SEC Issues Independence Proposal - Brief Article

Internal Auditor, August, 2000 by L. Miller

IN AN ONGOING ATTEMPT to eradicate breakdowns in the financial reporting process, the U.S. Security and Exchange Commission (SEC) recently released for comment an "auditor independence rule proposal." The proposal is intended to modernize the criteria against which the SEC measures external auditor independence.

The SEC focused on three primary areas when developing the rules: investments by auditors or their family members in audit clients, employment relationships between auditors or their family members and audit clients, and the scope of services provided by the audit firms to their audit clients. The proposal also lists four guiding principles that are rooted in the bedrock philosophy of the profession and ensure independence in fact and appearance.

The proposed regulations identify certain nonaudit services that, if provided to an audit client, would compromise independence. Outsourcing internal auditing is included in the list of nonaudit services. According to the proposal, external auditors rely, to some extent, on the internal control system when conducting audits of financial statements. Thus, they would be basing what should be objective analyses on a system they helped to establish and maintain. Other disallowed services proposed by the SEC include financial information systems design and implementation; appraisal, actuarial, investment advisor, and legal services; and management functions.

The regulations would allow for operational internal audits unrelated to internal accounting controls, financial systems, or financial statements. Also, the SEC proposal provides an accounting firm with limited exception from sanctions if the offending individual is "reasonably unaware" of the violation or if it is corrected promptly.

The proposal will be subject to public comment and hearings for 75 days following its publication in the Federal Register. The SEC conducted the first public hearing July 26; additional hearings will take place in September.