Qualifications of Accountants

Federal RegisterDec 11, 2020

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 210

[Release No. 33-10876; 34-90210; FR-88; IA-5613; IC-34052; File No. S7-26-19]

RIN 3235-AM63

Qualifications of Accountants

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

The Securities and Exchange Commission (“Commission” or “SEC”) is adopting amendments to update certain auditor independence requirements. These amendments are 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.

DATES:

Effective date:

June 9, 2021.

Compliance dates:

See Section II.G for further information on transitioning to the final amendments.

FOR FURTHER INFORMATION CONTACT:

Duc Dang, Senior Special Counsel, or Natasha Guinan, Chief Counsel, Office of the Chief Accountant, at (202) 551-5300; Alexis Cunningham, or Jenson Wayne, Assistant Chief Accountants, Chief Accountant's Office, Division of Investment Management, at (202) 551-6918, or Pamela K. Ellis, Senior Counsel, Brian McLaughlin Johnson, Assistant Director, Investment Company Regulation Office, or Sirimal R. Mukerjee, Branch Chief, Investment Adviser Regulation Office, Division of Investment Management, at (202) 551-6792, U.S. Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

We are adopting amendments to 17 CFR 210.2-01 (“Rule 2-01”) of 17 CFR 210.01

et seq.

(“Regulation S-X”).

Hereinafter, all references to Rule 2-01 and any paragraphs included within the rule refer to Rule 2-01 of Regulation S-X.

Table of Contents

I. Introduction

II. Amendments

A. Amendments to Definitions

1. Amendments to the Definitions of Affiliate of the Audit Client and the Investment Company Complex

2. Amendment to the Definition of Audit and Professional Engagement Period

B. Amendments to Loans or Debtor-Creditor Relationships

1. Amendment To Except Student Loans

2. Amendment To Clarify the Reference to “A Mortgage Loan”

3. Amendment To Revise the Credit Card Rule To Refer to “Consumer Loans”

C. Amendments to the Business Relationships Rule

1. Proposed Amendment to the Reference to “Substantial Stockholder”

2. Comments Received

3. Final Amendments

4. Conforming Amendments to the Loan Provision

D. Amendments for Inadvertent Violations for Mergers and Acquisitions

1. Proposed Amendment

2. Comments Received

3. Final Amendments

E. Miscellaneous Amendments

1. Proposed Miscellaneous Amendments

2. Comments Received

3. Final Amendments

F. Other Comments Received

G. Transition

III. Other Matters

IV. Economic Analysis

A. Introduction

B. Baseline and Affected Parties

C. Potential Costs and Benefits

1. Overall Potential Costs and Benefits

2. Costs and Benefits of Specific Amendments

a. Amendments to the Definition of an Affiliate of the Audit Client and Investment Company Complex

b. Amendment to the Definition of Audit and Professional Engagement Period

c. Amendments to Loans or Debtor-Creditor Relationships

d. Amendments to the Business Relationships Rule

e. Amendments for Inadvertent Violations for Mergers and Acquisitions

D. Effects on Efficiency, Competition and Capital Formation

E. Alternatives

V. Paperwork Reduction Act

VI. Final Regulatory Flexibility Act Analysis

A. Need for, and Objectives of, the Final Amendments

B. Significant Issues Raised by Public Comment

C. Small Entities Subject to the Proposed Rules

D. Projected Reporting, Recordkeeping and Other Compliance Requirements

E. Agency Action to Minimize Effect on Small Entities

VII. Codification Update

VIII. Statutory Basis

I. Introduction

On December 30, 2019, the Commission proposed amendments to Rule 2-01 to update certain auditor independence requirements, including by focusing the requirements on those relationships and services that are more likely to threaten an auditor's objectivity and impartiality in light of current market conditions and industry practice.

Specifically, the Commission proposed amendments to the definitions of “affiliate of the audit client,” “investment company complex,” and “audit and professional engagement period” in Rule 2-01. The Commission also proposed amending requirements relating to certain loans or debtor-creditor relationships in 17 CFR 210.2-01(c)(1) (“Rule 2-01(c)(1)”) and the reference to “substantial stockholders” in 17 CFR 210.2-01(c)(3) (“Rule 2-01(c)(3)” and the “Business Relationships Rule”). Finally, the Commission proposed amendments to address inadvertent violations of the independence requirements as a result of mergers and acquisitions and to make certain miscellaneous updates.

Amendments to Rule 2-01, Qualifications of Accountants,

Release No. 33-10738, Dec. 30, 2019 [85 FR 2332 (Jan. 15, 2020)] (the “Proposing Release”).

The Commission has long recognized that an audit by an objective, impartial, and skilled professional contributes to both investor protection and investor confidence.

If investors do not perceive that the auditor is independent from the audit client, investors will derive less confidence from the auditor's report and the audited financial statements. As such, the Commission's auditor independence rule, as set forth in Rule 2-01, requires auditors

to be independent of their audit clients both “in fact and in appearance.”

See Revision of the Commission's Auditor Independence Requirements,

Release No. 33-7919 (Nov. 21, 2000) [65 FR 76008 (Dec. 5, 2000)] (“2000 Adopting Release”).

We use the terms “accountants” and “auditors” interchangeably in this release.

See

current Preliminary Note 1 to § 210.2-01 and 17 CFR 210.2-01(b) (“Rule 2-01(b)”).

See also supra

note 25. The relevant AICPA definition, 0.400.02, includes as an affiliate “[a]n entity (for example, parent, partnership, or LLC) that

controls a financial statement attest client

when the

financial statement attest client

is material to such entity” (emphasis in original).

See

letter from RSM.

In response to a request for comment as to whether auditors and audit clients would face challenges in applying the materiality concept in connection with the proposed amendment and whether additional guidance was needed, some commenters noted that the concept of materiality already exists within Rule 2-01, and as such, indicated that current materiality guidance is sufficient.

By contrast, other commenters suggested that there may be challenges in applying the materiality concept in connection with the proposed amendments,

and a few commenters requested additional guidance or examples.

One commenter suggested that to ease the burden of monitoring for compliance in connection with unforeseen changes in circumstances, the Commission should consider establishing a framework to allow auditors to address “inadvertent independence violations that might arise when a materiality threshold is crossed.”

See e.g.,

letters from Deloitte, EY, and Crowe.

See e.g.,

letters from NYSSCPA and PwC. For example, one commenter suggested the Commission define “controlling entity.”

See

letter from PwC.

See e.g.,

letters from NYSSCPA, CTCPA, and AIC.

See

letter from PwC.

Some commenters suggested that the Commission reiterate the shared responsibility of audit firms and their audit clients to monitor independence, including monitoring affiliates and obtaining information necessary to assess materiality.

One commenter recommended the Commission clarify that, once the initial materiality assessment has been made, the auditor and audit client could satisfy their obligations under the proposed amendments by reevaluating materiality in response to significant transactions, Commission filings, or other information that become known to the auditor or the audit client through reasonable inquiry.

Another commenter requested the Commission discuss expectations regarding best efforts to obtain information and monitoring if, for example, certain information can only be obtained annually.

See e.g.,

letters from CAQ, PwC, and EY.

See

letter from Deloitte.

See

letter from GT.

Comments on “Entity Under Audit”

In the Proposing Release, the Commission used the term “entity under audit” to describe the application of the proposed amendments. The Commission explained that it was using this term to refer to the entity “whose financial statements or other information is being audited, reviewed or attested.”

The quoted language is the first clause of the definition of the term “audit client” in Rule 2-01(f)(6). Because the definition of audit client also includes any affiliates of the audit client, the Commission used the term “entity under audit” to describe those entities whose financial statements were subject to audit, review, or attestation, in an attempt to avoid the potential confusion that may arise from using the term “audit client.”

See

footnote 11 of the Proposing Release and accompanying text.

In response to this discussion, some commenters suggested that Rule 2-01 incorporate more precise usage of the terms “audit client” and “entity under audit,” which may require defining the term “entity under audit.”

Several of those commenters recommended that the term “entity under audit” be included in the definition of affiliate of the audit client,

because the term “audit client,” which is defined to include affiliates in the definition of affiliate of the audit client, may cause confusion. One of these commenters characterized the reference to audit client in the existing affiliate of the audit client definition as a “circular reference.”

See e.g.,

letters from AICPA, Deloitte, EY, Crowe, PwC, and GT.

See e.g.,

letters from AICPA, Deloitte, EY, and Crowe.

See

letter from Crowe.

Comments on “Controlling Entity” and “Control”

While we did not propose any amendments to the term “control” as defined in 17 CFR 210.1-02(g) (“Rule 1-02(g)”) of Regulation S-X, a few commenters suggested that, for private equity firms, the term “controlling entity” should be defined as the overall private equity firm or the ultimate parent.

One of these commenters requested further explanation or guidance, such as through illustrative examples, to address whether the relationship between an investment adviser and a fund it advises should be treated as a control relationship and suggested that the term “control” should be linked to the accounting literature.

While these comments pertained to entities within an ICC, the comments are relevant when the entity under audit is not an investment company or investment adviser or sponsor, but the entity under audit controls or is controlled by an investment company or investment adviser or sponsor.

See e.g.,

letters from PwC and AIC.

See

letter from PwC.

