5 Key Takeaways - SEC Statement on Independence

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In early June, Paul Munter, the Acting Chief Accountant of the Securities and Exchange Commission’s (SEC’s) Office of the Chief Accountant (OCA), released a statement entitled, “The Critical Importance of the General Standard of Independence and an Ethical Culture for the Accounting Profession” (Statement). This was the third statement in which Mr. Munter highlighted auditor independence (the others were released in October and December 2021). Here are five (5) key takeaways from his most recent statement:

#1. The general standard and underlying principles are critical elements of the SEC’s independence rules that apply in all cases

The general standard of auditor independence (Rule 2-01(b) of Regulation S-X) and four (4) guiding principles in the rule’s introductory text provide a framework for considering whether an accountant is independent with respect to an audit client. To apply the general standard, one considers whether a reasonable investor with knowledge of all relevant facts and circumstances would conclude that an auditor is capable of exercising objective and impartial judgment of all issues encompassed within the audit engagement.

In considering the standard, the SEC considers the following principles, which focus on whether an auditor’s relationship with a client or the provision of a service:

• Creates a mutual or conflicting interest between the auditor and the client

• Places the auditor in the position of auditing their own work

• Results in the auditor acting as management or an employee of the client

• Places the auditor in a position of being an advocate for the client

Rule 2-01(c) of Regulation S-X (Rule 2-01(c)) provides examples of situations that are inconsistent with the general standard, but compliance with Rule 2-01(c) alone is insufficient. The Statement notes that:

“The general standard requires an evaluation of auditor independence, including an assessment of independence both in fact and appearance from the perspective of a reasonable investor. Such a determination cannot be limited to a checklist compliance exercise under Rule 2-01(c). To reiterate: the general standard of Rule 2-01(b) is the heart of the Commission’s auditor independence rule, it always applies, and the Commission investigates and enforces against violations of the general standard.” [emphasis added]

#2. Auditors should not rely too heavily on historical OCA staff positions

When consulting with OCA staff on an independence matter, auditors will sometimes ask the staff to consider historical OCA staff positions that were previously provided and appear to involve similar circumstances. According to the Statement:

“OCA staff first independently assess how similar the circumstances of the current consultation are with respect to a historical consultation and any other relevant prior consultations of which a party seeking guidance may be unaware. OCA staff always take into consideration the degree to which applicable legal requirements may have changed since the time of historical staff consultations. We therefore strongly discourage accountants from placing undue reliance on any historical OCA staff positions, which are necessarily limited to the particular circumstances of the consultation.” [Emphasis added]

Recent developments may affect the applicability of prior OCA staff positions, which may not apply to the auditor’s facts and circumstances. Therefore, auditors, registrants, and audit committees are advised to consult with OCA staff on current auditor independence issues and questions and not rely too heavily on previously issued positions.

#3. OCA staff have noted “loosening attitudes” toward the SEC’s general standard in some areas

The OCA staff often discuss independence with audit committees, auditors, and registrants and have noted situations that reflect “loosening attitudes” toward the SEC’s general standard of auditor independence. Specifically, when evaluating independence in certain instances, the staff have observed that auditors, registrants, and audit committees treated Rule 2-01(c) as a checklist of prohibitions and ignored the general standard, which as noted earlier, is insufficient. Because of this, the Statement emphasizes (more than once) that the SEC investigates and enforces against violations of its general standard of auditor independence.  

#4. Auditors’ provision of non-audit services, increasingly complex business relationships, and audit firm restructurings concern the OCA

Long on its list of concerns, an auditor’s provision of non-audit services and business relationships are noted as increasing areas of concern. In this case, however, the auditor is not providing services or entering into a business relationship with its client, but rather with the client’s affiliates and non-affiliates. The OCA staff have observed situations in which the magnitude of non-audit services and business relationships between an auditor, the client’s affiliates and non-affiliates raise questions about compliance with the general standard.

The staff also note that many audit firms have recently engaged in complex business arrangements with their audit clients. In some cases, firms have facilitated these arrangements through restructurings and the use of alternative practice structures such as private equity investments in a firm’s non-audit practice that separate the firm’s audit and non-audit practices. Such arrangements have the potential to undermine auditor independence, the OCA warns.  

#5. A firm’s ethical culture is critical for auditor independence

According to the OCA, decreased vigilance about auditor independence (a “checklist compliance” mentality) has led to a deterioration in the ethical culture in some firms.  Firm leadership should take compliance with all aspects of the independence rules very seriously and lead by example. Among other things, firms should:

• prioritize auditor independence and a culture of ethical behavior in all professional activities

• in “close-to-the-line” calls, be willing to forego fees and/or further services to maintain independence

• have adequate quality controls aligned with independence regulations

• be vigilant about the possibility that firm staff may try to circumvent independence quality controls

• address auditor independence compliance with the seriousness and urgency it deserves

The Statement closed with the following:

“Accountants play a critical role in the integrity of our markets and the protection of investors, and audit professionals in particular have a difficult job—they are forced to sometimes make difficult determinations. But that is precisely how public accountants fulfill their gatekeeping function to help protect investors—by ensuring that issues are promptly identified and addressed. To maintain that function, and in training the next generations of public accountants, it is critical that our accounting firms foster and prioritize a culture of ethical behavior in all their professional activities, but especially with respect to auditor independence.”


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