On October 16, 2020, the SEC released an announcement that it adopted final amendments to Rule 2-01 of Regulation S-X, dealing with auditor independence. The amendments reflect updates based on observations that the SEC has made over several years and are expected to reduce time-consuming audit committee, management, and independent audit review of possible or identified nonsubstantive rule breaches.
The amendments will:
- Amend the definitions “affiliate of the audit client” in Rule 2-01 (f)(4), and “investment company complex” in Rule 201-(f)(14) to address certain affiliate relationships including entities under common control.
- Amend the definition of “audit and professional engagement period” under Rule 2-01(f)(5)(iii) to shorten the look-back period for domestic first-time filers in assessing compliance with the independence requirements.
- Amend Rule 2-01 (c)(1)(ii)(A)(1) and (E) to add certain student loans and de minimis consumer loans to the categorical exclusions from independence-impairing lending relationships.
- Amend Rule 2-01(c)(3) to replace the reference to “substantial stockholders” in the business relationships rule with the concept of beneficial owners with significant influence.
- Replace the outdated transition provision in Rule 2-01 (e) with a new Rule 2-01 (e) to introduce a transition framework to address inadvertent independence violations that only arise because of a merger or acquisition transaction.
There were other minor miscellaneous updates.
The SEC provided two examples to illustrate the benefit of the amendments. The first discussed two audit partners in the same firm. One partner audited a client that originated thousands of student loans per year. The other audit partner had student loan debt with the client but was not involved in the engagement. Under the old rules, this would be considered an independence conflict. Under the amended rules the student loan would no longer result in a violation of the independence rules.
The other illustration was regarding the audit of a portfolio company, which was one of hundreds of companies in an investment fund. Audit Firm A audits Company X, a nonpublic portfolio company of the fund in the United States. Two affiliates of Audit firm A provide limited short-term payroll and staffing services to two of the other portfolio companies (Company Y in Australia and Company Z in Spain). Under the old rule, if Company X wants to go public, it would need to replace the audit firm and would also have to wait to register with the SEC for 3 years. Alternatively, it could consult with the SEC and its audit committee to make the determination that the violation of the rule did not impair the auditor’s objectivity and impartiality. Under the new rules, this would not constitute an independence breach.
Two SEC commissioners criticized the amendments citing that they provide auditors with greater discretion and that there is no mechanism for investors and the SEC to see how auditors are making assessments. The amendments will be effective 180 days after publication in the Federal register. The amendments cannot be retroactively applied.
For more information on recent SEC updates and guidance, consider attending Surgent’s Annual Accounting and Auditing Update (ACAU).
Marci Thomas, MHA, CPA, CGMA is the Director of Auditing Content at Knowfully. She has been a nationally recognized author and discussion leader for 20 years. She has authored textbooks on Healthcare Financial Accounting and Board Governance.