[Federal Register Volume 85, Number 229 (Friday, November 27, 2020)]
[Notices]
[Pages 76131-76142]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-26145]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-90473; File No. PCAOB-2020-01]
Public Company Accounting Oversight Board; Notice of Filing of
Proposed Rules on Amendments to PCAOB Interim Independence Standards
and PCAOB Rules To Align With Amendments to Rule 2-01 of Regulation S-X
November 20, 2020.
Pursuant to Section 107(b) of the Sarbanes-Oxley Act of 2002 (the
``Act'' or ``Sarbanes-Oxley Act''), notice is hereby given that on
November 20, 2020, the Public Company Accounting Oversight Board (the
``Board'' or ``PCAOB'') filed with the Securities and Exchange
Commission (the ``Commission'' or ``SEC'') the proposed rules described
in Items I and II below, which items have been prepared by the Board.
The Commission is publishing this notice to solicit comments on the
proposed rules from interested persons.
I. Board's Statement of the Terms of Substance of the Proposed Rules
On November 19, 2020, the Board adopted amendments to the PCAOB's
interim independence standards and PCAOB rules to align with amendments
by the SEC to Rule 2-01 of Regulation S-X (collectively, the ``proposed
rules''). The text of the proposed rules appears in Exhibit A to the
SEC Filing Form 19b-4 and is available on the Board's website at
https://pcaobus.org/Rulemaking/Pages/Docket047.aspx and at the
Commission's Public Reference Room.
[[Page 76132]]
II. Board's Statement of the Purpose of, and Statutory Basis for, the
Proposed Rules
In its filing with the Commission, the Board included statements
concerning the purpose of, and basis for, the proposed rules. The text
of these statements may be examined at the places specified in Item IV
below. The Board has prepared summaries, set forth in sections A, B,
and C below, of the most significant aspects of such statements. In
addition, the Board is requesting that, pursuant to Section
103(a)(3)(C) of the Sarbanes-Oxley Act, the Commission approve the
proposed rules for application to audits of emerging growth companies
(``EGCs'').\1\ The Board's request is set forth in section D.
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\1\ The term ``emerging growth company'' is defined in Section
3(a)(80) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(80)). See also Inflation Adjustments and Other Technical
Amendments Under Titles I and III of the JOBS Act, Rel. 33-10332
(Mar. 31, 2017), 82 FR 17545 (Apr. 12, 2017).
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A. Board's Statement of the Purpose of, and Statutory Basis for, the
Proposed Rules
(a) Purpose
Summary
The federal securities laws require, among other things, that
issuers, brokers, and dealers file certain periodic reports with the
SEC that contain financial statements audited by an independent public
accountant. These laws recognize that audits conducted by objective and
impartial professionals can protect investors and instill confidence in
the public markets.
Congress has provided both the SEC and the PCAOB with jurisdiction
to establish auditor independence standards for audits of issuers and
broker-dealers. The Sarbanes-Oxley Act specifically authorizes the
PCAOB to establish independence standards and rules to be used by
registered public accounting firms in the preparation and issuance of
audit reports, and as may be necessary or appropriate in the public
interest or for the protection of investors.\2\
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\2\ 15 U.S.C. 7213.
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The Board first exercised its authority under the Act by adopting
the independence standards of the American Institute of Certified
Public Accountants (``AICPA''), as they existed as of April 16, 2003,
as the Board's interim independence standards, and subsequently adopted
independence rules set out in Section 3, Part 5 of the Rules of the
Board. Although the PCAOB's standard-setting authority initially
extended only to audits of issuers, as defined in the Act,\3\ the Dodd-
Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank'')
extended that authority to include audits of brokers and dealers.
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\3\ See Section 2(a)(7) of the Act, 15 U.S.C. 7201(a)(7).
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Because both the PCAOB and the SEC have jurisdiction with respect
to auditor independence, it is important for the PCAOB to consider how
its independence standards and rules relate to the SEC's requirements,
including Rule 2-01 of Regulation S-X (``Rule 2-01'').\4\ The PCAOB's
interim independence standards, as adopted from the AICPA in 2003,
cover many of the same topics as Rule 2-01. Recognizing the overlap,
the Board directed audit firms in 2003 to comply with the more
restrictive of the Board's interim independence standards and Rule 2-
01. Subsequently, the PCAOB's permanent independence rules have imposed
certain incremental independence obligations (e.g., additional
prohibitions on tax services for persons in financial reporting
oversight roles at issuer audit clients \5\) on registered public
accounting firms. The PCAOB's independence rules use definitions
aligned with the definitions in the SEC's Rule 2-01(f).
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\4\ See 17 CFR 210.2-01.
\5\ PCAOB Rule 3523.
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From 2003 to 2018, the SEC's requirements and the PCAOB's interim
independence standards and independence rules worked together to
establish the independence compliance requirements for auditors subject
to the Board's jurisdiction. In 2018, however, the SEC began the
process of making certain amendments to Rule 2-01. Specifically, the
Commission proposed in 2018, and then adopted in 2019, amendments to
Rule 2-01(c)(1)(ii)(A) to refocus the analysis that must be conducted
to determine whether an auditor is independent when the auditor has a
lending relationship with certain shareholders of an audit client at
any time during the audit and professional engagement period. The
Commission next proposed in 2019, and then adopted in 2020, additional
amendments to address certain arrangements and relationships that the
SEC believed were less likely to threaten an auditor's objectivity or
impartiality, so that auditors and audit committees could spend more
time focusing on relationships that are more likely to pose such
threats.\6\ Several commenters on the latter proposal noted that the
SEC's proposed amendments overlapped with the PCAOB's requirements
relating to lending arrangements and further observed that the SEC's
proposal to amend certain definitions in Rule 2-01(f) might give rise
to differences with some of the Board's existing definitions in Rule
3501.
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\6\ See Qualifications of Accountants, Release No. 33-10876
(Oct. 16, 2020) (``2020 Adopting Release'').
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To avoid differences and duplicative requirements, and to provide
greater regulatory certainty, the Board adopted targeted amendments to
its interim independence standards applicable to lending arrangements
between auditors and audit clients. In addition, the Board adopted
targeted amendments to align certain terms defined in Rule 3501 with
the Commission's recent amendments to its definitions of those terms in
Rule 2-01(f).
Background
SEC Authority and Independence Requirements
The federal securities laws authorize the SEC to establish
independence requirements for audits of financial statements filed with
the Commission.\7\ The SEC's rule on auditor independence is Rule 2-01,
which the SEC has described as setting forth a ``comprehensive
framework governing auditor independence.'' \8\ Under the general
standard in Rule 2-01(b), the SEC ``will not recognize an accountant as
independent, with respect to an audit client, if the accountant is not,
or a reasonable investor would conclude that the accountant is not,
capable of exercising objective and impartial judgment on all issues
encompassed within the accountant's engagement.''
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\7\ See, e.g., Strengthening the Commission's Requirements
Regarding Auditor Independence, Release No. 33-8183 (Jan. 28, 2003),
68 FR 6006, 6044 (Feb. 5, 2003) (identifying the SEC's statutory
bases to adopt independence requirements).
\8\ See Amendments to Rule 2-01, Qualifications of Accountants,
Release No. 33-10738 (Dec. 30, 2019), 85 FR 2332 (Jan. 15, 2020)
(``2020 Proposing Release'').
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In addition to the general standard in Rule 2-01(b), the rule
includes a non-exclusive specification of circumstances that are
inconsistent with Rule 2-01(b). Rule 2-01(c)(1)-(4) addresses
financial, employment, and business relationships between accountants
and their audit clients, as well as the performance of certain non-
audit services. Other provisions of Rule 2-01(c)-(e) address contingent
fees, partner rotation on audit engagements, audit committee
administration of the audit engagement, partner compensation,
independence quality controls, and grandfathering and transition
provisions.\9\ Rule 2-01(f)
[[Page 76133]]
defines certain terms used in Rule 2-01. The Commission's
interpretations on auditor independence are collected in the
Codification of Financial Reporting Policies,\10\ and the SEC staff has
also issued ``Frequently Asked Questions'' on auditor independence.\11\
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\9\ See Rule 2-01(c)(5)-(8) and Rule 2-01(d)-(e).
\10\ See Codification of Financial Reporting Policies, Section
600, Matters Relating to Independent Accountants.
\11\ See Office of the Chief Accountant: Application of the
Commission's Rules on Auditor Independence Frequently Asked
Questions, available at https://www.sec.gov/info/accountants/ocafaqaudind080607.htm.
