SEC plans update to auditor independence rules; Clayton and others issue audit committee reminders

By Mark S. Nelson, J.D.

The SEC proposed to amend the auditor independence requirements contained in Rule 2-01 of Regulation S-X to improve efficiency and effectiveness, said an SEC press release. The changes address five specific aspects of Rule 2-01, which was last significantly updated in the early 2000s but which the SEC press release said does not address recent evolutions in capital markets. Separately, SEC officials, including Chairman Jay Clayton, issued a statement reminding market participants of the role of audit committees, especially regarding year-end considerations. There will be a 60-day comment period after the Regulation S-X release is published in the Federal Register (Amendments to Rule 2-01, Qualifications of Accountants, Release No. 33-10738, December 30, 2019).

Rule 2-01. The proposal, if adopted, would remove the existing preliminary note and replace it with a new introductory paragraph that contains the same admonitions. More significant changes would be made to the following subsections of Rule 2-01:

• Amend “affiliate of the audit client” (Rule 2-01(f)(4)) and “Investment Company Complex” (Rule 2-01(f)(14)) regarding affiliate relationships, including common control issues.
• Amend “audit and professional engagement period” (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 relationship rule with the concept of beneficial owners with significant influence.
• Replace transition and grandfathering provisions contained 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 as a result of merger and acquisition transactions. 

Statement on audit committees. Clayton, SEC Chief Accountant Sagar Teotia, and William Hinman, Director of the SEC's Division of Corporation Finance, issued a separate statement on the role of audit committees. According to these SEC officials, the “observations and reminders” are intended to emphasize that audit committee requirements set forth in the Sarbanes-Oxley Act are among that Act’s most effective provisions. The officials also said firms should consider the areas cited in the statement while ensuring that their audit committees have adequate resources.

Several general observations include: (1) ensuring that the tone at the top promotes the integrity of the financial reporting process; (2) encouraging audit committees to mull the monitoring practices of the auditor and the issuer; (3) encouraging audit committees to proactively engage with management and auditors regarding new accounting standards, such as those for revenue recognition and leases; (4) ensuring that audit committees have sufficient information about a firm’s internal controls over financial reporting; and (5) facilitating communications from auditors to audit committees under the PCAOB’s AS 1301 standard for such communications.

The SEC officials also provided several more targeted reminders regarding non-GAAP financial measures, the transition from LIBOR to a new reference rate, and the communication of critical audit matters.

The release is No. 33-10738.