See infra

Examples 3 and 4 in Section II.A.1.a.iii.

iii. Final Amendments

After considering the public comments and recommendations received, we are adopting amended 17 CFR 210.2-01(f)(4) (“amended Rule 2-01(f)(4)”) with certain modifications from the proposal, as described below. We considered the comments received opposing the addition of materiality to the common control provision, but continue to believe that materiality is an appropriate principle to effectively focus on relationships with and services provided to sister entities that are more likely to threaten an auditor's objectivity and impartiality.

Dual Materiality Threshold

In response to comments, we are modifying the proposed amendments to Rule 2-01(f)(4)(ii) to incorporate a dual materiality threshold such that a sister entity will be included as an affiliate of the audit client if the sister entity and the entity under audit are each material to the controlling entity. Under the final amendments, if either the sister entity or the entity under audit is not material to the controlling entity, then the sister entity will not be deemed an affiliate of the audit client pursuant to amended 17 CFR 210.2-01(f)(4)(ii) (“amended Rule 2-01(f)(4)(ii)”).

In the Proposing Release, the Commission suggested that requiring that the entity under audit be material to the controlling entity as part of the proposed definition may exclude sister entities whose relationships with or services from an auditor would impair the auditor's objectivity and impartiality.

However, after consideration of the comments received and further evaluation, we are persuaded that where the entity under audit is not material to the controlling entity, an auditor's relationships with or services provided to sister entities would generally not threaten the auditor's objectivity and impartiality. In

this regard, we agree that when the entity under audit is not material to the controlling entity, it is less likely that a mutuality of interest would develop as a result of relationships with or services provided to sister entities. For example, as one commenter observed, sister entities with separate governance structures, such as sister portfolio companies within an ICC, typically lack decision-making capacity over other sister entities, including an entity under audit.

We also are making a technical amendment to renumber the paragraphs within amended Rule 2-01(f)(4).

See

footnote 20 of the Proposing Release.

We also recognize the benefit to auditors, audit clients, and investors of reducing compliance-related challenges. The adopted dual materiality threshold may help address some commenters' concerns about the inability to obtain all relevant information needed to make a materiality determination with respect to sister entities under the proposed single materiality threshold. Under the adopted dual materiality threshold, the need to assess the materiality relationship between the entity under audit and each of the controlling entities should reduce information access concerns because, in the event the entity under audit is not material to the controlling entity, the materiality assessment would be made for fewer sister entities as compared to the proposed single materiality threshold. However, as discussed in Section II.A.1.b.ii below, the auditor's non-audit services to and relationships with sister entities that are no longer deemed affiliates as a result of applying the dual materiality threshold will continue to be subject to the principles set forth in Rule 2-01(b), and as such, knowledge of services to and relationships with such non-affiliate sister entities will be needed to sufficiently consider the general standard.

Some commenters also suggested that we incorporate a materiality qualifier in the evaluation of whether controlling entities would be considered affiliates, similar to analogous provisions in the AICPA and IESBA ethics and independence requirements. While commenters cited the benefits of having a common regime for the consideration of controlling entities, we were not persuaded that the benefits from such conformity would justify the potential risk to an auditor's objectivity and impartiality in these circumstances. In particular, commenters did not specifically highlight ongoing monitoring or other compliance challenges associated with the identification of affiliates that control an entity under audit. It does not appear that the challenges related to the changing population of potential affiliates and the ability to obtain appropriate information that occur in the common control context also exist when evaluating entities that have control over the entity under audit. In addition, the relationship between sister entities and an entity under audit is generally different than the relationship between a controlling entity and the entity under audit. The controlling entity typically has some decision-making ability or an ability to influence the entity under audit. As such, we believe an auditor's independence likely would be impaired if the auditor provides non-audit services to or engages in relationships with the controlling entity that are described in Rule 2-01(c), even in situations in which the entity under audit is not material to the controlling entity. Accordingly, we are not adopting commenters' recommendations to incorporate a materiality qualifier in the evaluation of whether controlling entities should be considered affiliates.

Entity Under Audit

We are making modifications to incorporate the term “entity under audit” within amended 17 CFR 210.2-01(f)(4)(i) (“amended Rule 2-01(f)(4)(i)”) and amended 17 CFR 210.2-01(f)(4)(ii) (“amended Rule 2-01(f)(4)(ii)”). Given the comments received on this point and in light of other changes we are making to the final amendments, we believe it is appropriate to replace the term “audit client” with “entity under audit” in amended Rules 2-01(f)(4)(i) and (ii). Specifically, as illustrated in the example below, we are concerned that if we do not revise this terminology, it could be applied in a manner that would negate the adopted dual materiality threshold.

ER11DE20.000

In Figure 1, assume the controlling entities (

i.e.,

Parent 1 and Hold Co.) have control over all entities downstream from them. If amended Rules 2-01(f)(4)(i) and (ii) referred to an “audit client” instead of an “entity under audit,” Sister 1 may be deemed an affiliate of the audit client regardless of the materiality of Sister 1 or the Entity Under Audit to Parent 1 based on the following application:

• Parent 1 controls the entity under audit, which makes Parent 1 an affiliate of the audit client. Parent 1 also is an “audit client” because the definition of such term includes affiliates. A practitioner might then apply the control provision in amended Rule 2-01(f)(4)(i) to Parent 1 and deem Sister 1 an affiliate of the audit client, regardless of the dual materiality threshold. The practitioner would consider Sister 1 an affiliate because it is controlled by “audit client” Parent 1 without applying

the materiality analysis in the common control provision of amended Rule 2-01(f)(4)(ii).

Similarly, Entities A and B may be deemed affiliates of the audit client regardless of the materiality of Entity A, Entity B, or the entity under audit to Hold Co. based on the following application:

• Under the existing and amended rules, Hold Co. is an affiliate of the audit client (

i.e.,

Hold Co. has control over the entity under audit) and, as such, also is an audit client. A practitioner might then apply the control provision in amended Rule 2-01(f)(4)(i) to Hold Co. and deem both Entities A and B as affiliates of the audit client, regardless of the dual materiality threshold in amended Rule 2-01(f)(4)(ii). Again, the practitioner may deem Entities A and B to be affiliates because “audit client” Hold Co. controls both Entities A and B.

Relatedly, when assessing whether Entities A and B are affiliates under amended Rule 2-01(f)(4)(ii), it may otherwise be unclear to a practitioner assessing materiality of the “audit client” whether such assessment applies to the entity under audit or an affiliate (such as Parent 1).

Absent clarification, the above-illustrated application (

i.e.,

circular reading) of the final amendments could negate the Commission's objective to focus the common control provision on those relationships and services that are more likely to threaten the objectivity and impartiality of an auditor by introducing a dual materiality threshold. While the proposal did not use the term “entity under audit” in the rule text, we believe this modification is consistent with the proposal to separate out common control from existing Rule 2-01(f)(4)(i) and include a materiality provision within the definition. Now that the amended common control provision includes a dual materiality threshold, we believe the modification to use the term “entity under audit” in place of the term “audit client” in amended Rules 2-01(f)(4)(i) and (ii) is important to avoid any misunderstandings about how the common control provision should be applied in the final amendments.

While some commenters requested that we further amend our rules to incorporate more precise usage of the term “entity under audit”

in other paragraphs that currently refer to the “audit client,” those requests are beyond the scope of this rulemaking. We did not propose or seek comment on those particular amendments. Moreover, those additional amendments are not necessary to effectuate any aspect of the proposal. As such, we are not incorporating the term “entity under audit” into other paragraphs of the rule that currently refer to “audit client,” including the significant influence provisions of amended 17 CFR 210.2-01(f)(4)(iii) (“amended Rule 2-01(f)(4)(iii)”) and 17 CFR 210.2-01(f)(4)(iv) (“amended Rule 2-01(f)(4)(iv)”). However, the incorporation of “entity under audit” in amended Rules 2-01(f)(4)(i) and (ii), while leaving the term “audit client” within the significant influence provisions in amended Rules 2-01(f)(4)(iii) and (iv), does not imply a change from the historical practical application of these provisions, which has focused and should continue to focus on the entity under audit.

See supra

note 51.

Assessing Materiality and Monitoring

Several commenters requested clarification and examples of the application of the proposed amendments, including the proposed materiality qualifier. In response, we are providing several examples to illustrate the application of the final amendments to particular fact patterns.

Auditors and their audit clients have a shared responsibility to monitor independence in order to satisfy, as applicable, the requirements of the federal securities laws, including Rule 2-01 and 17 CFR 210.2-02.

This shared responsibility between auditors and audit clients applies to all aspects of Rule 2-01, including the final amendments. This responsibility includes the monitoring of affiliates and obtaining information necessary to assess materiality. We believe this process works most effectively when management, audit committees, and audit firms work together to evaluate the auditor's compliance with the independence rules. For example, auditors and their audit clients may need to work together to identify and monitor potential affiliates based on the affiliate of the audit client definition in the independence rules. In this regard, it will be important for management to notify the auditor in a timely manner of changes in circumstances that may affect the population of potential affiliates, such as by notifying an auditor of acquisitions before the acquisitions are effective. Additionally, management should consider communicating to auditors as early as possible the intent of private companies to file a registration statement in order for the SEC and PCAOB independence rules to be considered in advance. Issuers and their audit committees may want to consider having their own policies and procedures to identify, consider, and monitor the provision of services by and relationships with the issuer's independent accountant, which may help supplement the audit firm's system of quality control.

For an overview of the obligations of auditors and audit clients with respect to auditor independence under the federal securities laws, please

see

footnote 101 of the Loan Provision Adopting Release.

