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SEC Issues Guidance on Auditor Independence
Practical Law Legal Update 7-555-7085 (Approx. 4 pages)
SEC Issues Guidance on Auditor Independence
by Practical Law Corporate & Securities
| Published on 28 Jan 2014 • USA (National/Federal) |
The SEC issued new guidance on auditor independence in a report of investigation under Section 21(a) of the Exchange Act relating to its investigation of KPMG LLP.
On January 24, 2014, the SEC issued as an Exchange Act release a Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: KPMG, LLP (Report). The Report describes an investigation of KPMG by the SEC's Division of Enforcement to determine whether KPMG's independence was impaired under Rule 2-01 of Regulation S-X when the firm loaned non-manager level tax professionals to certain audit clients.
The purpose behind Rule 2-01 is to ensure that auditors are qualified and independent of their audit clients, both in fact and in appearance. Rule 2-01(b) sets out a general standard for auditor independence, while Rule 2-01(c) sets out certain non-exclusive circumstances that are inconsistent with the general standard. Among other things, Rule 2-01 prohibits an independent auditor from acting as an employee of an audit client.
The Report states that the SEC has decided not to pursue an enforcement action against KPMG relating to the loaned staff engagements. The SEC did, however, deem it appropriate and in the public interest to issue the Report to address uncertainty about the SEC's interpretation of the "acting as an employee" provisions of Rule 2-01.
Factual Background: KPMG Tax Loaned Staff Engagements
The SEC's investigation found that, from at least 2007 through 2011, KPMG entered into loaned staff engagements with multiple SEC audit clients. The engagements involved non-manager level KPMG professionals performing junior-level tasks related to tax compliance. Along other things, the loaned staff:
- Were supervised by, took sole direction from, and had their performance evaluated by, the audit clients' managers.
- Performed the same work as employees of the audit clients.
- Worked exclusively and continuously at the audit clients' places of business for extended periods of time of up to six months.
- Used the audit clients' resources, including physical work spaces, client-issued computers and e-mail addresses, and internal networks, spreadsheets and shared folders, to perform their loaned staff work.
KPMG paid the loan staff as it would a typical KPMG employee and continued to provide them with KPMG benefits. Fees for the loaned staff arrangements were billed to the audit clients in a way similar to the way that KPMG bills its clients for other non-audit services.
Guidance on Regulation S-X Rule 2-01
The Report provides new guidance for auditors and reporting companies interpreting the auditor independence requirements of Rule 2-01(b) and (c):
- An auditor may not provide otherwise permissible non-audit services (for example, permissible tax services) to an audit client in a manner inconsistent with the other provisions of the independence rules (including the prohibition against acting as an employee of the audit client). An auditor must therefore examine both:
- the nature of the proposed non-audit services; and
- the manner in which those services would be delivered.
- An arrangement or relationship that results in an accountant acting as an employee of an audit client implicates Rule 2-01(c)(4)(vi), separate from whether the accountant acted as a director or officer or performed any decision-making, supervisory or ongoing monitoring functions for the audit client. The SEC also noted that an accountant is not independent under Rule 2-01(c)(2)(i) when a current professional employee of the accounting firm is employed by an audit client. Rule 2-01(c)(4)(vi) also prohibits accountants from doing indirectly (in this case, acting as an employee) what they may not do directly (being an employee). Either situation could raise concerns that the firm and its employees would not be impartial in appearance or in fact.
- The SEC believes that the "acting as an employee" provision of Rule 2-01 requires accountants and audit committees to carefully consider whether a given relationship or service would cause the accounting firm's professionals to resemble, in appearance and function, even on a temporary basis, employees of the audit client. The degree of control that the audit client exercises over audit firm personnel is a key factor in this analysis. An accounting firm's independence under Rule 2-01 could be at risk if accounting firm personnel routinely work:
- at the direction and under the supervision and control of audit client management;
- along with and in a capacity identical or substantially similar to the audit client's own employees; and
- at the audit client's place of business.
The SEC noted that the Report is consistent with its earlier statement that an accounting firm can provide tax services to its audit clients without impairing the firm's independence. Unlike loaned staff arrangements, typical tax services engagements do not involve the audit firm providing personnel to the audit client. Instead, they involve the audit firm performing services for the audit client. Further, auditor personnel working on typical tax services engagements are supervised by the firm's managers, who remain responsible for directing the firm's personnel and ensuring the quality of their work product. Therefore, typical tax services engagements do not involve the same issues that loaned staff arrangements do.
For more on auditor independence and oversight, see Practice Note, Auditing: An Overview.