's independence rules. Similarly, in connection with the implementation of the new revenue recognition standard, or any other standard, the staff believes that, in general, the accountant may provide guidance about the proper application of accounting principles, including important factors to be considered in making judgments that may become critical in the accounting process. However, the accountant should always be mindful that in the course of providing such advice it should not find itself in the position of auditing its own work or in the position of acting as management, such as having direct involvement in, for example, the development of specific revenue recognition policies.
In closing I would like to remind you that the general standard in Rule 2-01(b) recognizes that an auditor must be independent in fact and appearance, while Rule 2-01(c) only sets forth a non-exclusive specification of circumstances inconsistent with the general standard. Maintaining auditor independence should not simply be treated as a compliance exercise. Auditors and their audit clients should keep in mind the vital role independence plays in promoting investor confidence and fostering high quality audits, and always be mindful of those services or relationships not specifically addressed in Rule 2-01(c).
 See OCA, Guidance for Consulting with the Office of the Chief Accountant, available at http://www.sec.gov/info/accountants/ocasubguidance.htm.
 See Brian Croteau, Remarks Before the 2013 AICPA National Conference on Current SEC and PCAOB Developments — Audit Policy and Current Auditing and Internal Control Matters (Dec. 9, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1370540472057
 See Rule 2-01(c)(7) of Regulation S-X.
 See Rule 2-01(f)(4) of Regulation S-X.
 See Rule 2-01(c)(3) of Regulation S-X.
 See e.g. In re Deloitte & Touche LLP, Alps Fund Services, Inc., and Andrew C. Boynton, AAER No. 3668 (July 1, 2015), available at http://www.sec.gov/litigation/admin/2015/34-75343.pdf; In re Deloitte & Touche (South Africa), AAER No. 3428 (Dec. 13, 2012), available at http://www.sec.gov/litigation/admin/2012/34-68432.pdf; In re Ernst & Young LLP, John F. Ferraro, CPA, and Michael G. Lutze, CPA, AAER No. 2858 (Aug. 5, 2008), available at http://www.sec.gov/litigation/admin/2008/34-58309.pdf; In re Mark C. Thompson, AAER No. 2859 (Aug. 5, 2008), available at http://www.sec.gov/litigation/admin/2008/34-58310.pdf.
 See Frequently Asked Questions related to independence (Dec. 13, 2011), available at http://www.sec.gov/info/accountants/ocafaqaudind080607.htm.
 See Rule 2-01(c)(4)(i) of Regulation S-X.
 See Rule 2-01(c)(4)(i)—(v) of Regulation S-X.
 See Commission Statement on Implementation of Internal Control Reporting Requirements (May 16, 2005), available at https://www.sec.gov/news/press/2005-74.htm.
 See Rule 2-01(b) of Regulation S-X.