The following are intended as illustrative examples only, and practitioners and audit clients should be aware that an assessment of materiality requires consideration of all relevant facts and circumstances, including quantitative and qualitative factors.

BILLING CODE 8011-01-P

ER11DE20.001

BILLING CODE 8011-01-C

In this example, Company A, the entity under audit, has five controlling entities, Entities 1 through 5, with Entity 5 as the ultimate parent. Since each of Entities 1 through 5 controls Company A, directly or indirectly, each of the entities is an affiliate of Company A regardless of materiality. For purposes of this example, assume that Company A is material to Entity 1 and Entity 2 and that Company A is not material to Entity 3, Entity 4, or Entity 5. Each of Entities 1 through 5 controls other entities (

i.e.,

sister entities) other than those listed in this example. In this example, the auditor must evaluate the materiality of the sister entities controlled by each of Entity 1 and Entity 2 to determine which sister entities are affiliates of the audit client. For a sister entity controlled by Entity 1, the auditor must assess the materiality of such sister entity to Entity 1. For a sister entity controlled by Entity 2, the auditor must assess the materiality of that sister entity to Entity 2.

Example 2—Controlling and Sister Entities and Monitoring Expectations

Assume the same facts as in Example 1. Company A and the controlling entities should provide the auditor with sufficient information to enable the auditor to appropriately monitor controlling entities and identify sister entities, even at the levels of Entities 3 through 5. We acknowledge the concerns raised by commenters that identifying sister entities that are not considered affiliates under the final amendments and re-assessing the materiality of the entity under audit and its sister entities may increase existing compliance burdens. However, identifying sister entities will be important for complying with the amended rules because there can be qualitative and quantitative changes that affect the materiality of such relationships, and audit firms will need to timely address when a sister entity becomes an affiliate. Such information also will be necessary for an audit firm to appropriately consider and apply Rule 2-01(b) on an ongoing basis.

After the initial materiality assessment is performed to identify potential affiliates, the auditor, with the assistance of and information provided by the audit client, should perform updated assessments based on, among other things, transactions, Commission filings, or other information that becomes known to the auditor and the audit client through reasonable inquiry. As a result, obtaining accurate organizational and financial information will be important to the auditor's and the audit client's ability to anticipate and plan for potential changes in materiality status that may lead to the identification of new affiliates at any point during the audit and professional engagement period. We understand that this likely will require additional compliance efforts and believe such efforts and the resultant costs are appropriate to ensure that an auditor is independent from its audit client for purposes of investor protection and investor confidence. To the extent the final amendments mitigate the compliance challenges associated with

independence violations or prohibitions, or allow an auditor to expand its audit or non-audit services or relationships, we expect that the auditor will weigh any related benefits against any additional monitoring and compliance costs. Also, auditors may already be familiar with the monitoring efforts related to a dual materiality threshold, as the AICPA and IESBA have analogous provisions. Where an auditor is unable to obtain the information needed to make reasonable determinations of affiliate status for sister entities, the auditor should treat such sister entities as affiliates of the audit client for the purpose of the Commission's independence requirements to avoid potentially impairing the auditor's objectivity and impartiality.

The final amendments do not include a transition framework, as requested by a commenter, to address changes in the materiality of the entity under audit or a sister entity to a controlling entity. As noted, above, we expect auditors and their clients to be able to anticipate and plan for changes in materiality and believe this approach fosters an auditor's objectivity and impartiality. To the extent that changes in materiality of the entity under audit or sister entities result in an independence violation, we encourage registrants and accountants to consult with the Commission's Office of the Chief Accountant.

See

Section II.E.3 and amended introductory paragraph to Rule 2-01.

ER11DE20.002

Company B is the entity under audit and a portfolio company controlled by Fund A. Fund A is an investment company within an ICC. Company B's auditor will identify affiliates of the audit client by applying amended Rules 2-01(f)(4)(i) through (iv). While there are entities described in the ICC definition that are part of Company B's organizational structure, including Fund A and its investment adviser or sponsor, Company B's auditor, assuming it does not audit any entity described in the ICC definition, such as Fund A or the Investment Adviser, will not apply the ICC definition. Company B's auditor must apply amended Rules 2-01(f)(4)(i) through (iv) to identify affiliates, which may result in certain investment companies and investment advisers or sponsors being deemed an affiliate of the audit client.

As noted above, we received a few comments related to the term “controlling entity” and the term “control,”

which is defined in Rule 1-02(g). We are not amending Rule 1-02(g) to link the definition of “control” to the accounting literature as one commenter suggested. We believe the suggestion to define “controlling entity” solely as the overall private equity firm when assessing materiality of entities, including a portfolio company, in a private equity structure

could raise issues beyond the scope of the proposal that warrant further consideration. We are therefore not adopting this approach. Under Rule 1-02(g), whether the entity under audit is a subsidiary of an operating or holding company or a portfolio company within a private equity structure, all entities that are identified to have control over an entity under audit are controlling entities.

See supra

note 54.

Id.

ER11DE20.003

Entity X is the entity under audit and is not an investment company, an investment adviser, or sponsor. Entity X has a subsidiary that serves as an investment adviser to several investment companies. If the auditor is not engaged to audit the investment company or investment adviser or sponsor on a standalone basis, the auditor will apply amended Rules 2-01(f)(4)(i) through (iv) to determine the affiliates of the audit client.

We note that in determining the affiliates of Entity X, in the context of amended Rules 2-01(f)(4)(i) through (iv), it will be important to consider the relationships between the investment adviser and the investment companies it advises. Even where an investment company has an independent board that oversees the investment company's operations and approves the advisory contract, the services provided by the investment adviser are generally critical to the management of day-to-day operations and execution of policies for the investment company. Therefore, the investment adviser generally will have a controlling relationship over the investment company for purposes of Rule 1-02(g).

In this example, if the auditor audited Entity X and the investment adviser subsidiary on a standalone basis, then the auditor would have to apply both amended Rules 2-01(f)(4)(i) through (iv) as they relate to the audit of Entity X and amended Rule 2-01(f)(14) as it relates to the audit of the investment adviser.

This is consistent with the discussion and example included in Section II.A.1.b.i of the Proposing Release.

b. Proposing Release's Discussion of Rule 2-01(b)

As noted in the 2000 Adopting Release, “[c]ircumstances that are not specifically set forth in our rule are measured by the general standard set forth in Rule 2-01(b).” The general standard includes, in part, that the “Commission will not recognize an accountant as independent, with respect to an audit client, if the accountant is not, or a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the accountant is not, capable of exercising objective and impartial judgment on all issues encompassed within the accountant's engagement.”

The Commission explained in the Proposing Release that relationships and services affected by the proposed amendments to the affiliate of the audit client definition remain subject to the general independence standard in Rule 2-01(b).

The Commission also noted that such relationships and services, individually or in the aggregate, could raise independence concerns pursuant to the general standard in Rule 2-01(b) due to the nature, extent, relative importance or other aspects of the service or relationship that may make the service or relationship a threat to an auditor's objectivity and impartiality. The Commission indicated that such services or relationships should be “easily known” due to the nature, extent, relative importance or other aspects of the services or relationships. Although the Commission did not propose amendments to Rule 2-01(b), a number of commenters provided feedback on the application of the general independence standard in light of the proposed amendments.

See

Section II.A.1 of the Proposing Release.

i. Comments on the Proposing Release's Discussion of Rule 2-01(b)

Several commenters agreed that relationships and services with entities that would no longer be deemed affiliates should still be evaluated under Rule 2-01(b).

However, one commenter recommended that the Commission consider whether Rule 2-01(b) is sufficient, or whether further clarification or rulemaking might be appropriate to address situations where relationships or non-attest services provided to a sister entity that is no longer an affiliate under the proposed definitions are of a magnitude that “eclipse” the attest services provided within a private equity or investment company complex.

See e.g.,

letters from Deloitte, EY, KPMG, GT, and Crowe. Some commenters also indicated that the general standard in Rule 2-01(b) is sufficient to mitigate the risks when relationships and services, individually or in the aggregate, with sister entities that are no longer deemed affiliates under the final amendments could impact an auditor's objectivity and impartiality.

See e.g.,

letters from Deloitte, EY, and KPMG.

See

letter from BDO.

A few commenters raised concerns with the Proposing Release's discussion of Rule 2-01(b).

One commenter

asserted that the statements were inconsistent with the 2000 Adopting Release, which stated that “[c]ircumstances that are not specifically set forth in our rule are measured by the general standard set forth in Rule 2-01(b)”

and expressed concern that the Proposing Release's discussion of Rule 2-01(b) could be applied more broadly than just to the entities captured by the affiliate of the audit client definition. Another commenter asserted that it “may be understood in practice as a change in application and operation of Rule 2-01(b).”

In voicing their concerns, these commenters noted that the consideration of Rule 2-01(b) would reduce the benefits expected to result from the proposed amendments as the auditor would continue to have to track relationships and services that are being provided to entities that are no longer affiliates.

See e.g.,

letters from RSM and PwC.

See

letter from RSM (citing to the 2000 Adopting Release at 65 FR 76030).

See infra

discussion in Section II.A.1.b.ii.

See

letter from PwC.

See e.g.,

letters from RSM and PwC.

One commenter disagreed with the Proposing Release's reference to “easily known” when describing the types of services or relationships that should be evaluated under Rule 2-01(b) as 17 CFR 210.2-01(c) (“Rule 2-01(c)”) no longer specifically addresses such items.

