NEW SEC AUDITOR INDEPENDENCE REQUIREMENTS

Financial Executives International

Janet Luallen

Director - Technical Activities

What does it cover?

• Financial Relationships

• Employment Relationships

• Business Relationships

• Scope of Services

The Auditor Independence Rule provides general guidance only. The SEC’s Office of the Chief Accountant should be consulted before entering relationships that are not described

Financial Relationships

• Applies to investments by audit firm employees and their family members

• Limits restrictions to those who work on the audit or can influence the audit

Auditors are not independent if the auditors or auditors’ family

members have:• Direct investments i.e., stocks, bonds notes,

options, or other securities, in the audit client• Beneficial ownership of more than 5% of the

equity or control• Control of an audit client • The position of trustee or executor with authority

to make decisions for a trust or estate with the securities of the audit client

...continued

• Material indirect investments in the audit client• Direct or material indirect investments in:

– an entity in which an audit client has an investment, where the investment is material to the audit client and gives it the ability to exercise significant influence over that entity

– an entity that has an investment in an audit client, where the investment is material and where that entity has the ability to exercise significant influence over that audit client.

Restrictions also apply to other financial interests

• Loan/debtor or creditor relationship

• Savings and checking accounts

• Broker-dealer accounts

• Specified restrictions also apply to futures commission accounts, credit cards and insurance products

Certain exceptions are made for:

• Inheritances and gifts

• New audit engagements

• Employee compensation and benefit plans

Auditors are also not independent if their audit client

• Has a financial relationship in the accounting firm

• Is engaged to act as an underwriter, broker-dealer, market-maker,etc for the firm

Employment Relationships

Restrictions on employment apply to:

– Current audit firm employees

– Certain relatives of audit firm employees

– Former audit firm employees

– Former audit client employees

The rules narrow the limits on people who leave the firm to go

to work for the audit client

designed to ensure that the economic relationships are severed

Business Relationships

• Direct or material indirect relationships with audit clients are prohibited

• Such as serving in a decision-making capacity as an a officer, director or substantial stockholder

Scope of Services

Internal auditIT

Human resources Legal

Information Technology Services

Financial information systems design and implementation is permissible if the following 5 conditions are met

Information Technology ServicesManagement must:1. Acknowledge in writing to the auditor and audit

committee, responsibility for internal controls2. Appoint an employee responsible for design and

implementation of system hardware or software3. Make decisions concerning systems evaluated and

selected, controls and procedures implemented, scope, timetable, testing, training and conversion plans

4. Evaluate adequacy and results of the design and implementation of the hardware or software system

5. Not rely on the auditor’s work as the primary basis for determining the adequacy of internal controls and financial reporting systems

Internal Audit Services

• Limited up to 40% of total hours for internal audit activities during the fiscal year

• Applies only to companies with $200 million or more in total assets

• Operational internal audit services that are not related to internal controls, financial systems, or financial statements are not restricted

To Avoid Internal Audit Services Restrictions

Management must:

1. Acknowledge in writing to external auditors and audit committee, responsibility for internal controls

2. Appoint an employee to be responsible for the internal audit function

3. Determine the scope, risk and frequency of internal audit activities, including those performed by the auditor

4. Evaluate findings and results arising from internal audit activities, including those performed by the auditor

5. Evaluate adequacy of audit procedures and findings

6. Not rely on the auditor’s work as the primary basis for determining the adequacy of internal controls

An auditor cannot be independent and perform

• Bookkeeping and other services related to audit client accounting records or financial statements– Exceptions are made for emergency or other unusual

situations– Foreign divisions or subsidiaries under certain

circumstances

• Financial information system design and implementation – Operation or supervision of the audit client’s LAN– Design or implementation work related to the

aggregation of data underlying the client’s financial statements

Other services restricted by guidelines

• Appraisal or valuation services

• Actuarial services• Human resources• Management functions• Broker-dealer services• Legal services...

Legal Services

• Refers to all types of services that requires a lawyer practicing before U.S. courts

Restrictions do not apply to services provided to

non-audit clients

Annual Proxy Statement Disclosures Must Report Fees Paid to the Principal Independent

Accountant Broken Down Into:• Type I – Annual Audit Fees

– Aggregate fees billed for auditing the annual financial statements and Forms 10-Q during the fiscal year

• Type II - Financial Information Systems Design and Implementation Fees

• Type III - All Other Fees – Can be broken out in greater detail to give better and

clearer disclosure

(Note: Year-over-year comparative disclosure is not required)

Disclosures (cont.)• Whether the audit committee considered the

provision of non-audit services as compatible with maintaining the auditor’s independence– AC only needs to disclose whether the consideration

was made, not required to state the conclusion– AC may disclose that the consideration was not made– AC is not required to pre-approve non-audit services

• If more than 50%, disclose the percentage of hours on the audit engagement performed by persons other than full-time employees of the firm

The Independence Rule Becomes Effective on February 5, 2001

Applies to proxy and information statements filed by companies with 12/31/00 year ends

Transition Provisions

•18 month transition period for non-audit services

•3 month transition period for financial and employment relationships that did not impair independence under the pre-existing rules of the SEC, ISB and AICPA