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PCAOB Authority and Independence Requirements
Under the Act, the Board is authorized to establish ethics and
independence standards to be used by registered public accounting firms
in the preparation and issuance of audit reports, as required by the
Act or SEC rules, or ``as may be necessary or appropriate in the public
interest or for the protection of investors.'' \12\ The Act also
authorized the Board to adopt as its rules other professional standards
that the Board determined satisfied the requirements of Section
103(a)(1) of the Act.\13\
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\12\ See Sections 103(a)(1) and 103(b) of the Act, 15 U.S.C.
7213(a)(1) and (b).
\13\ See Section 103(a)(3)(A) of the Act, 15 U.S.C.
7213(a)(3)(A).
When the PCAOB was established in 2003, the Board adopted the
professional standards promulgated by other bodies, including the
AIPCA, on an interim basis, as authorized under the Act,\14\ which
assured continuity and certainty in the standards that govern audits
of public companies.\15\ The Board further stated that it would
determine whether to adopt its interim standards as permanent
standards of the Board, or repeal or modify those standards, in the
future.\16\ Currently, Rule 3500T, Interim Ethics and Independence
Standards, requires registered public accounting firms to comply
with independence standards as described in Rule 101 of the AICPA's
Code of Professional Conduct (``AICPA Code''), as well as the
AICPA's interpretations and rulings thereunder that appear in ET
Sec. Sec. 101 and 191, as in existence on April 16, 2003, to the
extent not superseded or amended by the Board.\17\ A Note to Rule
3500T also states that the Board's interim independence standards do
not supersede the Commission's auditor independence rules and that
registered public accounting firms must comply with the ``more
restrictive'' of the rules.\18\
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\14\ See Section 103(a)(3)(B) of the Act, 15 U.S.C.
7213(a)(3)(B).
\15\ See PCAOB Rel. No. 2003-006, Establishment of Interim
Professional Auditing Standards (Apr. 18, 2003) (``2003 Adopting
Release'').
\16\ See id. at 3.
\17\ Rule 3500T also requires compliance with (1) certain
independence standards and interpretations of the former
Independence Standards Board, to the extent not superseded by the
Board and (2) certain ethics standards described in Rule 102 of the
AICPA Code and the related interpretations and rulings thereunder,
as in existence on April 16, 2003, to the extent not superseded or
amended by the Board.
\18\ See also PCAOB Release No. 2013-010, Amendments to Conform
the Board's Rules and Forms to the Dodd-Frank Act and Make Certain
Updates and Clarifications (Dec. 4, 2013) at 20 fn. 60 (stating that
the Note to Rule 3500T ``means that the less restrictive rule still
applies but satisfying the more restrictive rule is deemed to
satisfy the less restrictive rule'').
The PCAOB began to adopt permanent independence rules in 2005.\19\
These rules set forth the fundamental ethical obligation for a
registered public accounting firm and its associated persons to be
independent of the firm's audit clients throughout the audit and
professional engagement period,\20\ and include definitions of certain
terms used in the Board's independence rules.\21\ The rules also
prohibit contingent fee arrangements for any service or product a
registered public accounting firm provides to an audit client (Rule
3521), restrict certain types of tax services that may be provided to
an audit client and to persons in a financial reporting oversight role
at an issuer audit client (Rules 3522 and 3523), require audit
committee pre-approval of certain tax services and services related to
internal control over financial reporting to be performed for an issuer
audit client (Rules 3524 and 3525), and require certain communications
with an audit client's audit committee concerning auditor independence
(Rule 3526). In 2013, after Dodd-Frank was enacted, the Board adopted
amendments to certain of these rules to extend their application to
audits of brokers and dealers.\22\
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\19\ In 2005, the Board adopted Rules 3501-3502 and Rules 3520-
3524. See PCAOB Release No. 2005-014, Ethics and Independence Rules
Concerning Independence, Tax Services, and Contingent Fees (July 26,
2005) (``2005 Adopting Release''). In 2007 and 2008, the Board
adopted Rules 3525 and 3526, respectively. See PCAOB Release No.
2007-005, Auditing Standard No. 5--An Audit of Internal Control Over
Financial Reporting That Is Integrated with An Audit of Financial
Statements and Related Independence Rule and Conforming Amendments
(May 24, 2007); PCAOB Release No. 2008-003, Ethics and Independence
Rule 3526, Communication with Audit Committees Concerning
Independence, Amendment to Interim Independence Standards, Amendment
to Rule 3523, Tax Services for Persons in Financial Reporting
Oversight Roles, Implementation Schedule for Rule 3523 (Apr. 22,
2008).
\20\ See PCAOB Rule 3520. Registered public accounting firms
must satisfy not only the Board's independence requirements, but
also all other independence criteria applicable to a firm's
engagement, including Rule 2-01. See Note 1 to PCAOB Rule 3520.
\21\ In adopting the definitions in Rule 3501, the Board stated
that many of those definitions were based on the SEC's existing
definitions of those terms in Rule 2-01. See, e.g., 2005 Adopting
Release at 19 n. 36 (the Board's definition of the term ``audit and
professional engagement period'' in Rule 3501(a)(iii) ``adapts the
definition of `audit and professional engagement period' from the
definition of that term in * * * Rule 2-01 of the Commission's
Regulation S-X''); id. at 21 n. 43 (the Board's definitions of the
terms ``affiliate of the audit client'' and ``investment company
complex'' in Rules 3501(a)(i) and 3501(i)(ii) are ``verbatim the
SEC's definitions of these same terms and should be understood to
cover the same entities that would be covered by these terms in
applying the SEC's independence rules'').
\22\ See PCAOB Release No. 2013-010.
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Recent SEC Amendments to Rule 2-01
From 2003 through 2019, there were no changes to Rule 2-01 by the
Commission. In June 2019, the SEC adopted amendments to Rule 2-
01(c)(1)(ii)(A) (the ``Loan Provision'') ``to refocus the analysis that
must be conducted to determine whether an auditor is independent when
the auditor has a lending relationship with certain shareholders of an
audit client at any time during the audit and professional engagement
period.'' \23\ The Commission further stated that the amendments
``would more effectively identify those debtor-creditor relationships
that could impair an auditor's objectivity and impartiality, yet would
not include certain attenuated relationships that are unlikely to
present threats to objectivity or impartiality.'' \24\
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\23\ See Auditor Independence With Respect to Certain Loans or
Debtor-Creditor Relationships, Release No. 33-10648 (June 18, 2019),
84 FR 32040 (July 5, 2019) (``2019 Adopting Release'').
\24\ Id. at 84 FR 32043.
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In December 2019, the SEC proposed further updates to Rule 2-01,
including additional amendments to the provisions of Rule 2-01(c)(1)
that address lending relationships. In proposing these amendments, the
SEC stated that they were intended ``to more effectively focus the
[independence] analysis on those relationships or services that are
more likely to pose threats to an auditor's objectivity and
impartiality.'' \25\ After considering public comments on the proposal,
the Commission amended Rule 2-01 again in October 2020.\26\
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\25\ See 2020 Proposing Release at 85 FR 2350.
\26\ See 2020 Adopting Release.
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The final amendments added certain student and consumer loans to
the Commission's categorical exclusions from independence-impairing
lending relationships. The SEC also updated several of the definitions
in Rule 2-01(f), including amendments to the definitions of the terms
``affiliate of the audit client'' and ``investment company complex'' in
Rule 2-01(f)(4) and (f)(14) to address certain affiliate relationships,
including entities under common control, and an amendment to the
definition of ``audit and professional
[[Page 76134]]
engagement period'' in Rule 2-01(f)(5) to shorten the ``look back
period'' for domestic first-time filers in assessing compliance with
the Commission's independence requirements.\27\
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\27\ Other revisions to Rule 2-01 adopted by the SEC included an
amendment to the Commission's restriction on business relationships
in Rule 2-01(c)(3), an amendment to replace an existing transition
and grandfathering provision in Rule 2-01(e) with a new transition
provision addressing mergers or acquisitions involving an audit
client, and certain miscellaneous updates.
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Amendments to the Board's Independence Requirements
Overview
The Board adopted amendments to the PCAOB's interim independence
standards and independence rules to eliminate differences and
duplicative requirements in its independence requirements following the
SEC's amendments to Rule 2-01 in 2019 and 2020, respectively.
