Highlights of the new SEC Auditor Independence Rule

Attorney-CPA, The, 2001 by Carroll, Brian

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 the author's colleagues upon the staff of the Commission.

After months of wrangling with the accounting profession, the SEC recently adopted a new rule redefining its auditor independence requirements. Generally, the rule, entitled "Revision of the Commission's Auditor Independence Requirements" ("Rule"), revises two key categories of restrictions designed to ensure auditor independence: auditor investments in and employment by audit clients, and the scope of non-audit services provided by audit firms to their audit clients. While reducing restrictions on investment and employment opportunities on auditors and their families, the Rule restates existing restrictions on certain non-audit services and, in some instances, imposes new ones. This article highlights non-audit services restrictions placed on audit firms under the Rule.

This Rule primarily amends Rule 2-01 of Regulation S-X, 17 C.F.R. 210.2-01, which applies to "any independent certified or independent public accountant who performs an audit of or reviews a public company's financial statements or whose report or opinion is filed with the Commission in accordance with federal securities laws or the Commission's regulations." Rule at ftnt. 5, http://www.sec.gov/rules/final/33-7919.htm. Obviously, this broad language covers most, if not all, accounting engagements that result in a SEC filing under various provisions of the Securities Act of 1933, Securities Exchange Act of 1934, Public Utility Holding Company Act of 1935, Investment Company Act of 1940 and Investment Advisors Act of 1940. The Rule, however, does not apply to audit clients that are not required to file with the SEC.

Although the Rule restricts in some form the offering of nine specified non-audit services to audit clients, this list is not exclusive. The Rule establishes a "catch-all" test to determine whether auditor independence has not been maintained, regardless of whether the non-audit service is specifically restricted. As described in the "Preliminary Note to Section 210.2-01" ("Preliminary Note"), the new paragraph (b) of Rule 2-01 sets a "general standard of auditor independence." Under this standard, the SEC will not recognize an accountant as independent if "the accountant is not, or a reasonable investor with knowledge of all the 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." Rule 2.01(b).

Moreover, this Preliminary Note goes on to list four principles to be considered when determining whether the auditor is independent under paragraph b of Rule 2-- 01. These principles focus on the whether the auditor-- client relationship or the provision of service: "(a) creates a mutual or conflicting interest between the accountant and the audit client; (b) places the accountant in the position of auditing his or her own work; (c) results in the accountant acting as management or employee of the audit client; or (d) places the accountant in a position of being an advocate for the audit client."

In addition, paragraph (b) of Rule 2-01 permits the SEC to consider all relevant circumstances in determining whether the auditor is independent. Relevant circumstances include "all relationships between the accountant and the audit client, and not just those relating to the reports filed with the Commission." Rule 2-- 01(b). Taken together, the Preliminary Note and paragraph (b) of Rule 2-01 places practitioners on notice that the issue of their independence is subject to broad SEC scrutiny even though they may not have provided one of the nine restricted non-audit services to an audit client.

Under new paragraph (c)(4) of Rule 2-01, an accountant is not independent "if, at any point during the audit and professional engagement period, the accountant" provides any one of nine non-audit services to an audit client in violation of the Rule. These nine non-- audit services are list under paragraph (c)(4) as follows: (i) Bookkeeping or other services related to the audit client's accounting records or financial statements; (ii) Financial information systems design and implementations; (iii) Appraisal or valuation services or fairness opinions; (iv) Actuarial services; (v) Internal audit services; (vi) Management functions; (vii) Human resources; (viii) Broker-dealer services; and (ix) Legal services. Although some of these services are flatly prohibited, many may be provided, in varying degrees, under specified circumstances. Rule 2-01 (c)(4)(i)-(ix).

The legal services provision unequivocally prohibits "[p]roviding any service to an audit client under circumstances in which the person providing the service must be admitted to practice before the courts of a United States jurisdiction." Rule 2-01(c)(4)(ix). This position is consistent with the SEC's interpretation of its rules and regulations as illustrated in Matter of Charles E. Falk, A.P. No. 3-9902, 1999 SEC Lexis,