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Updated Department of Labor Independence Requirement – what has and has not changed
In September 2022, the Department of Labor (DOL) updated its Interpretive Bulletin Relating to the Independence of Employee Benefit Plan Accountants (Interpretive Bulletin or IB). The Interpretive Bulletin, which updates the previous version issued in 1975, applies to firms auditing employee benefit plans under the Employee Retirement Income Security Act of 1974 (“ERISA”). The new IB’s stated purpose is “to remove certain outdated and unnecessarily restrictive provisions and reorganize its provisions for clarity while continuing to ensure that the Department's interpretations foster proper auditor independence and access of employee benefit plan to highly qualified auditors and audit firms”.
In summary, the new IB allows a firm and its professionals to avoid an independence issue before a firm becomes the auditor of an employee benefit plan (EBP) sponsored by a public company by disposing of financial interests that would impair the firm’s independence. The updated guidance also provides new definitions that help to clarify the requirements. Overall, the changes bring the DOL independence requirement into closer alignment with the AICPA Code of Professional Conduct (Code), the Securities and Exchange Commission (SEC) independence rules, and rules of other regulators. A brief description of each change follows:
Financial interest held in EBP or EBP Sponsor
Under the previous and current IBs, independence is impaired if an audit firm or a professional in the audit firm meeting the definition of “member” held any direct or material indirect financial interest in the EBP or the EBP’s sponsor during the:
• period of professional engagement to examine the financial statements being reported,
• date of the audit opinion, or
• period covered by the financial statements.
“Member” was and continues to be defined as:
“all partners or shareholder employees in the firm and all professional employees participating in the audit or located in an office of the firm participating in a significant portion of the audit.”
Under the old IB, if a new EBP audit opportunity arose, any direct or material indirect financial interest in the EBP or the EBP’s sponsor held by the audit firm or a “member” of the firm disqualified the firm from becoming the EBP’s auditor because the rule applied to the period covered by the financial statements with no provision for disposing of the interest prior to becoming the auditor.
The updated IB maintains the financial interest prohibition but incorporates a new provision that allows the firm or a member of the firm (including the member’s immediate family) to dispose of any prohibited financial interests in a public company sponsor or its EBP prior to the period of the professional engagement. Two notes on this new provision: (1) it may only be applied when an EBP sponsor is a public company (i.e., the securities are publicly traded), and (2) the new provision explicitly mentions that interests held by a member’s immediate family (spouse or dependent) should be disposed of. On the latter point, the prior IB did not specify that immediate family’s financial interests impaired independence, but according to commentary explaining the new IB, the DOL staff has generally attributed such interests to the member, which is consistent with the Code and the SEC independence rules.
An example of how the new provision would apply under the new IB:
AB, Inc. (a public company) is seeking a new auditor for its “401K” benefit plan. XY Auditors determines that certain of its professionals hold AB stock. If those professionals sell their shares before XY signs the audit engagement letter or begins performing the audit of the EBP (whichever comes first), independence will not be impacted.
New Definition of “Period of Professional Engagement”
Aligning more closely with the Code and SEC rules, the definition “period of professional engagement” means the period:
• beginning when a firm signs an initial engagement letter or other agreement to perform the audit or begins to perform any audit, review, or attest procedures (including planning procedures), whichever is earlier, and
• ending with the formal notification (by the firm or client) of the termination of the professional relationship or issuance of the audit report, whichever is later.
New Definition of “Office”
Noting that the concept of an “office” for workplace purposes has changed to focus more on workgroups than on physical locations, the DOL adopted a new definition based on the AICPA’s definition of “office” for purposes of determining when an individual is “located in an office” of the firm participating in a significant portion of the audit. The new definition reads:
A reasonably distinct subgroup within a firm, whether constituted by formal organization or informal practice, in which personnel who make up the subgroup generally serve the same group of clients or work on the same categories of matters regardless of the physical location of the individuals who comprise the group. Substance should govern the office classification, and the expected regular personnel interactions and assigned reporting channels of an individual may well be more important than an individual’s physical location.
The DOL did not update other provisions in the 1975 IB, which remain intact.
In the new IB, the DOL notes its belief that certain provisions in the 1975 IB made it unnecessarily restrictive. Concerned in recent years about the quality of EBP audits, particularly auditors with very limited experience performing them, the DOL did not wish to unduly limit EBPs’ access to qualified auditors. The change allowing divestiture of certain securities, along with clarification of the terms, “office” and “period of professional engagement,” which aligns more closely with rules of the AICPA, the SEC, and other regulators, should help to achieve this.
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