ICBA - Publications - SEC Issues Final Auditor Independence Rule

SEC Issues Final Auditor Independence Rule

JANUARY 24, 2003


SEC Issues Final Auditor Independence Rule

The Securities and Exchange Commission (SEC) has issued a final rule to strengthen auditor independence as mandated by the Sarbanes-Oxley Act of 2002, adopting several modifications advocated by ICBA. Among other things, the rule prohibits accounting firms providing many non-audit services to their audit clients.

Internal Audit Outsourcing. Under the final rule, an accountant may not provide any internal audit service relating to a public company's internal accounting controls, financial systems or financial statements, unless it is reasonable to conclude that the results of the service will not be audited during the financial statement audit. An accountant may, however, make recommendations for improving internal controls during an audit, or when providing attestation services, without impairing the accountant's independence.

ICBA had strongly supported the SEC's intention to permit auditors to continue to assess the effectiveness of internal controls and to recommend improvements as appropriate. However, ICBA urged the SEC to provide companies with less than $200 million in assets more flexibility to use their audit firm for multiple functions, if approved by the audit committee. Prior to Sarbanes-Oxley, the SEC's auditor independence rule had an exemption for such companies. The Sarbanes-Oxley Act, however, does not include a size exemption.

Expert Services. The final rule prohibits an accountant from providing expert opinions or other expert services to an audit client, for the purpose of advocating the client's interests in litigation or in a regulatory or administrative proceeding or investigation. As requested by ICBA, the SEC clarified, however, that an accountant may provide factual accounts or testimony or explain positions taken or conclusions reached by the accountant during the performance of any service, without loss of their independence. ICBA told the SEC that there are legitimate instances where an outside accountant should be permitted to provide factual information to bank regulators and others.

Tax Services. The SEC decided not to place new restrictions on tax services that an accounting firm may provide to an audit client. Thus, tax compliance, tax planning and tax advice to audit clients is permissible, if preapproved by the audit committee. However, providing other tax services to an audit client, such as representing the client in tax court or otherwise acting in an advocacy role, would impair independence and is prohibited. ICBA had told the SEC that community banks often use their outside accountant to prepare tax forms and provide other valuable tax services that should not be considered to violate the independence standard.

Partner Rotation. Under the final rule, certain partners on the audit engagement team must rotate off after five or seven consecutive years, depending on the level of the partner's involvement in the audit. To mitigate the burden on smaller accounting firms, firms with fewer than five audit clients and fewer than ten partners are exempt from this requirement, but the engagement is subject to review by the Public Company Accounting Oversight Board every three years. ICBA had told the SEC that many smaller accounting firms would face difficulty meeting the rotation requirements because of their small staffs and may not be able to attract additional staff.

Information Systems. An accounting firm may not provide any service related to the audit client's information system, unless it is reasonable to conclude that the results of the services will not be audited as part of the financial statement audit.

Disclosures. Companies subject to the new rules must provide in their annual reports information about fees paid to the independent accountant for audit and related services, tax services and other services. Disclosures must include the audit committee's policies and procedures for pre-approval of services provided by the independent accountant.