A few commenters asserted that the Proposing Release's use of “easily known” appears to establish an expectation of continued monitoring that may reduce the benefits, efficiencies, and cost savings expected to result from the proposed amendments.

Two of these commenters requested further guidance on on-going monitoring obligations if Rule 2-01(b) continues to apply to non-affiliates and requested the Commission consider clarifying the reference to “easily known” in the Proposing Release's discussion of the general standard by utilizing the “knows or has reason to believe” approach of the AICPA ethics and independence rules.

See

letter from RSM.

See e.g.,

letters from PwC, RSM, and AIC.

See

letters from PwC and AIC.

ii. Application of Rule 2-01(b) to the Final Amendments

After considering the public comments and recommendations received, we affirm our view that Rule 2-01(b) applies to those relationships and services that previously were, but are no longer, covered by Rule 2-01(c) as a result of the final amendments. We do not believe that this position broadens the scope of the “all relevant facts and circumstances” concept in the general standard. Nor are we persuaded that this scope should be narrowed in light of the amendments we are adopting. Otherwise, for example, an auditor could have any number or magnitude of relationships with or provide services to sister entities that are no longer deemed affiliates under the final amendments—even where, for example, the importance of such relationships or services to the auditor and the controlling entity threatens the auditor's objectivity and impartiality.

In response to commenters who noted that “easily known” is not a defined term and requested further explanation, we are clarifying that the types of relationships and services that must be evaluated under Rule 2-01(b) are those that are known or should be known to the auditor because of the nature, extent, relative importance or other relevant aspects of the relationships or services. Consistent with our discussion in Example 2 above, auditors, with the assistance of their audit clients, are expected to have sufficient information to be able to be aware of and prepare for changes in materiality that could lead to changes in affiliate status of entities in a large corporate or ICC structure. As such, we do not expect that identifying and monitoring relationships with and services provided to non-affiliate sister entities that are known or should be known would require significant additional effort by audit firms. For example, if audit firms are performing a high volume of services for or have a number of relationships with non-affiliate sister entities, the audit firm should already know that these relationships exist.

As noted in Section II.A.1.a.iii, the final amendments will more effectively focus the independence rules and reduce the time and attention that auditors and audit committees spend avoiding or addressing compliance challenges that arise under the existing rules and should permit auditors and audit committees to use their resources more effectively to the benefit of investors. Nothing in the final amendments is intended to change the application of the general independence standard in Rule 2-01(b). As the Commission noted in the 2000 Adopting Release and in the rule text for Rule 2-01(c), paragraph (c) is a “non-exclusive” specification of circumstances. As such, while Rule 2-01(c) enumerates specific circumstances that are inconsistent with Rule 2-01(b), the general standard of Rule 2-01(b) may encompass relationships and services that are not otherwise deemed independence-impairing by Rule 2-01(c).

c. Amendments to the Investment Company Complex Definition

i. Proposed Amendments

The Commission proposed to amend Rule 2-01(f)(4) to clarify that, with respect to an entity under audit that is an investment company or an investment adviser or sponsor, the auditor and the audit client should look to proposed Rule 2-01(f)(14) (

i.e.,

the ICC definition) to identify affiliates of the audit client and not to proposed Rule 2-01(f)(4).

The Commission also proposed to amend the ICC definition in Rule 2-01(f)(14) to provide additional clarity by incorporating the term “entity under audit” into Rule 2-01(f)(14) to focus the analysis from the perspective of the entity under audit and to explicitly define the term “investment company” to include unregistered funds for the purpose of the ICC definition.

In the Proposing Release, the Commission indicated that the proposed amendments were designed to more effectively focus the independence analysis on the entity under audit, including unregistered funds under audit, and align that analysis with the independence analysis required for all investment companies.

The proposed amendment would replace the existing “and” that appears at the end of existing Rule 2-01(f)(4)(iii) with an “or” in order to direct auditors of an investment company or an investment adviser or sponsor to the ICC definition. In the final amendments, the “or” now appears at the end of amended Rule 2-01(f)(4)(iv) and before amended 17 CFR 210.2-01(f)(4)(v).

We use the term “unregistered fund” in this release to refer to entities that are not considered investment companies pursuant to the exclusions in Section 3(c) of the Investment Company Act of 1940 [15 U.S.C. 80a-3(c)].

In addition to the proposed amendments to clarify certain aspects of the ICC definition, the Commission proposed to include a materiality qualifier in the common control provision of the ICC definition to align with the proposed amendments to the affiliate of the audit client definition.

To further align with the affiliate of the audit client definition, the Commission proposed including a significant influence provision in the ICC definition.

Both of these proposed

amendments were meant to provide consistency between the definitions of affiliate of the audit client and ICC in light of the proposed amendment specifying that auditors of an investment company or investment adviser or sponsor would apply proposed Rule 2-01(f)(14) to identify affiliates of such entity under audit.

See

Proposed Rule 2-01(f)(14)(i)(D)(

See

Proposed Rule 2-01(f)(14)(i)(E). The existing definition of “audit client” in Rule 2-01(f)(6), for the purpose of Rule 2-01(c)(1)(i), excludes entities that are affiliates only by virtue of the significant influence provisions in existing Rules 2-01(f)(4)(ii) and (iii). To align the treatment of affiliates due to significant influence under proposed Rule 2-01(f)(14)(i)(E) with those in the affiliate of the audit client definition, the Commission proposed an amendment to the “audit client” definition in Rule 2-01(f)(6) to similarly exclude entities identified under proposed Rule 2-01(f)(14)(i)(E).

The Commission explained in the Proposing Release that while it was introducing a materiality qualifier in the common control provision, it was retaining within the scope of the ICC definition any investment company that has an investment adviser or sponsor that is an affiliate of the audit client—regardless of whether such sister investment companies are material to the shared investment adviser or sponsor.

See

Proposed Rule 2-01(f)(14)(i)(F).

The Commission also noted that while the proposed amendments to the ICC definition would alter the composition of entities that would be deemed affiliates of the audit client principally due to a materiality qualifier being added for sister entities, the general independence standard in Rule 2-01(b) would continue to apply.

The Commission stated its belief that the proposed amendments to the ICC definition would provide clarity and address certain compliance challenges, including challenges related to the number of related entities or the volume of acquisitions and dispositions in ICCs, and more effectively focus the ICC definition on those relationships and services that are more likely to threaten auditor objectivity and impartiality.

See

Section II.A.1.b of the Proposing Release.

See

Section II.A.1 of the Proposing Release.

ii. Comments Received

Comments on Overall Approach to ICC Definition

Commenters generally supported the Commission's proposal to clarify that with respect to an entity under audit that is an investment company or an investment adviser or sponsor, the auditor and the audit client should look solely to the ICC definition to identify affiliates of the audit client,

and no commenters specifically opposed the proposed approach.

See e.g.,

letters from NYSSCPA, CAQ, Deloitte, BDO, EY, KPMG, RSM, GT, Crowe, and ICI/IDC. One commenter recommended that the final amendments specify that the ICC definition applies when the entity obtains an audit “for SEC reporting or compliance purposes.”

See

letter from KPMG. We believe this concept is implied by the requirements to apply Rule 2-01 in certain applicable provisions of the Federal securities laws.

Several commenters expressly agreed with the proposed references to “entity under audit” in Rule 2-01(f)(14),

and no commenters specifically opposed the proposed references.

See e.g.,

letters from NYSSCPA, Deloitte, BDO, EY, KPMG, and GT.

Some commenters supported the Commission's proposal to include within the meaning of the term investment company, for the purposes of the ICC definition, entities “that would be an investment company but for the exclusions provided by Section 3(c) of the Investment Company Act.”

For example, one commenter stated that under the current rules, “it was not clear if unregistered funds would be part of the [ICC] definition, which created uncertainty and inconsistency in practice.”

Another commenter stated that, if adopted, the inclusion of unregistered funds within the ICC definition would enable “the asset management industry holistically [to] serve the interests of investors and provide for more consistent treatment across fund businesses.”

No commenters expressly opposed this proposed amendment.

See e.g.,

letters from Deloitte, EY, KPMG, Crowe, and RSM.

See

letter from Crowe.

See

letter from EY.

Many commenters who were supportive of the proposed amendments also requested clarification on the application of the proposed definitions to specific fact patterns, including the following circumstances:

• An investment adviser is the entity under audit and is both an issuer and parent entity;

See e.g.,

letters from CAQ and ICI/IDC. Consistent with the discussion in Section II.A.1 of the Proposing Release, where an auditor is auditing only an investment company or investment adviser or sponsor, such auditor would look to the amended ICC definition to identify affiliates of the audit client. Even where the investment adviser under audit is an issuer and a parent entity, the final amendments dictate that the adviser's auditor look solely to the amended ICC definition to identify affiliates of the audit client.

• An operating company is the entity under audit and has sister entities that include an investment company or an investment adviser or sponsor,

or the operating company under audit has a subsidiary that is an investment adviser that manages investment companies;

and

See e.g.,

letters from CAQ and Deloitte. The discussion in Section II.A.1.a.iii, above, including Example 3, illustrates how to apply the amended definitions where an auditor audits only a portfolio company.

See

letter from EY. The discussion in Section II.A.1.a.iii, above, including Example 4, illustrates how to apply the amended definitions in response to this circumstance.

• The entity under audit is an investment company with sister funds advised by the same investment adviser, and such sister funds control portfolio companies.

