The auditor independence rules set forth in Rule 2-01 of Regulation S-X require, among other things, auditors to be independent of their audit clients. Rule 2-01(b) sets forth the general auditor independence standard, which focuses on the objectivity and impartiality of the auditor, and Rule 2-01(c) provides a non-exclusive list of relationships and circumstances, including certain financial, employment, and business relationships, in which an auditor would not be considered “independent” from an audit client.
The Amendments update the auditor independence rules to address recurring fact patterns in which certain relationships and services triggered technical rule violations under the current auditor independence rules without necessarily impairing the auditor’s objectivity and impartiality. By adopting the Amendments, the SEC seeks to increase investor protection by focusing the auditor independence rules (and thereby the attention of audit clients, audit committees and auditors) on relationships and services that are more likely to jeopardize the objectivity and impartiality of auditors, while avoiding potentially time-consuming audit committee review of technical rule violations and similar non-substantive matters. The Amendments are particularly helpful for private equity firms and investment companies with numerous portfolio companies and investments.
Among other things, the Amendments:
- address potential independence issues arising when portfolio companies with a common private equity fund owner, or investment companies within the same investment company complex, have engaged an audit firm to provide audit and non-audit services that could impair the independence of the audit firm;
- shorten the look-back period for domestic first-time filers in assessing compliance with the independence requirements;
- clarify the application of the business relationship rule under Rule 2-01(c)(3); and
- introduce a transition framework to address inadvertent independence violations that only arise as a result of mergers or acquisitions.
Independence Issues Involving Affiliated Sister Entities