(The news featured below is a selection from the news covered in Federal Securities Law Reporter, which is distributed to subscribers of Federal Securities Law Reporter.)

Chief Accountant Updates Advice on Auditor Independence

The Office of the Chief Accountant has updated its responses to frequently asked questions about auditor independence. The updates cover areas related to financial relationships, prohibited and non-audit services, audit committee preapproval, fee disclosures and the cooling off period.

With respect to financial relationships, the advice stated that second mortgages, home improvement loans, equity lines of credit and similar obligations that are collateralized by a primary residence, are subject to the same exception as mortgages secured by the primary residence if one is not a covered person at the time of the loan origination. If the ownership of the loan changes and the borrower becomes a covered person, the staff would not object to the auditor's independence based solely on the existence of the loan as long as there is no modification in the terms or conditions after the borrower becomes a covered person, or in contemplation of becoming a covered person.

The Office of the Chief Accountant said that a successor auditor's independence would not be impaired in the current period if he or she provided prohibited and non-audit services relating to the financial statements of a prior period that were audited by a predecessor auditor as long as the services related solely to the prior period audited by the predecessor and were performed before the successor was engaged to audit the current period. 

An accountant would not be considered independent if, at any time during the audit and professional engagement period, he or she provided translation services to SEC audit clients based in foreign jurisdictions or U.S. clients with foreign operations. The staff advice explained that translation services require decisions and judgments on behalf of management with respect to the use of various words and phrases, and specific accounting, business and industry terms. In conveying the meanings as expressed by management in the original language, it could create a mutual or conflicting interest between the accountant and the audit client and may put the auditor in the position of auditing their own work.

Whether the independence of an auditor of a Form 11-K employee benefit plan filer would be impaired when providing prohibited non-audit services to the non-audit client sponsor of the plan depends on the type of service provided, according to the Office of the Chief Accountant. The employee benefit plan is a separate issuer but is considered to be an affiliate of the sponsor to the plan, so it is subject to the prohibited services rules. Since the accountant is auditing the plan, and not the plan sponsor, the services would be permissible as long as the services are limited to prohibited non-audit services that contain the modifier "unless it is reasonable to conclude that the results of these services will not be subject to audit procedures during an audit of the client's financial statements" and the auditor does not provide any services that would affect the plan's financial statements or the audit.

The advice stated that auditors of parent financial statements must be independent of entities that are consolidated due to the application of FASB Interpretation No. 46, Consolidation of Variable Interest Entities, known as "FIN 46R". An enterprise that consolidates variable interest entities may obtain the ability to make decisions that affect their activities through contracts or their governing documents. The Office of the Chief Accountant added that registrants may wish to consult with the staff if an enterprise believes that it does not control a variable interest entity that it was required to consolidate under FIN 46R.

The audit committee of a plan sponsor of an employee benefit plan does not have to preapprove the audit of the plan. However, audit committees are not precluded from establishing policies for preapproval. Audit committees are required to preapprove services provided by the issuer's principal accountant to variable interest entities that are consolidated under FIN 46R. 

Issuers must include in their fee disclosures any fees paid to the principal auditor of a sponsor for the audit of its employee benefit plan, regardless of whether the fees are paid by the sponsor or the plan. The issuer may identify the fees paid to the accountant that were not paid by the issuer or were not subject to the preapproval requirements if it wishes.

In response to an inquiry about the application of the cooling off period to the three years of audited financial statements included in an initial public offering and periods after a company becomes an issuer, the chief accountant's staff advised that accounting firms must consider their relationship with the client prior to and after the client becomes an issuer. Since the IPO will contain an audit report for three years, the cooling off rules would apply to all years. In applying the cooling off rules for time periods prior to the IPO filing, the day after the audit report release date constitutes the commencement of the audit procedures.