See e.g.,

letters from CAQ, BDO, EY, KPMG, Crowe, and AIC. The discussion in Section II.A.1.c.iii, including Example 5, below, illustrates how to apply the amended definitions in response to this circumstance. One commenter raised a related fact pattern and suggested aligning the proposed amendments with the recent amendments to the Loan Provision.

See

letter from PwC.

Regarding other general aspects of the proposed ICC definition, one commenter sought clarification about whether the reference to investment adviser or sponsor in the proposed ICC definition also would include custodians.

A different commenter requested that we revise the ICC definition to separately address affiliates of an investment company and affiliates of an investment adviser or sponsor.

See

letter from EY;

See also

letters from Deloitte (expressing a similar view as it relates to both Rule 2-01(f)(4) and Rule 2-01(f)(14)) and PwC (suggesting a transition framework to address inadvertent independence violations that arise out of an unexpected change in the population of affiliates for reasons other than a merger or acquisition).

Under the proposal, auditors and audit clients would have to assess the materiality of sister entities to their controlling entity even if the sister entities' investment advisers are not material to the entity that controls both the sister entities and the entity under audit. In response to a request for comment regarding whether auditors should have to assess the materiality of sister investment companies to a controlling entity even where the investment advisers for such sister investment companies are not material to a controlling entity, commenters generally thought requiring such assessment would be appropriate to account for instances when a controlling entity may have an investment in an investment company that would make the investment company material to the controlling entity even though the investment company's adviser is not material to the same controlling entity.

105

See e.g.,

letters from EY, KPMG, and RSM. One commenter noted that this situation is “not likely to be common.”

See

letter from EY. Another commenter requested additional guidance to foster consistent application.

See

letter from KPMG.

Comments on Proposed Rule 2-01(f)(14)(i)(F)—Inclusion of Investment Companies Advised or Sponsored by an Affiliate Investment Adviser or Sponsor

In the Proposing Release, the Commission requested comment regarding whether proposed Rule 2-01(f)(14)(i)(F), which would include within an ICC any investment company that has any investment adviser or sponsor that is an affiliate of the audit client pursuant to proposed Rules 2-01(f)(14)(i)(A) through (D), should be adopted. Several commenters supported the continued inclusion of sister investment companies under proposed Rule 2-01(f)(14)(i)(F), regardless of the materiality of the sister investment companies once an investment adviser is deemed to be an affiliate under Rules 2-01(f)(14)(i)(A) through (f)(14)(i)(D).

106

However, one commenter stated that not including a materiality qualifier in proposed Rule 2-01(f)(14)(i)(F) renders the relief intended by the common control provision in the proposed ICC definition “inconsequential.”

107

Another commenter, while supportive of proposed Rule 2-01(f)(14)(i)(F), recommended that the reference to proposed Rule 2-01(f)(14)(i)(D) be removed from proposed Rule 2-01(f)(14)(i)(F) with respect to investment companies advised by sister investment advisers, because the proposed provision appeared to be inconsistent with other proposed provisions that would include a materiality qualifier for sister entity affiliates.

108

106

See e.g.,

letters from BDO, EY, KPMG, and ICI/IDC.

107

See

letter from RSM. Specifically, the commenter stated that all entities with a common investment adviser or sponsor should not automatically be deemed affiliates when other common control entities that are not material to the controlling entity are not deemed affiliates.

108

See

letter from KPMG.

Comments on Proposed Rule 2-01(f)(14)(i)(E)—the Significant Influence Provision

Some commenters expressly supported the proposed amendment to introduce a significant influence provision in proposed Rule 2-01(f)(14)(i)(E),

109

and no commenters specifically opposed the proposed amendment. One commenter, while not explicitly supporting or objecting, recommended that the Commission reiterate the statement from the Loan Provision Adopting Release that provides guidance on how to apply significant influence in an investment company context.

110

109

See e.g.,

letters from CAQ, BDO, EY, KPMG, and RSM.

110

See

letter from ICI/IDC.

Commenters that addressed this aspect of the proposal also supported the proposed conforming amendment to Rule 2-01(f)(6) to reference the proposed significant influence provision in the ICC definition.

111

See e.g.,

letters from EY, KPMG, and RSM.

iii. Final Amendments

Overall Approach to ICC Definition

After considering the public comments and recommendations received, we are adopting, substantially as proposed, amendments to the ICC definition in amended 17 CFR 210.2-01(f)(14) (“amended Rule 2-01(f)(14)”), with modifications to address the concerns and suggestions raised by commenters and to align the ICC definition with the final amendment related to the dual materiality threshold in amended Rule 2-01(f)(4)(ii) discussed above.

112

See

Section II.A.1.a.iii.

Consistent with the proposal, the final amendments to Rule 2-01(f)(4), the affiliate of the audit client definition, direct an auditor of an investment company or investment adviser or sponsor to apply the ICC definition in amended Rule 2-01(f)(14) to identify affiliates. As proposed, the amended ICC definition uses the term “entity under audit” as the starting point for the analysis of entities included within the ICC definition.

113

We also are adopting

as proposed a definition of “investment company” for the purpose of amended Rule 2-01(f)(14) that includes unregistered funds.

114

113

In addition, the final amendments make conforming technical amendments to amended 17 CFR 210.2-01(f)(14)(i) to incorporate the term “entity under audit.” Using the term “entity under audit” in those subparagraphs alleviates the need to refer to each subparagraph separately, which makes the subparagraphs more concise. The conforming amendments to the subparagraphs of amended 17 CFR 210.2-01(f)(14)(i) retain the application of the

ICC definition as described in the Proposing Release.

114

One commenter suggested that the Commission clarify whether commodity pools are included within the meaning of the term investment company for the purpose of applying amended Rule 2-01(f)(14).

See

letter from PwC. The term investment company, for the purpose of amended Rule 2-01(f)(14), does not include a commodity pool unless that commodity pool is an investment company or would be an investment company but for the exclusions provided by Section 3(c) of the Investment Company Act of 1940.

Similarly, the final amendments to the ICC definition include the significant influence provision of new 17 CFR 210.2-01(f)(14)(i)(E) (“Rule 2-01(f)(14)(i)(E)”) substantially as proposed but modified to incorporate the term “entity under audit.”

New 17 CFR 210.2-01(f)(14)(i)(D)—Common Control and Materiality

After considering the public comments and recommendations received, we are adopting, with modification, new 17 CFR 210.2-01(f)(14)(i)(D) (“Rule 2-01(f)(14)(i)(D)”) to incorporate the dual materiality threshold in the common control provision, consistent with the modification to the common control provision we are adopting for the affiliate of the audit client definition.

115

See

Section II.A.1.a.iii.

We were persuaded by commenters that the dual materiality threshold for identifying common control affiliates will be equally helpful in reducing compliance challenges in the ICC context as in the operating company context.

116

Such alignment also provides internal consistency within Rule 2-01, which should facilitate compliance efforts by reducing the potential for confusion and inconsistency when assessing common control affiliates.

116

See e.g.,

letters from EY, AIC, and CCMC. For example, CCMC expressed the view that Rule 2-01(f)(14)(i)(D) should be amended to include sister investment advisers and investment companies only when both the sister entity and the investment adviser under audit, or the investment adviser or sponsor of an investment company under audit, are material to the controlling entity.

Although some commenters objected to including a materiality threshold in the ICC amendments, we do not believe the adopted approach increases the risk to auditor independence. When an entity under audit is under common control with an investment company, or an investment adviser or sponsor, and the adopted dual materiality threshold is not met, we believe there is less risk to an auditor's objectivity and impartiality from the auditor's services to or relationships with such sister entity, for the reasons discussed regarding the dual materiality threshold for the common control provision in the affiliate of the audit client definition.

117

Further, we believe any threats to independence that may exist when the entity under audit is not material to the controlling entity will be sufficiently mitigated by the general independence standard in Rule 2-01(b).

118

117

Rule 2-01(f)(14)(i)(D) retains the existing provision that includes sister entities engaged in the business of providing administrative, custodian, underwriting, or transfer agent services to any entity identified by amended 17 CFR 210.2-01(f)(14)(i)(A) (“amended Rule 2-01(f)(14)(i)(A)”) and amended 17 CFR 210.2-01(f)(14)(i)(B), regardless of materiality.

118

One commenter sought clarification about whether Rule 2-01(f)(14) would apply to engagements required by Rule 206(4)-2(a)(6) under the Investment Advisers Act of 1940 (the “Advisers Act Custody Rule”).

See

letter from EY; 17 CFR 275.206(4)-2(a)(6). The Advisers Act Custody Rule requires that when an investment adviser or a related person acts as a qualified custodian for client funds and securities, the investment adviser, in addition to the independent verification requirement, must annually obtain, or receive from the related person, an internal control report prepared by an independent public accountant. The Advisers Act Custody Rule defines a “related person” as “any person, directly or indirectly, controlling or controlled by [the investment adviser], and any person that is under common control with [the investment adviser].” 17 CFR 275.206(4)-2(d)(7). For purposes of this engagement, the related person qualified custodian would be the “entity under audit” under the final rule. Accordingly, the auditor engaged would apply amended Rule 2-01(f)(4)—not amended Rule 2-01(f)(14)—to determine the affiliates of the audit client, which would require the auditor to assess the investment adviser's materiality if under common control. In these circumstances, however, the accountant would be required to be independent of the adviser under Rule 2-01(b) regardless of the results of this materiality determination.

