[Federal Register Volume 63, Number 36 (Tuesday, February 24, 1998)]
[Rules and Regulations]
[Pages 9135-9137]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-4576]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 210 and 211
[Release No. 33-7507; 34-39676; IC-23029; FR-50]
Commission Statement of Policy on the Establishment and
Improvement of Standards Related to Auditor Independence
AGENCY: Securities and Exchange Commission.
ACTION: Policy Statement.
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SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') today reaffirmed that maintaining the independence of
auditors of financial statements included in filings with the
Commission is crucial to the credibility of financial reporting and, in
turn, the capital formation process. In so doing, the Commission
recognized the establishment of the Independence Standards Board
(``ISB'') and indicated that, consistent with its continuing policy of
looking to the private sector for leadership in establishing and
improving accounting principles and auditing standards, the Commission
intends to look to the ISB for leadership in establishing and improving
auditor independence regulations applicable to the auditors of the
financial statements of Commission registrants, with the expectation
that the ISB's conclusions will promote the interests of investors.
EFFECTIVE DATE: March 26, 1998.
FOR FURTHER INFORMATION CONTACT: Robert E. Burns or W. Scott Bayless,
Office of the Chief Accountant, at (202) 942-4400, Mail Stop 11-3,
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,
D.C. 20549.
SUPPLEMENTARY INFORMATION:
I. Background
The various securities laws enacted by Congress and administered by
the Securities and Exchange Commission underscore the crucial function
of independent auditors in protecting public investors by requiring, or
permitting the Commission to require, that financial statements filed
with the Commission by public companies, investment companies, broker-
dealers, public utilities, investment advisers, and others be certified
(or audited) by ``independent'' public accountants.\1\ They also give
the Commission the authority to define the term ``independent.'' \2\
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\1\ Certain provisions of the Securities Act of 1933
(``Securities Act'') and Securities Exchange Act of 1934 (``Exchange
Act'') expressly require that financial statements be audited by
independent public or certified accountants. Securities Act Schedule
A, items 25 and 26, 15 U.S.C. 77aa(25) and (26); Exchange Act
Sec. 17(e), 15 U.S.C. 78q. Various provisions of the securities laws
authorize the Commission to require the filing of financial
statements audited by independent accountants. Exchange Act Secs.
12(b)(1)(J) and (K) and 13(a)(2), 15 U.S.C. 78l and 78m; Public
Utility Holding Company Act of 1935 (``PUHCA''), Secs. 5(b) (H) and
(I), 10(a)(1)(G), and 14, 15 U.S.C. 79e(b), 79j, and 79n. Investment
Company Act of 1940, Secs. 8(b)(5) and 30(e), 15 U.S.C. 80a-8 and
80a-29; Investment Advisers Act of 1940, Sec. 203(c)(1)(D), 15
U.S.C. 80b-3(c)(1). In accordance with these provisions, the
Commission has required that certain financial statements be audited
by independent accountants. See, e.g., Article 3 of Regulation S-X,
17 CFR 210.3-01 et seq. (1996).
\2\ Various provisions of the securities laws grant the
Commission the authority to define accounting, technical, and trade
terms. Securities Act Sec. 19(a), 15 U.S.C. 77s(a); Exchange Act
Sec. 3(b), 15 U.S.C. 78c(b); PUHCA Sec. 20(a), 15 U.S.C. 79t(a); and
Investment Company Act Sec. 38(a), 15 U.S.C. 80a-37(a).
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Since the Commission's creation in 1934, it consistently has
emphasized the need for auditors to remain independent. The
Commission's regulations are set forth in Rule 2-01 of Regulation S-X
\3\ and in the extensive interpretations, guidelines, and examples for
registrants and auditors to use in evaluating specific independence
questions that are collected in Section 600 of the Codification of
Financial Reporting Policies (''Codification''), entitled ``Matters
Relating to Independent Accountants.'' \4\ The Commission also makes
publicly available the staff's written responses to requests for
informal advice on its independence requirements. Pursuant to the
Commission's regulations, the basic test for auditor independence is
whether a reasonable investor, knowing all relevant facts and
circumstances, would perceive an auditor as having neither mutual nor
conflicting interests with its audit client and as exercising objective
and impartial judgment on all issues brought to the auditor's
attention.\5\ In determining whether an auditor is independent, the
Commission considers all relevant facts and circumstances, and its
consideration is not confined to the relationships existing in
connection with the filing of reports with the Commission.\6\
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\3\ 17 CFR 210.2-01 (1996).
