Office of the Chief Accountant: Regarding Auditor Independence Letter to PricewaterhouseCoopers
May 12, 2017
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON. D C. 20549
July 26, 1999
Mr. Nigel Buchanan
32 London Bridge Street
London SEI 9SY
Dear Mr. Buchanan:
You have requested the SEC staff's concurrence with your firm's conclusion set forth in letters dated June 9, and July 9, 1999 that your firm is independent of your client Prudential Corporation plc ("Prudential"). As noted below, the staff is unable to concur with your conclusion.
Investment Management Services
You have represented to the staff in your letters and in meetings with the staff that Prudential provides investment management services to the trustees of a legacy Price Waterhouse LLP ("PW") defined benefit pension plan and that the trustees of the plan are partners in PwC.
Rule 2-01 of Regulation S-X states that, "... an accountant will be considered not independent with respect to any person or any of its parents, its subsidiaries, or other affiliates (1) in which, during the period of his professional engagement to examine the financial statements being reported on or at the date of his report, he or his firm or a member thereof had, or was committed to acquire, any direct financial interest or any material indirect financial interest..." For purposes of interpreting this section, as noted in section 602.02.b of the Codification of Financial Reporting ("the Codification"), "any financial interest in a client, owned by the accountant ... is considered to be a direct interest." And, "[a]s indicated in this section, materiality is not a consideration in the case of a direct financial interest."
Further, as noted in section 602.02.g of the Codification, "direct and material indirect business relationships, other than as a consumer in the normal course of business, with a client ... will adversely affect the accountant's independence with respect to that client. Such a mutuality or identity of interests with the client would cause the accountant to lose the appearance of objectivity and impartiality in the performance of his audit because the advancement of his interest would, to some extent, be dependent upon the client."
The SEC staff position regarding the independence of an auditor under these circumstances is accurately reflected in your correspondence dated July 9, 1999 stating that the "Investment Advisor .. cannot be an attest client of the Firm." The SEC staff believes that PwC is not independent under circumstances in which Prudential is acting as an investment adviser to the firm.
Unit Linked Insurance Policies
You have represented that Prudential offers, and members of PwC have invested in, unit-linked insurance products where the policy holder pays a premium, a portion of which is used to purchase a death benefit for the policyholder and the remainder is invested and managed by Prudential in unit linked funds. PwC has further represented that the value of the policies is linked to the underlying assets of the policy. You have stated your belief that this arrangement is analogous to the facts set forth in AICPA Ruling 41, Member as Auditor of Insurance Company.
The SEC staff believes that permitting a member to leave on deposit sums with an audit client raises the same independence issues that are raised under similar facts and circumstances where the staff has objected to the independence of the auditor. For example:
- As noted above, and as documented in PwC's correspondence to the staff, an auditor is not independent of an a client that acts as an investment adviser for the auditor. PwC has stated that Prudential manages the investment of the portion of premiums not used to purchase a death benefit for the policyholder. Thus, Prudential appears to be acting as an investment adviser to members that hold investments in unit-linked insurance products.
- The SEC staff has objected to the independence of auditors that allow a broker/dealer audit client to hold the auditor's funds or securities for longer than a normal settlement period. Permitting an insurance company/investment adviser to hold the auditor's cash and securities in a unit-linked fund conflicts with previous SEC staff positions in which the auditor was found to be lacking in independence from a broker/dealer audit client.
You have represented that the unit linked funds appear on the balance sheet of Prudential as "assets held to cover linked liabilities (or the corresponding balance sheet liability associated with the unit-linked policies." As a result, the auditor appears to be placed in the position of auditing the valuation of the respective assets and liabilities that include amounts attributable to the auditor. In essence, the auditor has a direct financial interest in the audit client that creates a lack of independence due to an impermissible mutuality of interest because the advancement of the interest of members of the audit firm would, to some extent, be dependent upon the client's ability to manage and value the members assets."
As noted above, the SEC staff believes that PwC is not independent under circumstances in which Prudential is acting as an investment adviser to the firm with respect to funds that are separately managed in unit-linked investment accounts.