Specifically, as discussed below, the Board amended ET Sec. 101.02 and
deleted ET Sec. 101.07, both of which are interpretations of Rule 101
of the AICPA Code that are part of the Board's interim independence
standards. In addition, the Board deleted ET Sec. Sec. 191.150-.151,
ET Sec. Sec. 191.182-.183, ET Sec. Sec. 191.196-.197, and ET
Sec. Sec. 191.220-.222, which are four Ethics Rulings under Rule 101
that also address lending arrangements and are part of the Board's
interim independence standards. Finally, the Board amended Rule 3501,
which defines certain terms used in Section 3, Part 5 of the Rules of
the Board, to align the definitions of three terms used in the
independence requirements of both the SEC and the PCAOB.\28\
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\28\ The Board also considered whether to amend the Board's
independence rules to align with the SEC's new provision for
addressing inadvertent violations described in Rule 2-01(e). Rule 2-
01(e) provides that an accounting firm's independence will not be
impaired because an audit client engages in a merger or acquisition
that gives rise to a relationship or service that is inconsistent
with Rule 2-01, provided that the firm satisfies certain conditions,
which include having a quality control system in place as described
in Rule 2-01(d)(3) with specified features. The PCAOB has an ongoing
project to consider revisions to the Board's quality control
standards, including an ethics and independence component that would
address the fulfillment of firm and individual responsibilities
under applicable ethics and independence requirements. See PCAOB
Release No. 2019-003, Potential Approach to Revisions to PCAOB
Quality Control Standards (Dec. 17, 2019). Accordingly, the Board
believed it would be premature to amend its independence rules to
conform to the SEC's exemption described in Rule 2-01(e). Pending
further action, however, the Board generally would not expect to
consider an accounting firm's independence impaired solely because
an audit client engages in a merger or acquisition that gives rise
to a relationship or service that is inconsistent with the Board's
independence rules, provided that the firm has satisfied all the
conditions in Rule 2-01(e). In such circumstances, firms should also
consider their obligations under Rule 3526, Communication with Audit
Committees Concerning Independence.
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As discussed further below, without amendments to the Board's
interim independence standards, certain provisions that address lending
relationships would overlap with and differ from Rule 2-01, as amended.
Specifically, ET Sec. 101.02 and ET Sec. 101.07 would be inconsistent
with the SEC's restrictions on lending relationships and the exceptions
to those restrictions in Rule 2-01(c)(1)(ii), as amended. In addition,
the four Ethics Rulings would also be inconsistent with the
Commission's independence requirements.
Moreover, absent amendments to the Board's definitions of the terms
``affiliate of the audit client,'' ``audit and professional engagement
period,'' and ``investment company complex'' in Rule 3501(a)(ii),
(a)(iii), and (i)(ii), these definitions would differ from the SEC's
definitions of those terms in Rule 2-01(f)(4), (f)(5), and (f)(14), as
amended. Confusion might arise if certain terms used in both the
PCAOB's and the SEC's independence rules were defined differently by
the Board and the Commission.\29\
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\29\ See 2005 Adopting Release at 19-21. Several commenters on
the 2020 Proposing Release identified a potential inconsistency
between the Commission's proposed amendments to the definitions in
Rule 2-01 and the existing definitions in Rule 3501 and urged the
SEC and the PCAOB to preserve the alignment of the definitions in
Rule 2-01 with the Board's definitions in Rule 3501.
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These targeted amendments to the Board's independence requirements
apply to all audits conducted under PCAOB standards. The amendments
should clarify the professional obligations of auditors and avoid
regulatory uncertainty regarding the treatment of lending arrangements
and the scope of the definitions in the independence requirements of
the PCAOB and the SEC.
Amendments to Interim Independence Standards
The SEC's 2019 amendments to Rule 2-01(c)(1)(ii)(A)(1) replaced the
category of owners of an audit client's equity securities whose lending
relationships with an accountant may impair independence (``any
individuals owning ten percent or more of the client's outstanding
equity securities'') with ``beneficial owners (known through reasonable
inquiry) of the audit client's equity securities where such beneficial
owner has significant influence over the client.'' At that time, the
Commission stated that it had become aware that ``in certain
circumstances, the existing [requirement] may not be functioning as it
was intended,'' and that the amendments ``would more effectively
identify those debtor-creditor relationships that could impair an
auditor's objectivity and impartiality,'' while excluding ``certain
attenuated relationships that are unlikely to present threats to
objectivity or impartiality.'' \30\
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\30\ See 2019 Adopting Release at 84 FR 32042-43.
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In addition, as amended in October 2020, Rule 2-01(c)(1)(ii)(A)(1)
includes an exception from the scope of the Loan Provision for student
loans obtained from a financial institution client under its normal
lending procedures, terms, and requirements by a covered person in a
firm or his or her immediate family members, provided the loans were
not obtained while the covered person was a covered person. The
amendments also replace a prior exception in Rule 2-01(c)(1)(ii)(E) for
certain credit card balances and cash advances from a lender that is an
audit client with an exception for consumer loans, provided that the
aggregate outstanding balance is reduced to $10,000 or less on a
current basis taking into consideration the payment due date and any
available grace period.\31\
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\31\ See 2020 Adopting Release at 53-57 and 59-62. In proposing
amendments to Rule 2-01(c)(1)(ii), the SEC reiterated that certain
debtor-creditor relationships between an accounting firm, a covered
person, or a covered person's immediate family members ``reasonably
may be viewed as creating a self-interest that competes with the
auditor's obligation to serve only investors' interests,'' but
stated that ``not all creditor or debtor relationships threaten an
auditor's objectivity and impartiality.'' See 2020 Proposing Release
at 85 FR 2339, citing Revision of the Commission's Auditor
Independence Requirements, Release No. 33-7870 (June 30, 2000), 65
FR 43148, 43161 (July 12, 2000).
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The amendments to Rule 2-01 in 2019 and 2020 created differences
between Rule 2-01 and the Board's independence requirements. Under Rule
3500T, registered public accounting firms and their associated persons
must comply with independence standards in Rule 101 of the AICPA Code
and the interpretations and rulings thereunder, as in existence on
April 16, 2003, to the extent not superseded or amended by the Board.
These interpretations include ET Sec. 101.02, which provides, among
other things, that loans from owners of 10% or more of an audit
client's equity securities to an accounting firm, other individuals who
fall within the definition of a ``covered member'' of the firm,\32\ and
the immediate family of
[[Page 76135]]
such covered members may impair the accounting firm's independence,
unless permitted by ET Sec. 101.07. ET Sec. 101.02 also includes
provisions relating to the collection and repayment of loans by covered
members who were formerly employed by or otherwise associated with an
audit client. In turn, ET Sec. 101.07, which is also an interpretation
of Rule 101 of the AICPA Code, reiterates the restrictions on certain
loans in ET Sec. 101.02, but provides exceptions for certain
grandfathered and permitted loans that are not deemed to impair a
covered member's independence. Following the SEC's amendments to Rule
2-01 in 2019 and 2020, the requirements under existing ET Sec. 101.02
and ET Sec. 101.07 with respect to lending arrangements are
inconsistent with the Commission's requirements under Rule 2-01, as
amended.
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\32\ The definition of a ``covered member'' for purposes of ET
Sec. 101.02 and ET Sec. 101.07 is similar to the definition of a
``covered person in the firm'' in Rule 2-01(f)(11) in certain
respects, but differs in other respects. For example, the AICPA's
definition of ``covered member,'' as of April 16, 2003, includes an
accountant's firm, whereas the SEC's definition of ``covered persons
in the firm'' in Rule 2-01(f)(11) only includes certain natural
persons.
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ET Sec. Sec. 191.150-.151, ET Sec. Sec. 191.182-.183, ET
Sec. Sec. 191.196-.197 and ET Sec. Sec. 191.220-.221 are four Ethics
Rulings under Rule 101 of the AICPA Code, as in existence on April 16,
2003. These rulings (Ethics Rulings 75, 91, 98, and 110) discuss the
application of ET Sec. 101.02 and ET Sec. 101.07 regarding lending
arrangements in specific circumstances and include references to ET
Sec. 101.02, ET Sec. 101.07, or both:
Ethics Ruling 75 addresses membership in a client credit
union and conditions to be followed to preserve independence if loans
are made to the auditor, including compliance with requirements with
respect to lending arrangements under ET Sec. 101.02 and ET Sec.
101.07.
Ethics Ruling 91 addresses the leasing by an auditor of
property to or from a client and provides that certain capital leases
would be considered a loan that impairs independence unless the
arrangement complied with requirements with respect to lending
arrangements under ET Sec. 101.02 and ET Sec. 101.07.
