At the end of October 2020, the Securities and Exchange Commission (SEC) announced amendments to the auditor independence rules under Regulations S-X.
As a general rule, auditors must be independent from the entity being audited for the entire engagement period and the period covered by the financial statements being audited. For this reason, auditors are required to disclose any potential conflicts to the companies’ audit committee before engaging in the audit. Audit committees in turn must investigate any potential conflicts and decide whether an auditor is capable of exercising objective and impartial judgment on issues encompassed within the audit engagement based on certain connections the auditor might have with the company.
Under the new amendments to the auditor independence rule, the SEC will focus more on whether an auditor is practically capable of exercising objective and impartial judgment and less on their relationship with the company.
First, SEC has added certain student loans and de minimis consumer loans to the list of exclusions that would not prevent an independent auditor to qualify for an audit if for example there is another partner in the audit firm who is still paying off student loans to the lender who is being audited.
Second, SEC has shortened the look-back period, in the context of initial public offerings (IPOs). Previously companies had to look back three years to determine whether they met the independent auditor requirements, now, companies will only have to look back one year for this determination.
Additionally, there are some changes to the rules in the context of Mergers and Acquisitions as well as interest ownership percentage requirements which arguably make these Amendments one of the most significant changes to the auditor independence rules since 2003.
Companies that need to comply with SEC rules should revisit and update their auditor and conflicts of interest policies in order to comply with the new requirements which will be effective 180 days after publication of the final rule in the Federal Register. However, in light of the recent changes in the administration the effectiveness of the rule might be delayed until the new administration charts its regulatory course.
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