\4\ Financial Reporting Codification, Section 600-Matters
Relating to Independent Accountants, reprinted in SEC Accounting
Rules (CCH) para. 3,851, at 3,781.
\5\ This test encompasses an evaluation of an auditor's
independence in both fact and appearance. See Codification
Sec. 601.01 (quoting Accounting Series Release No. 296).
\6\ Rule 2-01(c), 17 CFR 210.2-01(c) (1996).
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In certain matters, the Commission also has referred registrants
and their auditors to independence requirements adopted by the American
Institute of Certified Public Accountants (``AICPA''), to the extent
those standards do not conflict with those of the Commission.\7\
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\7\ See, e.g., Office of the Chief Accountant, Staff Report on
Auditor Independence, Appendix II at 5-7 (1994) (discussing AICPA
requirements regarding loans to or from an audit client or its
officers, directors, or stockholders; and stating that Commission
has not adopted additional requirements in this area).
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Day-to-day, the Commission's staff receives inquiries regarding the
application of the Commission's independence regulations to specific
situations confronting registrants and their auditors. In recent years,
these situations have become more complex as auditors have entered into
new service areas for their clients, auditing firms have merged and
restructured their operations, and business practices and technology
have become more sophisticated and, increasingly, more global in scope.
Some of the Commission's auditor independence regulations, written
years ago, do not provide obvious guidance in today's business
environment. The Commission recognizes, therefore, that an update of
the Commission's regulations may be in order.
II. The Independence Standards Board
After careful consideration, and without abdicating its statutory
responsibilities, the Commission intends to look to a standard-setting
body designated by the accounting profession--known as the Independence
Standards Board (``ISB'')--to provide leadership not only in improving
current auditor independence requirements, but also in establishing and
maintaining a body of independence standards applicable to the auditors
of all Commission registrants.\8\ The Commission has taken a similar
course in developing its relationship with the Financial Accounting
Standards Board (``FASB''), a standard-setting body designated by the
accounting profession that provides leadership in establishing and
improving accounting principles.\9\ Although the Commission expects to
look to the ISB as the private sector body responsible for establishing
independence standards and interpretations for auditors of public
entities, the Commission's existing authority regarding auditor
independence is not affected. This includes the Commission's authority
to institute such enforcement actions as it deems appropriate, such as
actions or proceedings instituted pursuant to Rule 102(e), 17 CFR
102(e). The Commission also retains ultimate authority to not accept,
or to modify or supplement, ISB independence standards and
interpretations in the same manner that
[[Page 9137]]
the Commission can modify or supplement accounting standards and
interpretations issued by the FASB. Moreover, the functioning of the
ISB does not affect the authority of state licensing or disciplinary
authorities regarding auditor independence.
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\8\ The Commission generally has required foreign issuers and
the auditors of their financial statements to comply with United
States independence requirements when foreign issuers' audited
financial statements are filed with the Commission. Accordingly, the
ISB's pronouncements would apply to foreign as well as domestic
audit reports that are filed with the Commission.
\9\ See Accounting Series Release No. 150 (Dec. 20, 1973)
(recognizing establishment of FASB); Accounting Series Release No.
280 (Sept. 2, 1980) (commenting on FASB's role in establishing and
improving accounting principles).
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The Commission expects that the public interest will be served by
having the ISB take the lead in establishing, maintaining, and
improving auditor independence requirements; and that operation of the
ISB will promote efficiency, competition, and capital formation. The
ISB, which is composed equally of public members (from which the ISB
chairman must be elected) and practicing accountants, has undertaken to
develop an institutional framework that will permit prompt and
responsible actions by the ISB and its staff flowing from research and
objective consideration of the issues. Collectively, the ISB members
bring substantial experience and expertise to the process. In addition,
the accounting profession's commitment of financial resources to the
ISB is evidence of the private sector's willingness and intention to
support the ISB. Under these circumstances, the Commission expects that
determinations of the ISB will preserve and enhance the independence of
public accountants, and thereby promote the interests of investors.
