The Securities and Exchange Commission (SEC) has moved forward with relaxing its conflict-of-interest rules for independent auditors.

The amendments to Rule 2-01 of Regulation S-X create certain exemptions from the SEC’s rules that outline when an independent auditor must investigate a potential conflict and potentially decline to serve a client for which a conflict is found to exist.

The amendments, proposed back in December 2019, passed the SEC on Friday by a 3-2 vote, with Commissioner Jay Clayton joining Republican Commissioners Hester Peirce and Elad Roisman in favor. Democratic Commissioners Allison Herren Lee and Caroline Crenshaw dissented.

In a statement, Clayton said the current SEC rules are limiting “auditor choice which, in turn, may adversely affect the important arms-length nature of the issuer-auditor relationship.” He characterized the changes as “modest and tailored,” drafted through experience of SEC staff as they dealt with unintended consequences resulting from strict adherence to the current rule. The amended rules, he said, will “eliminate adverse effects on auditor choice without detracting from the independence obligations of auditors and issuers.”

But Lee and Crenshaw, the two Democratic commissioners who voted against the amendments, wondered if the rules were being loosened too much. In a joint statement, entitled “Who Watches the Watchers?” as a nod to an episode of “Star Trek,” the commissioners said:

“Today’s rules replace a clear standard with one that provides auditors greater discretion when assessing their own independence and presents greater risk of mistaken or inconsistent application of that standard. What’s more, under the final rules, there is no mechanism for ensuring that the SEC and the investing public have visibility into how effectively auditors are making these assessments.”

The amendments, which take effect 180 days after publication in the Federal Register, change conflict-of-interest rules in three areas: affiliate of the audit client, investment company complex, and audit and professional engagement period.

Under the current definition of affiliate of the audit client, the requirement to “identify and monitor for potential independence-impairing relationships and services applies to affiliated entities, including sister entities, regardless of whether the sister entities are material to the controlling entity.”

Under the amended rule, a sister entity would be deemed an affiliate of the audit client “unless the entity is not material to the controlling entity,” according to the SEC. The SEC said it is appropriate to exclude sister entities that are not material to the controlling entity because such entities “do not typically pose a threat to the auditor’s objectivity and impartiality and their exclusion would allow auditors and audit clients to focus on those relationships that are more likely to threaten the auditor’s objectivity and impartiality.”

The exclusion is consistent with the definition of “affiliate” used by the American Institute of Certified Public Accountants (AICPA) in its ethics and independence rules, the SEC said.

The amended rules would also eliminate potential conflicts of interest regarding student loans.

Another amendment to the rules involves potential conflicts for independent auditors who audit a company that is invested in by a particular fund who also audits other companies which are part of the fund’s portfolio of investments. (The example assumes the three companies have no other connections, other than they are part of the same portfolio of investments).

In its press release announcing the amendments, the SEC gives an example of such a scenario.

The current rules would require the first company being audited to replace the audit firm with another audit firm; to wait to register with the SEC for up to three years after terminating audit relationships with other firms part of the same investment portfolio; or “make a determination, likely in consultation with Commission staff and/or the audit committee, that the rule violation did not impair the auditor’s objectivity and impartiality.”

The amended rules would clear away these conflicts of interest and allow the audit firm to provide services to the first company.

The amended rules also apply the one year look-back period for first-time filers to all such filers, “which would result in treating all first-time filers (i.e., domestic issuers and FPIs) similarly for purposes of the independence requirements” under the rule, the SEC said.