You have represented that Prudential sold its Canadian subsidiary and thereafter had no employees in Canada. PwC also represented that PwC Canada performed bookkeeping services for a price that was less than 1% of total audit fees for Prudential. This amount has been permitted under certain circumstances by the SEC Staff as set forth in section 602.02.c.iii of the Codification of Financial Reporting. PwC has also indicated that the service has been terminated. Based on the facts and circumstances, the aforementioned bookkeeping services would not impair the firm's independence.
You have represented that PwC received a contingent fee from an entity ("Newco") of which Prudential owns 45% and that Prudential has the right to appoint one of six board members of Newco.
Under Rule 2-01 of Regulation S-X, an auditor would lack independence where the auditor had a direct financial interest in an audit client or any affiliate of the audit client. A contingent fee is viewed by the SEC staff as a direct financial interest that creates an impermissible mutuality of interests between the audit client and the auditor. The staff believes that an auditor lacks independence even if the contingent fee arrangement was with an affiliate of the audit client. The staff does not concur with PwC that Newco is not an affiliate of Prudential.
In this case, PwC indicates that the contingent fee does not cause PwC to lack independence since the fee was immaterial to PwC, and the audit client. However, the staff does not use a materiality test in assessing whether a contingent fee arrangement causes the auditor to lack independence. Consequently, the staff believes that PwC's independence was impaired due to the contingent fee arrangement with Prudential's affiliate.
Investments by Former Partners
You have represented that ownership of investments in audit clients by former partners that continue to share in the profits of PwC is not precluded under applicable independence rules. PwC has represented that it has informed the affected former partners that US independence rules preclude those partners from holding any direct or material indirect financial interests in Prudential, and in Prudential unit trusts (which are not unit-linked insurance policies).
Based on the aforementioned discussion of unit-linked insurance policies, the staff would object to PwC's independence if former partners that continue to share in the profits of PwC hold unit-linked insurance policies in Prudential or its affiliates.
Investments in Prudential Held in Retirement Plan
You have represented that several years ago, C&L acquired Deloitte, Haskins & Sells-UK ("DH&S") and that the DH&S retirement plan was not discontinued. The plan held 292,OOO shares in Prudential and 16,226 shares in Prudential Property Managed Fund (which was not an audit client). PwC has represented that these shares "have recently been disposed of" Based on the facts and circumstances, the investments held in the DH&S retirement fund would not impair the firm's independence.
Based on the facts and circumstances that you have provided the staff in your letters dated June 9, and July 9, 1999 and in subsequent discussions, the Staff is unable to concur with your conclusion and can provide you with no comfort that you are independent of Prudential under the U.S. independence rules.
In order to comply with the US independence rules, you must undertake the following:
1. Terminate the relationship through which Prudential provides investment management services to the trustees of the legacy PW benefit pension plan.
2. Eliminate any investments by members of PwC in unit-linked insurance products offered by Prudential and any of its affiliates. Also, please provide the SEC staff with a copy of the letter(s) notifying the affected former partners and describe to the staff the procedures that PwC and Prudential will undertake to assure that no affected former partners continue as investors in Prudential.
3. Discontinue providing any services to Prudential and any of its affiliates or investees on a contingency fee basis. Also, please provide the staff with a copy of the PwC policy on contingent fees as well as a description of the quality controls in place to assure that the firm does not enter into contingent fee arrangements with other US and foreign registrants or their affiliates.
You may be aware that where am auditor has complied with home country independence requirements for all periods, the staff has permitted the inclusion of the auditor's reports in an initial registration statement if the auditor was independent under U.S. requirements for at least the most recent fiscal year covered by the reports. You have represented to the staff that PwC was in compliance with the independence requirements applicable in the home country in this instance.
This letter outlines steps that PwC must take to comply with U.S. independencerules. If PwC completes those steps before beginning its audit of Prudential's 1999 financial statements, and Prudential's registration statement includes audited financial statements for a period in 1999 of not less than nine months, the staff will not object to the inclusion of PwC's audit reports for all periods presented. This should not be construed as a conclusion by the staff that PwC was independent for any period prior to January 1, 1999.
These staff conclusions are based on the facts presented in your letters and meetings with the staff. Different facts may result in different positions being taken by the staff. If you have any questions, please contact Scott Bayless at (202)942-4400.
Lynn E. Turner