Ethics Ruling 98 addresses an auditor's loan from a
nonclient subsidiary or parent of an attest client and provides, among
other things, that a loan from a nonclient subsidiary would impair the
auditor's independence unless it was a grandfathered or permitted loan
pursuant to ET Sec. 101.07.
Ethics Ruling 110 addresses, among other things, loans
from an audit firm's client to or from an entity over which an auditor
has control and provides that, in such situations, independence is
impaired unless the loan is permitted under ET Sec. 101.07.
Each of these rulings also includes other language that is
inconsistent with the SEC's independence requirements. For example, ET
Sec. Sec. 191.150-.151 (Ethics Ruling 75) permits an auditor to have
certain uninsured deposits at a credit union client that are not
allowed under Rule 2-01(c)(1)(ii)(B), while ET Sec. Sec. 191.196-.197
(Ethics Ruling 98) provides that certain loans from a nonclient parent
of an audit client would not impair independence, even though such
loans are not allowed under Rule 2-01(c)(1)(ii)(A) in some
circumstances.\33\
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\33\ In addition, ET Sec. Sec. 191.-182-.183 (Ethics Ruling 91)
and ET Sec. Sec. 191.220-.221 (Ethics Ruling 110) are less
restrictive in certain respects than Section 602.02.e of the
Codification of Financial Reporting Policies. In particular, ET
Sec. Sec. 191.-182-.183 (Ethics Ruling 91) permits an auditor to
enter into certain operating leases with an audit client without
regard to the materiality of the lease, which is inconsistent with
Section 602.02.e, while ET Sec. Sec. 191.220-.221 (Ethics Ruling
110) differs from Section 602.02.e in describing the circumstances
in which a loan to or from an audit client from an entity with which
an auditor is connected as an officer, director, or shareholder may
impair independence.
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The Board updated its requirements with respect to lending
relationships to avoid such differences and duplicative requirements.
Specifically, the Board amended ET Sec. 101.02 to delete the language
in that interpretation that addresses lending arrangements and deleting
ET Sec. 101.07 in its entirety. In addition, the Board deleted ET
Sec. Sec. 191.150-.151, ET Sec. 191.182-.183, ET Sec. Sec.
191.196-.197 and ET Sec. Sec. 191.220-.221 (Ethics Rulings 75, 91, 98,
and 110) to eliminate inconsistent requirements in these rulings
relating to lending arrangements under the Board's interim independence
standards and the SEC's independence rules and guidance.
The Board took this action in light of the SEC's amendments to Rule
2-01. Removing the provisions relating to lending arrangements from the
Board's interim independence standards, rather than making specific
amendments to conform them to the SEC's amendments to Rule 2-01, avoids
duplicative Board and SEC independence requirements on lending
arrangements and helps facilitate compliance with Rule 2-01, as
amended, by clarifying a firm's professional obligations. The
amendments should also facilitate cooperation and coordination between
the Board and the SEC when monitoring compliance with the SEC's revised
independence requirements in Rule 2-01.
In adopting the amendments to the interim independence standards,
the Board also took notice of the regulatory process employed by the
Commission to update its independence framework for lending
arrangements in Rule 2-01. Specifically, before amending Rule 2-01 in
both 2019 and 2020, the SEC issued a rulemaking proposal, identified
the Commission's rationale for proposed amendments to Rule 2-01,
solicited public comment on its proposals, and included an economic
analysis that included a description of the problem, an analysis of
potential benefits and costs, and a consideration of alternatives.
After receiving public comments on the proposals, many of which broadly
supported the objective of the proposed amendments or were generally in
favor of the proposals, the Commission then adopted the amendments
largely as proposed.\34\ The Board has considered the SEC's rulemaking
record on both proposals. The Board believed that this process--
structured by the Commission to satisfy the requirements of the
Administrative Procedure Act--is at least as robust as the Board's
process would have been had the PCAOB considered amendments to the
Board's independence requirements without the benefit of the SEC's
analysis.
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\34\ A few commenters did not support the SEC's proposals, and
one of these commenters expressed the view that the proposals could
negatively affect investor protection and capital formation. This
commenter suggested that, in lieu of the proposals, more should be
done to strengthen auditor independence standards and the
enforcement of such standards. See 2020 Adopting Release at 5-6.
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Accordingly, the Board did not perceive any reason or compelling
basis in the SEC's rulemaking record to disregard the goal of the SEC's
2019 and 2020 amendments or to impede the benefits that the Commission
sought to achieve through its revisions to Rule 2-01 by maintaining
differences between the independence requirements of the Board and the
SEC relating to lending arrangements. If the Board were to determine at
a future date that diverging from the SEC's approach to lending
arrangements is necessary or appropriate in the public interest or for
the protection of investors, the Board retains the authority under the
Act to do so.
Amendments to Rule 3501
The Board adopted Rule 3501 as part of a suite of independence
rules in 2005. Although the Board's permanent independence rules, which
now include Rules 3520 through 3526, impose additional substantive
restrictions on auditors beyond those set forth in Rule 2-01, the scope
of those rules has been consistent with the SEC's approach in Rule 2-
01.
Specifically, when the Board adopted Rule 3501, it based the
definitions of the terms ``affiliate of the audit client'' in Rule
3501(a)(ii), ``audit and professional
[[Page 76136]]
engagement period'' in Rule 3501(a)(iii), and ``investment company
complex'' in Rule 3501(i)(ii) on the SEC's definitions of the same
terms in Rule 2-01.\35\ The existing definitions of ``affiliate of the
audit client,'' and ``investment company complex'' in Rule 3501 largely
tracked the SEC's definitions of those terms verbatim, except for
different formatting. The definition of ``audit and professional
engagement period'' in Rule 3501 was adapted from the Commission's
definition of that term in Rule 2-01, with the only difference being
the replacement of references to an ``accountant'' in Rule 2-01(f)(5)
with references to a ``registered public accounting firm'' in Rule
3501(a)(iii). This distinction reflects the use of the term
``accountant'' under Rule 1001(a)(ii) to refer to natural persons who
are certified public accountants or authorized to engage in public
accounting or participate in audits, whereas Rule 2-01(f)(5) defines
the term more broadly to include accounting firms with which certified
public accountants or public accountants are affiliated.
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\35\ See 2005 Adopting Release at 19-21.
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The Board's definitions in Rule 3501, in turn, determine the scope
of the substantive requirements in Rules 3520 through 3526.\36\ Rules
3520 through 3526 address independence matters in addition to those
expressly addressed in Rule 2-01, including the impact of certain tax
services on independence (Rules 3522 and 3523), audit committee pre-
approval of certain tax services and services related to internal
control over financial reporting (Rules 3524 and 3525), and
communications with audit committees concerning independence (Rule
3526).\37\
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\36\ Specifically the term ``investment company complex''
appears in the definition of ``affiliate of the audit client.'' In
turn, the term ``affiliate of the audit client'' appears in the
definition of the term ``audit client,'' which is used in each of
Rules 3520 through 3526.
\37\ In addition, both the SEC and the PCAOB have adopted
restrictions on the receipt of contingent fees by audit firms. The
Commission's restrictions are set forth in Rule 2-01(c)(5), and the
Board's restrictions are set forth in Rule 3521.
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The SEC's amendments to Rule 2-01 in 2020 included revisions to the
definitions of each of the terms ``affiliate of the audit client,''
``audit and professional engagement period,'' and ``investment company
complex'' in Rule 2-01(f). These amendments resulted in differences
between the SEC's definitions of those terms and the Board's
definitions in Rule 3501. Discussed in more detail below are (1) the
relevant SEC amendments and why the Commission changed these
definitions; (2) the resulting differences between the SEC's amended
definitions and the Board's existing definitions; and (3) why and how
the Board amended the definitions of these three terms in Rule 3501 to
avoid differences with the SEC's amended definitions.
As discussed above with respect to the amendments to the Board's
interim independence standards, in amending the definitions of
``affiliate of the audit client,'' ``investment company complex,'' and
``audit and professional engagement period'' in Rule 3501, the Board
took note of the SEC's rulemaking process when the Commission amended
the definitions of those terms in Rule 2-01(f) in 2020. The SEC's
robust process included a detailed rationale for the amendments to the
definitions and was also informed by public comment on the Commission's
proposals. The Board believed it was important to align the definitions
of these terms in Rule 3501 with the SEC's amended definitions in Rule
2-01(f) to ensure they have the same meaning under the independence
rules of the Board and the SEC and avoid the confusion that might arise
if the same terms were used in the independence rules of the PCAOB and
the Commission, but defined differently.