In response to commenters' request for guidance, consistent with the discussion in Section II.A.1.a.iii above, we remind auditors and their audit clients of their shared responsibility to monitor independence, including monitoring affiliates and obtaining information necessary to assess materiality. We are not providing any specific guidance on materiality at this time because we understand that auditors and their audit clients have developed approaches to determine materiality in compliance with current rules, and we expect those approaches would continue to be applicable under the final amendments. Auditors, working together with their audit clients, should assess materiality for the purpose of complying with Rule 2-01, as amended, including consideration of relevant qualitative and quantitative factors. Depending on the circumstances, it may be reasonable to use certain measures, such as assets under management, when evaluating a potential affiliate in one instance, but not when evaluating a different potential affiliate. The assessment also should be attentive to the nature of the relationship, the governance structure of the entity, certain business and financial relationships, and other relevant qualitative considerations.

As noted in Section II.A.1.a.iii, understanding the organizational structure of an audit client is important when considering the general standard under Rule 2-01(b). We believe that after the initial materiality assessment to identify potential affiliates, the auditor and the audit client should conduct updated assessments based on any transactions, Commission filings, or other information that become known to the auditor or the audit client through reasonable inquiry.

New 17 CFR 210.2-01(f)(14)(i)(F)—The Provision To Include Investment Companies Advised or Sponsored by an Affiliate Investment Adviser or Sponsor

After considering the public comments and recommendations received, we are adopting, as proposed, new 17 CFR 210.2-01(f)(14)(i)(F) (“Rule 2-01(f)(14)(i)(F)”), which includes certain sister investment companies within the ICC definition regardless of materiality. We believe that this paragraph, together with the amendments to the common control provision in Rule 2-01(f)(14)(i)(D), as discussed above, will focus the scope of our independence rules on entities where relationships and services are more likely to threaten an auditor's objectivity and impartiality.

Specifically, under the existing ICC definition, sister investment advisers or sponsors and, as a result, their funds, regardless of whether the sister investment advisers or sponsors are material to the applicable controlling entities, would be included in the ICC of an investment company under audit.

119

Rule 2-01(f)(14)(i)(F) includes within the ICC definition investment advisers or sponsors identified by amended Rules 2-01(f)(14)(i)(A) through (D), which will include sister investment advisers or sponsors where a dual material relationship exists pursuant to Rule 2-01(f)(14)(i)(D) and exclude sister investment advisers or sponsors where a dual material relationship does not exist. While some commenters indicated that Rule 2-01(f)(14)(i)(F) should include a materiality qualifier, we believe that such an approach risks excluding entities where an auditor's services to or

relationships with a sister investment company could impair an auditor's objectivity and impartiality because the sister investment company is advised or sponsored by an affiliate investment adviser or sponsor.

119

See

Rule 2-01(f)(14).

Where a sister investment company shares the same adviser or sponsor as an investment company under audit, we continue to believe that these entities should be included as part of the ICC in evaluating the auditor's independence, regardless of whether such sister investment company is material to the shared investment adviser or sponsor. In our view, the nature of the relationship between the investment adviser and the entity under audit that it advises presents risks to an auditor's objectivity and impartiality when the auditor has relationships with or provides services to investment companies advised by such investment adviser.

Similarly, when a sister investment adviser or sponsor is included under the dual materiality threshold, we believe that the investment companies advised or sponsored by the sister investment adviser or sponsor should be included as part of the ICC in evaluating the auditor's independence, regardless of whether such sister investment companies are material to the applicable controlling entities. Once the sister investment adviser or sponsor is included in the ICC due to the dual materiality threshold, relationships with and services to investment companies advised or sponsored by the sister investment adviser or sponsor also are more likely to pose a threat to an auditor's objectivity and impartiality.

Amended 17 CFR 210.2-01(f)(14)(i)(C)—Application to Portfolio Companies Controlled by Sister Investment Companies

As noted above, we received several comments regarding how the control provision in proposed Rule 2-01(f)(14)(i)(C) applies to portfolio companies of an affiliate sister investment company when an investment company is under audit.

120

We are mindful of the concerns raised by commenters and are adopting the control provision in amended 17 CFR 210.2-01(f)(14)(i)(C) (“amended Rule 2-01(f)(14)(i)(C)”) with modifications to apply a dual materiality threshold for portfolio companies of sister investment companies that are controlled by the investment adviser or sponsor unless the portfolio companies are engaged in the business of providing administrative, custodial, underwriting, or transfer agent services to any entity identified by amended Rules 2-01(f)(14)(i)(A) or (B). As illustrated by Example 5 below, this modification will affect only the application of the rule for portfolio companies because Rule 2-01(f)(14)(i)(F), as discussed above, will dictate when sister investment companies are included within the ICC definition.

120

See e.g.,

letters from CAQ, BDO, EY, KPMG, Crowe, and AIC.

Under a scenario where neither the investment company under audit nor the portfolio company is material to the shared investment adviser or sponsor, there is less risk to the auditor's objectivity and impartiality. The modification in amended Rule 2-01(f)(14)(i)(C) does not alter the application of the ICC definition to portfolio companies controlled by an investment company under audit, as such portfolio companies will always be included in the ICC pursuant to amended 17 CFR 210.2-01(f)(14)(i)(C)(

) (“amended Rule 2-01(f)(14)(i)(C)(

)”). The following is intended as an illustrative example only, and practitioners and audit clients should be aware that an assessment of materiality requires consideration of all relevant facts and circumstances, including quantitative and qualitative factors.

ER11DE20.004

Investment Company A, the entity under audit, is advised by Adviser 1, which also advises Investment Company B. Investment Company B controls Portfolio Company X and, as a result, Adviser 1 is deemed to control Portfolio Company X. Pursuant to amended Rule 2-01(f)(14)(i)(C)(

), Investment Company A's auditor would include in the ICC any portfolio company controlled by Investment Company A even if the portfolio company is not material to Adviser 1. Pursuant to Rule 2-01(f)(14)(i)(F), the auditor also would include in the ICC Investment Company B even if Investment Company B is not material to Adviser 1. However, the auditor would apply the dual materiality threshold in new 17 CFR 210. 2-01(f)(14)(i)(C)(

) (“Rule 2-01(f)(14)(i)(C)(

)”) to determine if Portfolio Company X is included in the ICC in connection with Investment Company A's audit. If neither Portfolio Company X nor Investment Company A is material to Adviser 1 and Portfolio

Company X is not engaged in the business of providing administrative, custodial, underwriting, or transfer agent services to any entity identified by amended Rules 2-01(f)(14)(i)(A) and (B), Portfolio Company X would not be included in the ICC in connection with the audit of Investment Company A.

2. Amendment to the Definition of Audit and Professional Engagement Period

Rules 2-01(c)(1) through (5) prescribe certain circumstances the occurrence of which during the “audit and professional engagement period” are inconsistent with the general standard under Rule 2-01(b).

121

Under the current rule, the term “audit and professional engagement period” is defined differently for domestic issuers and foreign private issuers (“FPIs”)

122

that are filing, or required to file, a registration statement or report with the Commission for the first time (“first-time filers”). Specifically, 17 CFR 210.2-01(f)(5)(i) and (ii) define the audit and professional engagement period as including both the “period covered by any 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 . . .” (the “look-back period”). However, 17 CFR 210.2-01(f)(5)(iii) (“Rule 2-01(f)(5)(iii)”) of the definition narrows the audit and professional engagement period for audits of the financial statements of foreign private issuers to the “first day of the last fiscal year before the foreign private issuer 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.”

121

See

Preliminary Note 2 and Rules 2-01(c)(1) through (5).

122

17 CFR 240.3b-4(c). 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).

a. Proposed Amendments

The Commission proposed to amend Rule 2-01(f)(5)(iii) so that the one year look-back period for first-time filers will apply 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 Rule 2-01.

123

The proposed amendment would not impact the compliance analysis related to the partner rotation provisions in 17 CFR 210.2-01(c)(6).

In the Proposing Release, the Commission explained that the proposed amendment would provide parity between domestic issuers and FPIs and noted feedback that such parity may also benefit capital formation.

124

The Commission stated its belief that the proposed requirement to comply with applicable independence standards in all prior periods included in the first-time filing sufficiently mitigates the risk associated with shortening the look-back provision for domestic first-time filers. In addition, as it relates to relationships and services in prior years that would not be included in the look-back period as a result of the proposed amendment, the Commission noted that such relationships and services still would be considered under the general independence standard of Rule 2-01(b), either individually or in the aggregate.

124

See

Section II.A.2 of the Proposing Release.

b. Comments Received

Many commenters supported the proposed amendment to shorten the domestic company look-back period for evaluating independence compliance to the most recent year to be included in the first filing with the Commission.

125

Several commenters stated that the current requirement can result in challenges, cost, or delays to an initial public offering (“IPO”).

126

One commenter indicated that these challenges are especially relevant in the private equity environment where strategies change within a one- or two-year time frame.

127

Some commenters also noted that the current provision puts domestic issuers at a disadvantage relative to FPIs.

128

125

See e.g.,

letters from NASBA, CAQ, AICPA, Deloitte, BDO, EY, KPMG, RSM, PwC, Crowe, AIC, EQT, FEI, GT, CCMC, and Parrett.

126

See e.g.,

letters from CAQ, Deloitte, EY, EQT, GT, PwC, and AIC.

127

See

letter from BDO.

128

See e.g.,

letters from EQT and FEI.