The central mission of the ISB will be to establish independence
standards applicable to auditors of public entities that serve the
public interest by promoting investor confidence in the securities
markets. To further that goal, ISB standard-setting meetings will be
open to the public, and proposed standards will be exposed for public
comment before they are issued, in a process similar to that used by
the FASB. In addition, the Commission will provide timely oversight of
the ISB consistent with the Commission's statutory mandate to protect
investors and safeguard the integrity of the capital markets.\10\
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\10\ The Commission and its staff will consult with the ISB
during the course of ISB consideration of standards or
interpretations, including those dealing with matters addressed by
existing SEC guidance. As the ISB reconsiders and effectuates
changes in independence standards and practices that involve
existing SEC guidance, the Commission will consider modifying or
withdrawing its conflicting guidance unless the Commission
determines that it should not accept the ISB position in a
particular area.
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As noted, in the exercise of its statutory authority the Commission
has the responsibility to ensure that independent audits of
registrants' financial statements protect the interests of investors.
In reviewing questions related to the fact or appearance of an
auditor's independence from an audit client, the Commission will
consider an auditor to be not independent unless the auditor has
substantial authoritative support for the position that the questioned
transaction, event, or other circumstance, does not impair the
auditor's independence. In this regard, the Commission will consider
principles, standards, interpretations, and practices established or
issued by the ISB as having substantial authoritative support for the
resolution of auditor independence issues.\11\ Conversely, the
Commission will consider principles, standards, interpretations, and
practices contrary to such ISB promulgations as having no such
support.\12\
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\11\ Positions of the ISB staff and consensuses of a permanent
task force that will assist the ISB, the Independence Issues
Committee, will not be considered authoritative unless or until
ratified by the ISB. Positions issued by the ISB staff to a
particular party, however, may be relied upon by that party in
accordance with the ISB Operating Policies.
\12\ Entities that may issue such principles, standards, or
interpretations include the AICPA's Professional Ethics Executive
Committee.
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III. Review of ISB Operations
Since the formation of the ISB, there have been public
announcements of mergers of several of the ``Big 6'' accounting firms.
The impact of these mergers, and the accelerating trend toward
consolidation of auditing firms generally, on foreign and domestic
self-regulatory programs is being discussed within the United States,
other countries, and international organizations. These events will be
monitored closely and may prompt the Commission to reconsider certain
of the accounting profession's self-regulatory programs, including the
ISB.
In view of the significance of auditor independence to investor
confidence in the securities markets, the Commission also will review
the operations of the ISB as necessary or appropriate and, within five
years from the date the ISB was established, will evaluate whether this
new independence framework serves the public interest and protects
investors.
IV. Regulatory Requirements
This general policy statement is not an agency rule requiring
notice of proposed rulemaking, opportunities for public participation,
and prior publication under the provisions of the Administrative
Procedure Act (``APA'').\13\ Similarly, the provisions of the
Regulatory Flexibility Act,\14\ which apply only when notice and
comment are required by the APA or another statute, are not applicable.
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\13\ 5 U.S.C. 553.
\14\ 5 U.S.C. 601-602.
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V. Codification Update
The ``Codification of Financial Reporting Policies'' announced in
Financial Reporting Release No. 1 (April 15, 1982) (47 FR 21028) is
updated to:
Add a new Section 601.04, captioned ``Statement of Policy on the
Establishment and Improvement of Standards Related to Auditor
Independence'' to include the text in topics I., II., and III. of this
release.
The Codification is a separate publication of the Commission. It
will not be published in the Federal Register/Code of Federal
Regulations.
VI. Conclusion
The Commission believes that the foregoing statement of policy
provides a sound basis for the Commission and the ISB to make
significant contributions to meeting the needs of investors and the
capital markets.
Dated: February 18, 1998.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-4576 Filed 2-23-98; 8:45 am]
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