``Affiliate of the Audit Client'' and ``Investment Company Complex''
Definitions
Prior to the SEC's 2020 amendments to Rule 2-01, the term
``affiliate of the audit client'' was defined in Rule 2-01(f)(4) to
include, in part, both ``[a]n entity that has control over the audit
client, or over which the audit client has control, or which is under
common control with the audit client, including the audit client's
parents and subsidiaries'' and ``[e]ach entity in the investment
company complex when the audit client is an entity that is part of an
investment company complex'' (emphasis added). Rule 2-01(f)(14), in
turn, had defined an ``investment company complex'' to include, in
part, ``[a]ny entity controlled by or controlling an investment adviser
or sponsor * * * or any entity under common control with an investment
adviser or sponsor * * * if the entity: (1) Is an investment adviser or
sponsor; or (2) Is engaged in the business of providing administrative,
custodian, underwriting, or transfer agent services to any investment
company, investment adviser, or sponsor * * *.''
In its 2020 amendments to Rule 2-01, the Commission amended these
definitions to address challenges that had arisen in their application,
including in the private equity and investment company contexts, and
more effectively focus on those relationships and services that the SEC
believed were more likely to threaten auditor objectivity and
impartiality. The SEC's amendments also include dual materiality
thresholds in the respective common control provisions and distinguish
how the definition applies when an accountant is auditing a portfolio
company, an investment company, or an investment adviser or sponsor.
The SEC's amendments created differences with certain definitions
in Rule 3501. Accordingly, the Board aligned the definitions of the
terms ``affiliate of the audit client'' and ``investment company
complex'' in Rule 3501 to be consistent with the SEC's 2020 amendments
to the definitions of these terms in Rule 2-01(f). The Board's
amendments to these definitions avoid potential confusion by auditors
when applying the independence rules of the SEC and PCAOB; without such
amendments, auditors would be required to undertake a different
analysis to determine which entities fall within or outside the scope
of the ``affiliate of the audit client'' and ``investment company
complex'' definitions (and, therefore, considered the ``audit client'')
for purposes of Rule 2-01 and the Board's rules.
Accordingly, the Board amended Rule 3501(a)(ii) and Rule
3501(i)(ii) to conform to the SEC's amended definitions in Rule 2-
01(f)(4) and 2-01(f)(14). Specifically, the Board amended these
definitions to incorporate the SEC's amended definitions by cross-
referencing the SEC's definitions in Rule 2-01(f). This approach is
intended to facilitate the continued alignment of the Board's
definitions in Rule 3501(a)(ii) and Rule 3501(i)(ii) with the SEC's
definitions in Rule 2-01(f). In the event of later changes by the SEC
to the scope of those definitions in Rule 2-01(f), the definitions of
these terms in Rule 3501 would automatically update, without requiring
further action by the Board.\38\ The Board did not delete these
definitions, as it did with respect to the provisions of the Board's
interim independence standards that address lending arrangements and
overlap with the SEC's independence criteria, because the definitions
in Rule 3501 remain relevant for purposes of Rules
[[Page 76137]]
3520 through 3526, which are part of the Board's permanent independence
rules. The Board retains the authority to amend these definitions in
the future, should the Board determine that such amendments are
necessary or appropriate in the public interest or for the protection
of investors.
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\38\ The Board only amended through cross-references those
definitions in Rule 3501 that were identical to the SEC's
definitions in Rule 2-01(f) and also the subject of the Commission's
2020 amendments. Certain other defined terms in Rule 3501, such as
the definitions of ``financial reporting oversight role'' and
``immediate family member'' in Rules 3501(f)(i) and 3501(i)(i),
respectively, continue to track the text of the SEC's definitions of
those terms in Rule 2-01(f).
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``Audit and Professional Engagement Period'' Definition
Prior to its amendment by the SEC in 2020, the term ``audit and
professional engagement period'' had been defined differently in Rule
2-01(f)(5) for domestic issuers and for foreign private issuers
(``FPIs'') with respect to situations where a company first files, or
is required to file, a registration statement or report with the
Commission.\39\ Specifically, Rule 2-01(f)(5)(i) and (ii) had defined
the ``audit and professional engagement period'' to include both the
``period covered by the financial statements being audited or
reviewed'' and the ``period of the engagement to audit or review the
financial statements or to prepare a report filed with the
Commission.'' For audits of the financial statements of FPIs, however,
Rule 2-01(f)(5)(iii) narrowed the ``audit and professional engagement
period'' to exclude periods prior to ``the first day of the last fiscal
year before the [FPI] first filed, or was required to file, a
registration statement or report with the Commission, provided there
has been full compliance with home country independence standards in
all prior periods covered by any registration statement or report filed
with the Commission.''
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\39\ A ``foreign private issuer'' is any foreign issuer other
than a foreign government, except for an issuer that (1) has more
than 50% of its outstanding voting securities held of record by U.S.
residents; and (2) any of the following: (i) A majority of its
executive officers or directors are citizens or residents of the
United States; (ii) more than 50% of its assets are located in the
United States; or (iii) its business is principally administered in
the United States. See 17 CFR 240.3b-4(c).
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Under the SEC's amendments to the definition of ``audit and
professional engagement period'' in Rule 2-01(f)(5)(iii), the one-year
``look back'' provision for issuers filing or required to file a
registration statement or report with the Commission for the first time
(``first-time filers'') will apply to all such filers. As a result, an
auditor for a first-time filer that is either a domestic issuer or an
FPI would apply Rule 2-01 for the most recently completed fiscal year
included in its first filing, provided there has been full compliance
with applicable independence standards in all prior periods covered by
any registration statement or report filed with the Commission. In
amending Rule 2-01(f)(5)(iii), the SEC stated that the prior definition
of ``audit and professional engagement period'' may have resulted in
certain inefficiencies in the initial public offering (``IPO'') process
for domestic filers, and that the narrower definition applicable to
FPIs had created a disparate application of the independence
requirements between domestic issuers and FPIs.\40\
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\40\ See 2020 Adopting Release at 101.
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The Commission's amendment to Rule 2-01(f)(5)(iii) created a
difference between that definition and the definition of ``audit and
professional engagement period'' in Rule 3501(a)(iii), specifically
under paragraph (3) of this definition. Maintaining different
definitions of this term under the independence rules of the SEC and
PCAOB could lead to potential confusion among auditors, since the term
``audit and professional engagement period'' appears in numerous
provisions of Rule 2-01, while Rules 3520 through 3523 also set forth
certain circumstances that are deemed to impair an audit firm's
independence if they occur during either the ``audit and professional
engagement period'' or the ``professional engagement period.''
To avoid this potential confusion when applying the independence
rules of the SEC and PCAOB, the Board amended the definition of ``audit
and professional engagement period'' in Rule 3501(a)(iii)(3) to be
consistent with the SEC's amendment to Rule 2-01(f)(5)(iii). As
discussed above with respect to the amendments to the definitions of
``affiliate of the audit client'' and ``investment company complex,''
without an amendment to this definition, it would no longer be
consistent with the SEC's definition in Rule 2-01(f)(5)(iii), as has
been the case since the Board adopted its definition in 2005. Instead,
the one-year look back period would apply to both domestic issuers and
FPIs that were first-time filers under Rule 2-01, but only to FPIs that
were first-time filers under Rule 3501(a)(iii)(3).
The Board did not replace the current definition of ``audit and
professional engagement period,'' however, with a cross-reference to
Rule 2-01(f)(5). Specifically, the Board continued to use the term
``registered public accounting firm'' in the definition of ``audit and
professional engagement period,'' rather than the term ``accountant,''
which is used in Rule 2-01(f)(5). The term ``accountant'' has a
different meaning under Rule 1001(a)(ii) than under Rule 2-01(f)(1),
whereas the use of the term ``registered public accounting firm'' is
consistent with the Act and other rules of the Board. As with the SEC's
amendment to Rule 2-01(f)(5)(iii) in 2020, under Rule 3501(a)(iii)(3),
as amended, the one-year look back period will apply to both domestic
issuers and FPIs that are first-time filers.
Administrative Considerations
The Board took action to make targeted amendments to its interim
independence standards and Rule 3501 in light of the SEC's recent
amendments to Rule 2-01. Removing the provisions relating to lending
arrangements from the Board's interim independence standards avoids
differences and duplicative PCAOB and Commission requirements that
would otherwise exist after the effective date of the SEC's amendments
to the independence requirements in Rule 2-01(c)(1)(ii) on lending
arrangements. The Board also amended the definitions of certain terms
used in Rule 3501 to align these definitions with the SEC's amended
definitions of the same terms in Rule 2-01(f) to ensure they have the
same meaning under the independence rules of the Board and the SEC. The
Board believed the regulatory process employed by the Commission to
update its independence rules under Rule 2-01 was at least as robust as
the Board's process would have been had the PCAOB considered amendments
to the Board's independence requirements without the benefits of the
SEC's analysis. Therefore, the Board believed that public notice and
comment in advance of adopting these targeted amendments to the Board's
independence requirements was not necessary.
