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Office of the Chief Accountant Updates FAQ on Auditor Independence

The SEC's Office of the Chief Accountant has expanded and updated its frequently asked questions release on auditor independence. OCA has consolidated previous auditor independence FAQs into a single release which will be updated and maintained in one place for easier access. At a recent conference on SEC and PCAOB developments, Senior Assistant Chief Accountant Edmund Bailey said he is not aware of any new auditor independence initiatives underway at the SEC. The most recent initiative was the PCAOB's proposed prohibition on certain tax services by auditors to their audit clients.

The updated FAQ responds to a question about the transition period for partner rotations once an exemption no longer applies, such as when a public accounting firm accepts its fifth issuer audit client or its tenth partner. The staff advised that there is a transition period, similar to the transition period provided for a firm that no longer qualifies for the small firm exemption. A firm should determine on an annual basis, at the end of each calendar year, whether it still qualifies for the small firm exemption. If the exemption no longer applies, the lead partner may continue to serve a client through the first annual audit period after the exemption is no longer applicable, even if the partner has served for more than five consecutive years.

The concurring review partner may continue to serve through two annual audit periods ending after the exemption is no longer applicable, regardless of whether the partner has served the client for more than five consecutive years. Audit partners, other than the lead and concurring partners, receive a "fresh clock" and may continue to serve through seven annual audit periods ending after the exemption is no longer available.

Once an audit partner rotates off of an audit engagement, any services that continue the direct relationship with the issuer, such as tax services or national office/technical services, would not be considered time off of the engagement. The rules permit only limited discussions between the audit engagement team and the rotated-off partner.

The entire audit of an issuer must be conducted by independent auditors, including the audit of the issuer's subsidiary or equity method investee whose report is required to be included in an SEC filing. The principal auditor is primarily responsible for determining and confirming compliance with the independence rules, according to the FAQ.

The definition of audit partner for purposes of the rotation requirement would include a partner who is primarily responsible for the audit of internal control over financial reporting.

The independence rules apply to audits of financial statements required by the SEC rules except those required by Regulation S-X rules 3-05 and 3-14 and Regulation S-B Items 310(c) and (e).

There has been no change to the SEC's policy on accountant indemnification agreements with registrants. When an accountant and client, directly or through an affiliate, enter into an agreement of indemnity that seeks to provide the accountant with immunity from liability for negligent acts, whether by omission or commission, the accountant is not independent, according to the FAQ. A firm's independence would also be impaired if the engagement letter includes a clause that the registrant will release, indemnify or hold the firm harmless from any liability and costs resulting from knowing misrepresentations by management.

The FAQ revises a number of previously issued responses, including three relating to fee disclosures. The revised responses explain that fees that are billed or are expected to be billed for the audit of the registrant's financial statements for the two most recently completed fiscal years and the review of financial statements for any interim periods within those years should be disclosed in response to Schedule 14A Item 9(e)(1). If the registrant has not received a bill for those audit services prior to filing its definitive proxy statement, it should ask the auditor for the amount to be billed for such services, and disclose that amount. The Items 9(e)(2)-9(e)(4) disclosure should include amounts billed for services that were rendered during the most recent fiscal year, even if the auditor did not bill the registrant for those services until after the year-end.

The staff also noted in a revised response that Item 9(e) does not specify where in the proxy statements the disclosures should appear. The staff believes it is appropriate that the disclosures accompany the information required by Schedule 14A Items 7(d) and 9(a)-(d). The information can be included in the audit committee report, but the staff reminded registrants that the Item 7(d)(3)(v) safe harbor applies only to information disclosed under Item 7(d)(3). The safe harbor in Regulation S-K Item 306(c) applies only to information disclosed in Items 306(a) and (b). Neither safe harbor would cover the disclosures required by Item 9(e) but included in the audit committee report.

Domestic companies may incorporate the Items 9(a)-(d) disclosure from the proxy or information statement into the annual report. Registrants that do not issue proxy statements must disclose the information in their annual filings.

Where there is a change of accountants during the year, the fee disclosure should only be made for the accountant who renders an audit opinion on that year's financial statements.