Just before 2019 ended, the Securities and Exchange Commission OK’d a proposal to modernize its decades-old auditor independence rules. If finalized, the updated rules would relax some restrictions that currently prevent auditors from working for companies when those auditors have relationships with or provide services to affiliates of those companies.

The proposed rules also would shorten the so-called “look-back” period for U.S. companies planning to go public to align domestic requirements with those of foreign companies. The “look-back” period refers to the time period for which companies planning to go public have to determine their auditor is independent.

Comments on the proposed rules are due 60 days from their publication in the Federal Register.

Why now?

The Commission has long required auditors to be independent of their audit clients both “in fact and in appearance,” the SEC notes in its proposed rule. Accountants are limited in their ability to have business relationships with an audit client or to provide non-audit services to an audit client.

An audit by an “objective, impartial, and skilled professional” enhances “investor protection” as well as “market integrity,” which, in turn, “facilitates capital formation,” SEC Chairman Jay Clayton said when the proposed updates were announced Monday.

In some measure, the proposed revisions reflect years of experience SEC staff has gained in administering the auditor independence rules, some of which yielded unintended consequences. The revisions “primarily focus on fact patterns presented to Commission staff through consultations,” the SEC explained in a press release announcing the proposal.

Overreach in the current rules

The SEC rolled out the current framework of rules for determining whether an auditor is independent back in the year 2000. In practice, according to the SEC, some restrictions currently in place do not impact an audit firm’s objectivity and impartiality.

For instance, under the current framework, an auditor based in Atlanta at an audit firm would not be able to audit a large lender that provided a student loan to one of the auditor’s Atlanta-based partners if that partner is still paying off that student loan from college. “Under the current rules, the student loan of the audit partner who is not part of the audit would still lead to an independence violation for the audit engagement of the lender,” the SEC explained in a fact sheet about its proposed changes.

The extensiveness of the current conflicts-of-interest requirements applicable to auditors have limited the choice audit clients have to choose an auditor, the SEC noted in its proposed revisions. For instance, while “those responsible for selecting an auditor may believe a certain audit firm is the best fit from an audit quality perspective,” the SEC explained, that preferred audit firm would be conflicted out “if it is providing a prohibited service to a sister entity, even where such sister entity is not material to the controlling entity.”

A practical approach

To ease this problem, the SEC is proposing to modify the definition of affiliates of audit clients to focus more on “relationships and services that are most likely to threaten auditory objectivity and impartiality,” the SEC explained.

As a result of its modernization effort, the SEC predicts the pool of eligible auditors will expand, there will be more alignment of between a client’s needs and an auditor’s expertise, and that the quality of financial reporting will improve. The SEC also anticipates corporate audit committees will not have to waste time addressing independence questions when an auditor’s objectivity is not really at issue.

More on audit committees

In a separate development also Monday, Clayton, along with the SEC’s chief accountant and the SEC director of the division of corporation finance, issued reminders to audit committees on their financial reporting and oversight responsibilities.

Among the observations they made in their public statement, they encourage audit committees to consider the sufficiency of an auditor’s and the corporation’s monitoring processes in assuring auditor independence. Monitoring processes should address corporate changes that could affect auditor independence such as events that result in new affiliates or business relationships.

Lori Tripoli is a writer based in the greater New York City area who focuses on legal and regulatory issues.