Effective Date
The Board determined that the targeted amendments to its interim
independence analysis and Rule 3501 take effect, subject to approval by
the SEC, 180 days after the date of the publication of the SEC's
October 16, 2020 amendments to Rule 2-01 in the Federal Register. The
effective date is aligned with the effective date of the Commission's
amendments to Rule 2-01.\41\ Auditors may elect to comply before the
effective date at any point after SEC approval of the Board's
amendments, provided that the final amendments are applied in their
entirety.
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\41\ See 2020 Adopting Release at 81.
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(b) Statutory Basis
The statutory basis for the proposed rules is Title I of the Act.
[[Page 76138]]
B. Board's Statement on Burden on Competition
Not applicable. The Board's consideration of the economic impacts
of the proposed rules is discussed in section D below.
C. Board's Statement on Comments on the Proposed Rules Received From
Members, Participants or Others
The Board did not solicit written comments on the proposed rules.
Therefore, there are no comments on the proposed rules received from
stakeholders.
D. Economic Considerations and Application to Audits of Emerging Growth
Companies
The Board is mindful of the economic impacts of its rulemaking.
This section discusses economic considerations related to the
amendments, including the need for the rulemaking; description of the
baseline; consideration of benefits, costs, and unintended
consequences; and alternatives considered. It also discusses
considerations related to audits of EGCs.
Need for Rulemaking
The Board needed to amend its interim independence standards and
independence rules to (1) eliminate differences and duplicative
requirements between Rule 2-01 and the Board's independence
requirements; and (2) avoid the confusion that might arise if certain
terms were used in the independence rules of the PCAOB and the
Commission, but defined differently. The Board also did not perceive
any reason or compelling basis in the SEC's rulemaking record to impede
the benefits that the Commission sought to achieve through its
revisions to Rule 2-01 in 2019 and 2020 by maintaining differences
between the independence requirements of the Board and the SEC relating
to lending arrangements or by not addressing the differences in the
definitions of certain terms that appear in the independence rules of
both the Commission and the Board.
Specifically, because the PCAOB and the SEC both have jurisdiction
with respect to auditor independence, it is important for the PCAOB to
consider how its independence standards and rules relate to the SEC's
requirements. The PCAOB's interim independence standards, as adopted
from the AICPA in 2003, cover many of the same topics as Rule 2-01 and
the SEC's regulations and the PCAOB's interim independence standards
and independence rules have worked together to establish the
independence obligations for auditors subject to the Board's
jurisdiction. Amendments to Rule 2-01 adopted by the SEC, however,
included amendments to the scope of Rule 2-01(c)(1)(ii) to exclude
certain lending arrangements that the SEC did not believe posed a
threat to an auditor's objectivity or impartiality. The Commission also
adopted targeted amendments to the definitions of the terms ``affiliate
of the audit client,'' ``audit and professional engagement period,''
and ``investment company complex,'' as used in Rule 2-01(f).
To avoid differences and duplicative requirements, the Board
adopted targeted amendments to its interim independence standards
applicable to lending arrangements between auditors and audit clients.
These amendments deleted the independence criteria that relate to
lending arrangements under ET Sec. Sec. 101.02 and 101.07, as well as
under ET Sec. Sec. 191.150-.151, ET Sec. Sec. 191.182-.183, ET
Sec. Sec. 191.196-.197 and ET Sec. Sec. 191.220-.221, and thereby
eliminated inconsistent requirements under the Board's interim
independence standards and the SEC's independence rules and guidance.
In addition, the Board adopted targeted amendments to its independence
rules to align the definitions of ``affiliate of the audit client,''
``audit and professional engagement period,'' and ``investment company
complex'' with the SEC's amendments to the definitions of the same
terms in Rule 2-01(f). These amendments avoid the potential confusion
that might arise if these terms were used in both the SEC's and the
PCAOB's independence rules, but defined differently in Rule 2-01(f) and
Rule 3501.
Baseline
The Board evaluated potential benefits, costs, and unintended
consequences of the Board's amendments relative to a baseline that
includes the amendments to Rule 2-01 adopted by the SEC in 2019 and
2020. In other words, the baseline assumes that the amendments that the
SEC adopted in 2020 to Rule 2-01 have become effective.
In identifying the baseline, the Board gave consideration to the
existing framework of independence requirements as well as the parties
that would be affected by the Board's amendments. The existing
framework of independence requirements applicable to engagements
performed by registered public accounting firms and their associated
persons is described in section A and includes the Board's interim
independence standards, the Board's permanent independence rules
(including Rules 3501 and 3502 and Rules 3520 through 3526), and the
SEC's independence rules and guidance. In addition, the Board's quality
control standards require firms to establish policies and procedures to
provide reasonable assurance that firm personnel maintain independence,
both in fact and appearance, in all required circumstances.\42\ This
framework, including the amendments to Rule 2-01 adopted by the SEC in
2019 and 2020, provides the baseline against which the impacts of the
Board's amendments can be considered.
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\42\ See QC Sec. 20.09, System of Quality Control for a CPA
Firm's Accounting and Auditing Practice.
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With respect to the affected parties, the Board took note of the
SEC's analysis of the parties that would be affected by the SEC's
amendments to Rule 2-01 in the 2019 Adopting Release and the 2020
Adopting Release. The SEC observed that the amendments will affect
auditors, audit clients, institutions engaging in financing
transactions with audit firms and their partners and employees, current
or potential affiliates of audit clients, and ``covered persons'' of
accounting firms and their immediate family members, and will affect
investors indirectly.\43\ The Board's amendments are expected to affect
the same parties.
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\43\ See 2019 Adopting Release at 84 FR 32054; 2020 Adopting
Release at 86.
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Due to limitations on the data available, the SEC was unable to
estimate precisely the number of audit engagements, the number of
lenders, or the number of covered persons and their immediate family
members that would be immediately affected by the SEC's amendments.\44\
Instead, the SEC estimated the potential universe of auditors that
might be impacted by the amendments, and reported that 1,729 audit
firms were registered with the PCAOB as of August 3, 2020.\45\ The SEC
also estimated that approximately 6,792 issuers filing on domestic
forms and 849 FPIs filing on foreign forms would be affected by the
SEC's amendments.\46\ In addition:
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\44\ See id.
\45\ See 2020 Adopting Release at 87.
\46\ See id.
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For the SEC's amendments to the Loan Provision, the
Commission focused mainly on the investment management industry and
provided statistics on audited fund series and their investment company
auditors.\47\
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\47\ See 2019 Adopting Release at 84 FR 32054-55.
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For the SEC's amendment related to the ``look-back''
period for assessing independence compliance with respect to first-time
filers, the Commission examined historical data for domestic IPOs and
reported that there were
[[Page 76139]]
approximately 543 domestic IPOs between January 1, 2017 and December
31, 2019.\48\
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\48\ See 2020 Adopting Release at 88.
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For the SEC's amendments to the ``investment company
complex'' definition, the Commission focused on registered investment
companies and unregistered funds. The SEC reported that, as of
September 2020, there were 2,763 registered investment companies that
filed annual reports on Form N-CEN. It also reported the numbers and
total net assets of mutual funds, exchange traded funds, closed-end
funds, variable annuity separate accounts, money market funds, and
business development companies as of July 2020.\49\
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\49\ See id. at 88-89.
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The above estimates and statistics regarding the parties
immediately affected by the SEC's amendments are also relevant to the
Board's related amendments. Specifically, the Board's amendments are
intended to align the Board's interim independence standards relating
to lending arrangements with the independence criteria presented in
Rule 2-01 and to align the meaning of the definitions of certain terms
used in the independence rules of the SEC and the PCAOB.
Consideration of Benefits, Costs, and Unintended Consequences
This section discusses the potential benefits, costs, and
unintended consequences of the Board's amendments. The analysis is
largely qualitative in nature because the Board is unable to quantify
the economic effects due to a lack of information necessary to provide
reasonable estimates. Similar to the SEC, the Board is not able to
reasonably estimate the number of current audit engagements that will
be immediately affected by the amendments as we lack relevant data
about such engagements. The Board also similarly does not have precise
data on audit clients' ownership and control structures.\50\
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\50\ See id. at 86.
