[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]


=======================================================================
-----------------------------------------------------------------------

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.

-----------------------------------------------------------------------

[[Page 9136]]

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\
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \13\ 5 U.S.C. 553.
    \14\ 5 U.S.C. 601-602.
---------------------------------------------------------------------------

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]
BILLING CODE 8010-01-P