When independent auditors are able to maintain their actual independence it is referred to as?

Independence is a core value for auditors, who must have an objective, impartial, and skeptical mindset as they work to strengthen the integrity of information that investors and others rely on.

At the very end of last year, the US Securities and Exchange Commission (SEC) announced a proposal to modernize its auditor independence framework. Comments on this proposal are due by March 16, and the Center for Audit Quality (CAQ) looks forward to providing our detailed views to the SEC.

At a high level, what are key points to know about these developments now? Here are a few questions and answers, from the CAQ point of view.

Broadly speaking, what kind of change does the SEC proposal contemplate?

Before diving in to the SEC's 86-page proposal, the following three points are worth bearing in mind.

• The SEC's rule proposal is aimed at strengthening and modernizing the rules around auditor independence, an objective that the CAQ supports. Auditor independence rules haven't been updated since 2003, and the SEC is using real-life consultation experience to bring them in line with the current business ecosystem.
• Provisions in the Sarbanes-Oxley Act of 2002 (SOX) greatly enhanced auditor independence and objectivity, and these policies remain effective today. In the SEC proposal, there are no proposed changes to prohibited services in SOX.
• This proposal does not change the general rule, which essentially states that the Commission will not recognize an accountant as independent if the accountant is not (or a reasonable investor would conclude the accountant is not) capable of exercising objective and impartial judgment on all issues encompassed within an engagement.

Specifically, what are the key changes that the SEC is proposing?

Here are a few noteworthy changes.

• Adding a materiality qualifier to sister entities under common control to the definition of affiliate
• Shortening the look-back period to one year for which an auditor must comply with SEC independence rules before a domestic company goes public
• Excluding certain student loans and de minimis consumer loans from restricted lending relationships
• Providing a transition framework for auditors of no more than six months for inadvertent violations for mergers and acquisitions, while still requiring corrections of known violations and maintaining a system of quality control
• Replacing the term "substantial stockholder" in the Business Relationships Rule with the phrase “beneficial owners (known through reasonable inquiry) of the audit client’s equity securities where such beneficial owner has significant influence over the audit client.”

How might the SEC proposal affect audit firms?

Again, being independent is integral to the auditor's role, and the auditing profession has always been strongly committed to maintaining auditor independence. Audit firms will continue to have systems and controls in place to comply with regulatory requirements and maintain independence.

How might the SEC proposal affect audit quality?

It’s important to understand that the goal of the proposed amendments is to evolve current rules to reflect the SEC’s experience and to benefit audit quality. As the SEC states in its release:

 “The proposed amendments would more effectively focus the independence analysis on relationships and services that are most likely to threaten auditor objectivity and impartiality.”

Under the current rule set, the shared responsibility of the audit client, the audit firm, and the audit committee to monitor independence is often substantial, especially in the context of a changing list of affiliates. The proposal looks to sharpen the focus of both the audit firm and the client on potential threats to independence.

What are the implications of this proposal in terms of competition among audit firms?

We agree with the SEC that the proposed amendments could encourage competition.

The way the rules are written currently, auditor choice is often limited due to relationships an audit firm has with either a pre-IPO company or an affiliate of an audit client. The proposed amendments would focus the definition of affiliate on those sister entities that are material to the controlling entity. In some cases, this could result in an audit firm previously excluded from contention for an audit to be allowed to compete for the work. This scenario could be more common, for example, in the private equity space, given that private equity structures have become larger and more complex over the past two decades.

I welcome your thoughts in the comments section, and for more on auditor independence, check out the CAQ's website.

Vanessa Teitelbaum, CPA, is a Technical Director of Professional Practice at the Center for Audit Quality. 

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