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Benefits
The Board's amendments avoid differences between the independence
requirements of the PCAOB and the SEC by deleting the portions of the
interim independence standards relating to lending arrangements and
aligning the meaning of certain definitions used in the independence
rules of the SEC and the PCAOB. The amendments should thus clarify the
professional obligations of auditors and avoid regulatory uncertainty
regarding the treatment of lending arrangements and the meaning of
certain terms used in the independence requirements of both the SEC and
the PCAOB, leading to a potential reduction in overall compliance
costs. In amending the Board's independence requirements, the Board
also took note of certain of the potential benefits identified by the
Commission when amending Rule 2-01 in 2019 and 2020.\51\
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\51\ See generally 2019 Adopting Release at 84 FR 32055-56; 2020
Adopting Release at 89-92.
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For example, the SEC stated in the 2019 Adopting Release
and the 2020 Adopting Release that its amendments to Rule 2-01 may
reduce compliance costs for audit firms and audit clients by updating
existing requirements that may be unduly burdensome. The SEC also
observed that, under the amended rules, auditors and their clients will
be able to focus their attention and resources on monitoring those
relationships and services that pose the greatest risk to auditor
independence, thus reducing overall compliance burdens without
significantly diminishing investor protections.\52\
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\52\ See 2020 Adopting Release at 89.
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The SEC observed that the amendments to Rule 2-01 may lead
to a potentially larger pool of auditors eligible to perform audit
engagements, which in turn could reduce the costs associated with
searching for an independent auditor and reduce the costs resulting
from switching from one audit firm to another. In this regard, the
Commission further stated that an expanded pool of eligible auditors
also might improve matching between auditor expertise and necessary
audit procedures and considerations for a particular audit client,
which could lead to improvements in audit quality and financial
reporting quality, as well as improvements in the efficiency of
auditing processes. If the amendments lead to improvements in financial
reporting quality, investors might be positioned to make more efficient
investment decisions.\53\
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\53\ See 2019 Adopting Release at 84 FR 32055; 2020 Adopting
Release at 95-96.
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The SEC stated that auditors also could benefit from
potentially having a broader spectrum of audit clients and clients for
non-audit services as a result of the SEC's amendments to Rule 2-01.
For example, the Commission observed that if the amendments reduce
certain burdensome constraints on auditors in complying with the
independence requirements, auditors likely will incur fewer compliance
costs. Another example was the Commission's observation that the
amendments potentially could reduce auditor turnover due to changes in
audit clients' organizational structure arising from certain merger and
acquisition activities.\54\
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\54\ See 2020 Adopting Release at 91.
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The Commission's 2019 Adopting Release and the 2020
Adopting Release also discuss the expected benefits of each of the
specific amendments to Rule 2-01 adopted by the Commission. For
example, the SEC stated that its amendments to Rule 2-01(c)(1)(ii) to
permit some covered persons to be considered independent
notwithstanding the existence of certain lending relationships, such as
student and consumer loans satisfying the criteria set forth in Rule 2-
01, might lead to improved matching between partner and staff
experience and audit engagements and, therefore, to increases in audit
efficiency and audit quality.\55\ Another example was the Commission's
observation that the amendment to the definition of ``audit and
professional engagement period'' in Rule 2-01(f)(5), such that the one-
year look back provision applies to all first-time filers, domestic and
foreign, might avoid the need for a domestic first-time filer to delay
an IPO or switch to a different auditor to comply with independence
requirements.\56\
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\55\ See id. at 103-04.
\56\ See id. at 101.
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To the extent they eliminate potential conflicts with Rule 2-01, as
amended, the Board's amendments to its interim independence standards
regarding lending arrangements increase the likelihood that the
benefits anticipated by the SEC will be realized. In addition, the
Board's amendments to align the definitions of ``affiliate of the audit
client,'' ``audit and professional engagement period,'' and
``investment company complex'' with the SEC's amendments avoid the
potential compliance costs of having to apply different definitions of
the same terms when complying with the independence rules of the SEC
and the PCAOB.
Costs and Unintended Consequences
The Board also considered the potential costs and unintended
consequences of the amendments to its interim independence standards
and independence rules. Overall, the Board does not anticipate that the
amendments are likely to impose significant incremental compliance
costs on audit firms and audit clients, or give rise to unintended
consequences, since the amendments are limited in nature and audit
firms are expected to revise their independence policies and procedures
[[Page 76140]]
to take into account the SEC's amendments to Rule 2-01 in 2019 and
2020.
In evaluating the potential costs and unintended consequences of
the Board's amendments, the Board also took note of the SEC's analysis
of the potential costs and other consequences associated with its
amendments to Rule 2-01 in the 2019 Adopting Release and the 2020
Adopting Release. For example, in adopting amendments to Rule 2-01 in
2020, the SEC stated that, if the amendments to Rule 2-01 result in an
increased risk to auditor objectivity and impartiality due to newly
permissible relationships and services, then investors might have less
confidence in the quality of financial reporting, which could lead to
less efficient investment allocations and increased cost of
capital.\57\ The Commission also observed, however, that it did not
anticipate significant costs to investors or other market participants
associated with the amendments because they address relationships and
services that are less likely to threaten auditors' objectivity and
impartiality.\58\
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\57\ See id. at 92.
\58\ See id.
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The Commission further observed in the 2019 Adopting Release and
the 2020 Adopting Release that its updates to Rule 2-01 might require
more efforts from auditors and audit clients to familiarize themselves
with the SEC's amended requirements. For example, the Commission
observed in the 2019 Adopting Release that its revisions to the Loan
Provision might require the exercise of more judgment in independence
determinations, thus potentially contributing to increases in
compliance costs in the short term.\59\ However, the Commission also
stated that it did not anticipate that its amendments to the Loan
Provision in 2019 would impose significant compliance costs on
auditors.\60\ The Commission similarly observed in the 2020 Adopting
Release that certain of its amendments to Rule 2-01 earlier this year,
such as the inclusion of a dual materiality threshold in the
``affiliate of the audit client'' and ``investment company complex''
definitions in Rules 2-01(f)(4) and 2-01(f)(14), might require more
efforts from audit firms and audit clients to familiarize themselves
with and apply the amended requirements, but that it did not anticipate
significant incremental compliance costs.\61\
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\59\ See 2019 Adopting Release at 84 FR 32056-57.
\60\ See id. at 84 FR 32056.
\61\ See 2020 Adopting Release at 97, 99-100.
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The Board also took note of the Commission's observation in the
2019 Adopting Release and the 2020 Adopting Release that the SEC's
updates to Rule 2-01 could result in some crowding-out effect in the
audit industry. For example, the SEC stated in the 2019 Adopting
Release that the potentially increased ability of larger firms to
compete for audit clients under the amendments to Rule 2-01 adopted by
the SEC in 2019 could potentially crowd out smaller audit firms, but
also estimated that four audit firms already performed 86% of audits in
the investment management industry.\62\ In addition, the Commission
observed in the 2020 Adopting Release that the larger accounting firms
may be more likely to be positively affected by the amendments to Rule
2-01 as these firms may be able to compete for or retain a larger pool
of audit clients, which could potentially crowd out the audit business
of smaller audit firms.\63\ The SEC estimated that the four largest
accounting firms already performed 49.2% of audits for all registrants
and more than 80% of audits in the registered investment company space
and, as a result, it did not expect any potential change in the
competitive dynamics among accounting firms to be significant.\64\
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\62\ See 2019 Adopting Release at 84 FR 32057.
\63\ See 2020 Adopting Release at 108-09.
\64\ See id. at 109.
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Alternatives Considered
The Board considered three alternatives to the amendments to its
interim independence standards and independence rules described herein:
(1) Making amendments to its interim independence standards and
independence rules to track the language of the SEC's amendments to
Rule 2-01 as closely as possible; (2) issuing guidance relating to
compliance with the independence requirements of the PCAOB and the SEC
following the Commission's amendments to Rule 2-01 in 2020; or (3)
taking no action.
First, the Board considered making specific amendments to its
interim independence standards to track the language of the SEC's
amendments to Rule 2-01 as closely as possible. This alternative would
have maintained duplicative and overlapping requirements relating to
lending arrangements under ET Sec. 101.02 and ET Sec. 101.07, as well
as under ET Sec. Sec. 191.150-.151, ET Sec. Sec. 191.182-.183, ET
Sec. Sec. 191.196-.197, and ET Sec. Sec. 191.220-.221, in the Board's
interim independence standards established by the AICPA. This approach
also would have been more challenging from a drafting perspective,
especially with respect to potential amendments to the provisions of
the Board's interim independence standards relating to grandfathered
and permitted loans, since the Board's interim independence standards
use different terminology and have a different organizational structure
than Rule 2-01. As a result, this alternative would have provided less
clarification to auditors on their professional obligations with
respect to lending arrangements than the approach adopted by the Board,
which eliminates duplicative and overlapping requirements relating to
lending arrangements under the Board's interim independence standards.