Some commenters opposed the proposed amendment and, instead, suggested the Commission lengthen the look-back period for FPIs.

129

One of these commenters posited that entities contemplate going public for years before an IPO and, as such, the current domestic look-back period is not an “egregious” burden.

130

Another commenter cited the increased risk associated with “unicorn” IPOs and asserted that this proposed amendment would weaken the applicable independence rules when serious questions “have arisen around accounting practices at some of the largest private companies.”

131

129

See e.g.,

letters from NYSSCPA, CII, and CFA.

130

See

letter from NYSSCPA.

131

See

letter from CFA.

A few commenters supported the Commission's view that all relationships and services in prior periods should still be evaluated under Rule 2-01(b) and that these relationships and services should be easily known.

132

See e.g.,

letters from Deloitte and KPMG.

But see

letters from RSM and PwC. The view expressed by RSM and PwC regarding the application of Rule 2-01(b) also applies to the discussion of its applicability in this context.

Several commenters also requested that the Commission clarify how the proposed amendment would apply to specific situations such as:

• Reverse mergers or special purpose acquisition companies, if such a transaction is being considered by an audit client that is currently an issuer;

133

See

letter from GT.

• An existing and a new audit relationship;

134

and

134

See

letter from KPMG.

• When a registration statement is withdrawn and a new registration statement subsequently is filed.

135

See

letters from GT and Crowe.

c. Final Amendments

After considering the public comments and recommendations received, we are adopting amended 17 CFR 210.2-01(f)(5)(iii) (“amended Rule 2-01(f)(5)(iii)”) as proposed. As noted in the Proposing Release, the staff has observed, from its independence consultation experience related to potential filings of initial registration statements, that often one factor, among many, in the auditor's objectivity and impartiality analysis is how long ago the service or relationship ended. If the service or relationship ended in the early years of the financial statements included in the initial registration statement, that fact may support a conclusion that the auditor is objective and impartial under Rule 2-01 at the time the IPO is consummated. As discussed above, a number of commenters supported the Commission's reasoning for the proposal.

We were not persuaded by the commenters who opposed the proposal and who recommended lengthening the look-back period for FPIs instead. As a general matter, we believe that lengthening the look-back period would unnecessarily increase the burden on

capital formation and impose new regulatory costs on FPIs without significantly enhancing investor protection. With respect to the comment regarding the impact of shortening the look-back period for “unicorn” IPOs,

136

it is not clear that financial reporting quality would be undermined or concerns, such as “inadequate corporate governance and lax accounting practices,” would be exacerbated by the shorter look-back period for domestic issuers. Moreover, the final amendments do not affect the auditing standards to which a company undergoing an IPO is subject. Additionally, we continue to believe that applying Rule 2-01 to the most recent fiscal year, together with the application of the general independence standard in Rule 2-01(b) and the requirement to comply with applicable independence standards for the earlier years, mitigate the risk to an auditor's objectivity and impartiality associated with the shorter look-back period.

137

136

See

letter from CFA.

137

For additional guidance regarding the application of Rule 2-01(b) to the final amendments, see Section II.A.1.a.iii, above.

In response to some commenters' request for clarification or guidance, we note that the final amendment applies to both existing and new audit relationships. We see no proportionate investor protection benefit to introducing complexity to a first-time filer's decision whether to retain or select a new auditor by applying different standards. Where a registrant is undergoing a reverse merger that is in substance similar to an IPO, the audit client and auditor should not apply the transition framework discussed in Section II.D, but may apply the shorter look-back period under the final amendments.

138

Finally, consistent with the position taken by the staff in consultations, we are clarifying that where an issuer withdraws an initial registration statement, the re-filing of a new registration statement would be considered the issuer's first-time filing.

138

See

Section II.D.3.

B. Amendments to Loans or Debtor-Creditor Relationships

1. Amendment To Except Student Loans

a. Proposed Amendment

The Loan Provision in Rule 2-01(c)(1)(ii)(A) provides that an accountant is not independent if it has any loan to or from an audit client and certain other persons related to the audit client. The Loan Provision also excepts four types of loans from its scope.

139

The Commission proposed to add an exception to 17 CFR 210. 2-01(c)(1)(ii)(A)(

) (“Rule 2-01(c)(1)(ii)(A)(

)”) for student loans obtained from a financial institution under its normal lending procedures, terms, and requirements for a covered person's educational expenses, provided the loan was obtained by the individual prior to becoming a covered person in the firm as defined in 17 CFR 210.2-01(f)(11).

140

139

See

Rule 2-01(c)(1)(ii)(A)(

)(

) through (

), which lists as excepted loans those that are collateralized by automobiles, insurance policies, cash deposits, and primary residences.

140

See

17 CFR 210.2-01(f)(11), defining which partners, principals, shareholders, and employees of an accounting firm are considered covered persons.

In the Proposing Release, the Commission indicated that limiting the exception to student loans “not obtained while the covered person in the firm was a covered person” would provide a familiar compliance principle as it is consistent with the limitation to the primary mortgage loan exception in current 17 CFR 210.2-01(c)(1)(ii)(A)

(1)(iv)

(“Rule 2-01(c)(1)(ii)(A)

(1)(iv)

”). The Commission also expressed the belief that obtaining a student loan as a covered person poses a higher risk to the auditor's objectivity and impartiality and creates, at a minimum, an independence appearance issue that is not present when a non-covered person obtained a similar student loan from such audit client.

The proposed amendment also limited the exclusion to student loans obtained for the covered person's educational expenses. The Commission did not propose to extend the exception to a covered person's immediate family members due to concerns, at that time, that the amount of student loan borrowings could be significant when considering student loans obtained for multiple immediate family members and thus could impact an auditor's objectivity and impartiality.

b. Comments Received

Commenters generally supported adding student loans to the list of excepted loans.

141

Many commenters recommended that the Commission expand the exception to include student loans of the covered person's immediate family members under the same terms as the proposed amendment.

142

For example, one commenter questioned the Commission's argument that “the amount of student loan borrowings could be significant when considering student loans obtained for multiple immediate family members and thus could impact an auditor's objectivity and impartiality” when considering that there is no similar proscription with respect to a mortgage loan, which could be substantially more significant than student loan debt in terms of absolute dollars.

143

However, another commenter agreed with the proposal not to include student loans of immediate family members in the proposed amendment.

144

141

See e.g.,

letters from NASBA, NYSSCPA, CAQ, Deloitte, BDO, EY, KPMG, RSM, PwC, GT, Crowe, CII, ICI/IDC, IBC, FEI, Fund AC Chairs, and CCMC.

142

See e.g.,

letters from NASBA, NYSSCPA, CAQ, Deloitte, BDO, EY, KPMG, RSM, PwC, GT, Crowe and ICI/IDC.

143

See

letter from NYSSCPA.

144

See

letter from CII.

In the Proposing Release, the Commission requested comment on whether student loans of a covered person's immediate family members also should be excluded. Some commenters indicated that even if the proposed amendment were expanded to include student loans of immediate family members, there should be no limit on the amount outstanding.

145

One commenter suggested that the materiality of the loan to the covered person's net worth should be considered.

146

A few commenters indicated that Rule 2-01(b) should mitigate the risks of the amount of student loans impairing an auditor's objectivity and impartiality.

147

Without addressing immediate family members' loans, some commenters asserted that there should be no limit on the amount outstanding, similar to the existing primary residence mortgage exception.

148

We also note that certain commenters requested that the Commission clarify the scope of the term “educational expenses” and whether it includes expenses for room and board, tuition, books, and other educational supplies.

149

145

See e.g.,

letters from RSM, Deloitte, and EY.

146

See

letter from NASBA.

147

See e.g.,

letters from Deloitte and EY.

148

See e.g.,

letters from NYSSCPA, BDO, and KPMG.

149

See e.g.,

letters from CAQ, BDO, PwC, Crowe, and GT.

c. Final Amendment

After considering the public comments and recommendations received, we are adopting amendments to except certain student loans from the Loan Provision with two modifications from the proposed amendments. Consistent with the recommendation of many commenters, the final amendment also will except student loans obtained by a covered person's immediate family members, as that term is defined in 17 CFR 210.2-01(f)(13). We are persuaded that there is no need to include such a limitation, especially in light of the fact that similar exclusions, such as the one

for mortgage loans, are not similarly proscribed. Also, in response to comments seeking guidance on the term “educational expenses,” we believe the entire balance for loans that qualify as a student loan under the applicable terms, conditions, and requirements should be within the scope of the final amendments.

The proposed amendment's reference to student loans “obtained for a covered person's or his or her immediate family members' educational expenses” was intended to make explicit that it is only student loans for the covered persons' and their immediate family members' educational expenses that should be covered and not loans that they undertake to pay for another person's educational expenses. That limitation continues to apply. However, we are modifying the rule text to delete this phrase to avoid potential confusion about whether “educational expenses” is meant as a limitation on the amount of student loans excepted.

150

The remaining terms of the exclusion are consistent with the proposal.

150

With “educational expenses” deleted, the reference to covered persons and their immediate family members would be duplicative of the same references in 17 CFR 210.2-01(c)(1)(ii).