Under the first alternative, the Board also considered amending the
definitions of ``affiliate of the audit client'' and ``investment
company complex'' in Rules 3501(a)(ii) and (i)(ii), respectively, to
track the language of the SEC's amendments to the definitions of the
same terms in Rule 2-01 as closely as possible. The Board decided to
amend the definitions of ``affiliate of the audit client'' and
``investment company complex'' by incorporating by reference the
definition of these terms used in Rule 2-01. Amending the definitions
to clarify that these terms have the same meaning as defined in Rule 2-
01(f) avoids having to repeat the same definitions in the Board's
rules. As discussed, however, the Board amended the definition of
``audit and professional engagement period'' in Rule 3501(a)(iii) to
conform to the SEC's amendments to the definition of ``audit and
professional engagement period'' in Rule 2-01(f)(5) by adapting the
Commission's definition and using specific terms used in the Act and
other rules of the Board (specifically, by replacing the term
``accountant'' with the term ``registered public accounting firm'').
Second, as an alternative to rulemaking, the Board considered the
issuance of guidance to inform auditors that, after the effective date
of the SEC's 2020 amendments to Rule 2-01, the Board would not object
if auditors looked to the requirements of Rule 2-01, as amended, when
complying with the independence requirements relating to lending
arrangements under the Board's interim independence standards and
applying the definitions set forth in Rule 3501(a)(ii), (a)(iii) and
(i)(ii). This alternative could be accomplished relatively quickly and
would avoid the need for the Board to amend the Board's interim
independence standards or Rule 3501. This approach would leave in
place, however, provisions of the Board's interim independence
standards relating to lending arrangements and definitions of certain
terms in Rule 3501
[[Page 76141]]
that include differences with Rule 2-01, as amended, or otherwise
overlap with the SEC's independence requirements relating to lending
arrangements. This approach might also create regulatory uncertainty
and additional costs by leaving auditors and audit clients, especially
those who were not aware of the Board's guidance, uncertain as to their
professional obligations.
Third, the Board considered taking no action at this time to amend
its interim independence standards or independence rules. This
alternative would require auditors to comply with two different sets of
independence requirements relating to lending arrangements under Rule
2-01 and the Board's interim independence standards \65\ and to look to
two different definitions of ``affiliate of the audit client,'' ``audit
and professional engagement period,'' and ``investment company
complex'' when complying with the independence rules of the SEC and the
PCAOB. While this approach might underscore the Board's authority to
establish independence standards for registered public accounting
firms, it would leave unaddressed certain differences between the
independence requirements of the Board and the SEC that had not existed
when the PCAOB adopted its interim independence standards in 2003 or
began to adopt its permanent independence rules in 2005, including with
respect to both lending arrangements and the scope of the entities
considered part of the ``audit client'' for purposes of the Board's
independence rules. This approach might also impede some of the
benefits that the Commission sought to achieve through its revisions to
Rule 2-01 and result in additional compliance costs when applying two
different definitions of the same terms in Rule 2-01 and the Board's
rules.
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\65\ See supra note 15 (discussing the Note to Rule 3500T).
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In comparison to these alternatives, the Board's decision to remove
the provisions relating to lending arrangements from the Board's
interim independence standards avoids duplicative requirements in the
independence requirements of the Board and the SEC on lending
arrangements and helps facilitate compliance with Rule 2-01, as
amended, by clarifying the professional obligations of audit firms. The
amendments should also facilitate cooperation and coordination between
the Board and the SEC when monitoring compliance with the SEC's revised
provisions in Rule 2-01(c)(1)(ii) relating to lending arrangements.
Application to Audits of Emerging Growth Companies
Pursuant to Section 104 of the Jumpstart Our Business Startups Act
(``JOBS Act''), rules adopted by the Board subsequent to April 5, 2012
generally do not apply to the audits of EGCs, as defined in Section
3(a)(8) of the Securities Exchange Act of 1934, unless the SEC
``determines that the application of such additional requirements is
necessary or appropriate in the public interest, after considering the
protection of investors, and whether the action will promote
efficiency, competition, and capital formation.'' \66\ As a result of
the JOBS Act, the rules and related amendments to PCAOB standards the
Board adopts are generally subject to a separate determination by the
SEC regarding their applicability to audits of EGCs.
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\66\ See Public Law 112-106 (Apr. 5, 2012). See Section
103(a)(3)(C) of the Act, as added by Section 104 of the JOBS Act.
Section 104 of the JOBS Act also provides that any rules of the
Board requiring (1) mandatory audit firm rotation or (2) a
supplement to the auditor's report in which the auditor would be
required to provide additional information about the audit and the
financial statements of the issuer (auditor discussion and analysis)
shall not apply to an audit of an EGC. The Board's amendments do not
fall within either of these two categories.
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To inform consideration of the application of the Board's rules and
standards to audits of EGCs, the Board's staff publishes a white paper
that provides general information about characteristics of EGCs.\67\ As
of the November 15, 2019 measurement date, the PCAOB staff identified
1,761 companies that had identified themselves as EGCs and had filed
audited financial statements with the SEC, including an audit report
signed by a registered public accounting firm in the 18 months
preceding the measurement date.
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\67\ See PCAOB white paper, Characteristics of Emerging Growth
Companies and Their Audit Firms as of November 15, 2019 (Nov. 9,
2020), available on the Board's website.
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In amending Rule 2-01 in 2019 and 2020, the Commission conducted an
economic analysis, which included an analysis of the effect of the
amendments to Rule 2-01 on efficiency, competition, and capital
formation. The SEC concluded that the amendments to Rule 2-01 likely
would improve the practical application of Rule 2-01 and reduce
compliance burdens, and might increase competition among auditors and
lead to a potential reduction in audit costs. In addition, the
Commission determined that the amendments to Rule 2-01 may also
facilitate capital formation.\68\ Additionally, the SEC's economic
analysis regarding the amendments to the definition of ``audit and
professional engagement period'' in Rule 2-01(f)(5) concluded that a
shorter look-back period may facilitate additional IPOs and thereby
promote efficiency and capital formation.
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\68\ See 2019 Adopting Release at 84 FR 32057; 2020 Adopting
Release at 107.
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The economic considerations discussed above are generally
applicable to audits of EGCs. Moreover, if the Board's amendments were
determined not to apply to the audits of EGCs, auditors would be
required to address the differing independence requirements in their
independence policies and procedures and in their quality control
systems, which would create the potential for confusion.
Accordingly, and for the reasons explained above, the Board
requests that the Commission determine that it is necessary or
appropriate in the public interest, after considering the protection of
investors and whether the action will promote efficiency, competition,
and capital formation, to apply the Board's targeted amendments to its
interim independence standards and independence rules to audits of
EGCs. The Board stands ready to assist the Commission in considering
any comments the SEC receives on these matter during the Commission's
public comment process.
III. Date of Effectiveness of the Proposed Rules and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period not more than an
additional 45 days (i) if the Commission determines that such longer
period is appropriate and publishes the reasons for such determination
or (ii) as to which the Board consents, the Commission will:
(A) By order approve or disapprove such proposed rules; or
(B) institute proceedings to determine whether the proposed rules
should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed
rules are consistent with the requirements of Title I of the Act.
Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (http://www.sec.gov/rules/pcaob.shtml); or
[[Page 76142]]
Send an email to [email protected]. Please include
File Number PCAOB-2020-01 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number PCAOB-2020-01. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (http://www.sec.gov/rules/pcaob.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rules that are filed
with the Commission, and all written communications relating to the
proposed rules between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549 on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of such filing will also be available for inspection
and copying at the principal office of the PCAOB. All comments received
will be posted without charge. Persons submitting comments are
cautioned that we do not redact or edit personal identifying
information from comment submissions. You should submit only
information that you wish to make available publicly. All submissions
should refer to File Number PCAOB-2020-01 and should be submitted on or
before December 18, 2020.
For the Commission by the Office of the Chief Accountant, by
delegated authority.\69\
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\69\ 17 CFR 200.30-11(b)(1) and (3).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-26145 Filed 11-25-20; 8:45 am]
BILLING CODE 8011-01-P