We are not specifying a numerical limit to the amount of outstanding student loans held by a covered person or a covered person's immediate family members that would be excepted. In light of comments received, we are persuaded that the purpose for which student loans are incurred and the standard terms associated with such loans set them apart from other debtor/creditor relationships not excepted from the Loan Rule and are less likely to threaten an auditor's objectivity and impartiality. We believe the nature of student loans and the requirement that the loans are obtained from a financial institution under its normal lending procedures, terms, and requirements mitigate the risk such loans would pose to an auditor's objectivity and impartiality. Not including a numerical limit also is consistent with the exception for mortgage loans in Rule 2-01(c)(1)(ii)(A)

(1)(iv)

2. Amendment To Clarify the Reference to “A Mortgage Loan”

a. Proposed Amendment

The Commission proposed a clarifying amendment to the reference to “a mortgage loan” in Rule 2-01(c)(1)(ii)(A)(

)(

) to refer to “mortgage loans” in the plural. As noted in the Proposing Release, Rule 2-01(c)(1)(ii)(A)(

)(

) was not intended to exclude just one outstanding mortgage loan on a borrower's primary residence, and the Commission staff has previously provided guidance consistent with the proposed amendment.

151

See

Section B. Question 1 Office of the Chief Accountant: Application of the Commission's Rules on Auditor Independence Frequently Asked Questions (June 27, 2019) (originally issued August 6, 2007) (“Auditor Independence FAQs”) (indicating the staff's view that the rationale for a mortgage on a primary residence also applies to second mortgages, home improvement loans, equity lines of credit and similar mortgage obligations collateralized by a primary residence obtained from a financial institution under its normal lending procedures, terms and requirements and while not a covered person in the firm).

b. Comments Received

Commenters supported the proposed amendment.

152

We received no comments specifically opposing this proposed amendment. One commenter requested examples of how the proposed amendment applies to different types of mortgage loans, such as home equity or home improvement loans.

153

Another commenter suggested that the Commission consider extending the exemption to include mortgages collateralized by property other than primary residences.

154

One commenter requested that the Commission include in the adopting release the guidance discussed in Section II.B.2 of the Proposing Release regarding the situation where a borrower becomes a covered person only because of a change in the ownership in the loan.

155

152

See e.g.,

letters from NASBA, NYSSCPA, CAQ, BDO, EY, KPMG, RSM, PwC, GT, FEI, and Crowe.

153

See

letter from FEI.

154

See

letter from Crowe.

155

See

letter from EY.

c. Final Amendment

After considering the public comments and recommendations received, we are adopting as proposed the amendment to Rule 2-01(c)(1)(ii)(A)(

)(

) to refer to “mortgage loans” instead of “a mortgage loan.” In response to the commenter who requested examples or guidance on the application of the mortgage loan exception when a borrower has obtained different types of loans collateralized by a primary residence, we note that the Commission has previously clarified that the rationale for the mortgage loan exception focuses on the status of the covered person at the time of the loan origination.

156

The same focus applies to second mortgages, home improvement loans, equity lines of credit, and similar mortgage obligations collateralized by a primary residence obtained from a financial institution under its normal lending procedures, terms and requirements and while the borrower is not a covered person in the firm.

156

See

2000 Adopting Release.

Also, as noted in the Proposing Release,

157

where the borrower becomes a covered person only because of a change in the ownership in the loan, and provided there is no modification in the original terms or conditions of the loan or obligation after the borrower becomes, or in contemplation of the borrower becoming, a covered person, the loan would be included within this exception.

157

Section II.B.2 of the Proposing Release.

Regarding a commenter's suggestion to extend the mortgage loan exception to loans collateralized by a non-primary residence (

e.g.,

a secondary or vacation home), we believe excepting loans on non-primary residences, which may be held for investment, would introduce increased risk to an auditor's objectivity and impartiality. As such, we do not see a compelling reason to expand the exception as suggested.

3. Amendment To Revise the Credit Card Rule To Refer to “Consumer Loans”

a. Proposed Amendment

The Commission proposed revising 17 CFR 210.2-01(c)(1)(ii)(E) (“Rule 2-01(c)(1)(ii)(E)”) (the “Credit Card Rule”) to replace the reference to “credit cards” with “consumer loans” and revise the provision to reference any consumer loan balance owed to a lender that is an audit client that is not reduced to $10,000 or less on a current basis taking into consideration the payment due date and available grace period. The Proposing Release set forth the Commission's view that a limited amount of debt that is routinely incurred by a covered person or any of his or her immediate family members for personal consumption, even if the audit client is the lending entity, would typically not impair an auditor's objectivity and impartiality. The proposed amendment would expand the current Credit Card Rule to encompass the types of consumer financing borrowers routinely obtain for personal consumption, such as, for example, retail installment loans, cell phone installment plans, and home improvement loans that are not secured by a mortgage on a primary residence. The Proposing Release explained that the types of consumer loans contemplated, like credit cards, would typically have a payment due date (

e.g.,

monthly).

158

Section II.B.3 of the Proposing Release.

b. Comments Received

All commenters that addressed this proposed amendment expressed their support.

159

We received no comments that specifically opposed this proposed amendment. Some commenters supported the proposed $10,000 limit,

160

while other commenters recommended raising the limit to $20,000 to account for inflation.

161

One commenter suggested an increase to $20,000 or $25,000 while citing to recent studies about consumer finances.

162

Some commenters encouraged the Commission to consider adjustments of the dollar threshold to account for inflation.

163

A few commenters requested that the Commission reconsider the limit, but did not suggest an alternative amount.

164

159

See e.g.,

letters from NASBA, NYSSCPA, CAQ, Deloitte, BDO, EY, KPMG, RSM, PwC, GT, Crowe, ICI/IDC, IBC, FEI, Fund AC Chairs, and Law Office of Edward B. Horahan III (Mar. 12, 2020) (“Horahan”).

160

See e.g.,

letters from NYSSCPA and Crowe.

161

See e.g.,

letters from BDO and EY.

162

See

letter from Horahan.

163

See e.g.,

letters from CAQ, PwC, and RSM.

164

See e.g.,

letters from KPMG and IBC.

In the Proposing Release, the Commission requested comment on whether further guidance was needed with respect to the reference to current basis. Some commenters indicated that the term “current basis” does not require further guidance.

165

A few commenters stated that the term “consumer loans” is well understood and does not require further defining,

166

while other commenters stated that further guidance is needed.

167

One commenter recommended that the Commission define the term “consumer loan” along the lines of the discussion in the Proposing Release and suggested that the rule retain a reference to “credit cards” for additional clarity.

168

Another commenter suggested the Commission use the term “other consumer loans” because, in its view, consumer loans commonly include auto, home equity, and student loans and mortgages.

169

Some commenters requested that the Commission consider whether similar exclusions should be applied to other consumer financial arrangements, such as digital payment application balances,

170

deposit overdraft protections,

171

insurance policies, leases, and deposit account balances that exceed FDIC insurance limits or are not subject to FDIC or similar insurance.

172

165

See e.g.,

letters from BDO, KPMG, RSM, and EY.

166

See e.g.,

letters from BDO and EY.

167

See e.g.,

letters from KPMG, RSM, IBC, and PwC.

168

See

letter from PwC.

169

See

letter from RSM.

170

See

letter from FEI.

171

See e.g.,

letters from PwC, KPMG, and FEI.

172

See

letter from PwC.

c. Final Amendment

After considering the public comments and recommendations received, we are adopting as proposed amended 17 CFR 210.2-01(c)(1)(ii)(E). The amendment is intended to broaden this provision so that credit card debt and other forms of consumer financing, such as retail installment loans, cell phone installment plans, and home improvement loans that are not secured by a mortgage on a primary residence, would be excluded if the outstanding balance is $10,000 or less on a current basis. Consistent with the payment terms in the current Credit Card Rule, in assessing the current basis of a consumer loan balance, the borrower would consider the payment due date, plus any available grace period, which is typically monthly for credit cards. We considered inflationary adjustments in light of comments received asking for an increase from the proposed $10,000 outstanding balance limit. However, we are not modifying the proposed outstanding balance limit because we believe $10,000 remains a significant amount of money for an individual covered by the final amendment (

i.e.,

any covered person or his or her immediate family members). In particular, we believe that when an individual covered by the final amendment has outstanding consumer loan(s) with an audit client in excess of this amount, the auditor's objectivity and impartiality could be impaired.

The additional exclusions suggested by commenters for other consumer financial arrangements, such as digital payment application balances, among others, were not included as part of the proposal and may involve their own unique set of issues. Accordingly, the final amendment does not cover such arrangements. Also, we believe including many enumerated types of consumer loans in the rule will increase complexity of the rule and may become outdated as consumer lending arrangements evolve. As such, we have not included within Rule 2-01(f) a definition of the term “consumer loan.” We also did not adopt commenters' suggestions to use a term other than “consumer loans,” such as to retain the current reference to “credit cards” or to add “other,” as we believe the rule is sufficiently clear as to what types of loans are covered under this exception.

C. Amendments to the Business Relationships Rule

1. Proposed Amendment to the Reference to “Substantial Stockholder”

The Commission proposed to replace the term “substantial stockholders” in the Business Relationships Rule with the phrase “beneficial owners (known through reasonable inquiry) of the audit client's equity securities where such beneficial owner has significant influence over the audit client.” Currently, Rule 2-01(c)(3) prohibits, at any point during the audit and professional engagement period, the accounting firm or any covered person from having “any direct or material indirect business relationship with an audit client, or with persons associated with the audit client in a decision-making capacity, such as an audit client's officers, directors, or

substantial stockholders

. . . .” (emphasis added).

In the Proposing Release, the Commission expressed its belief that referring to “beneficial owners (known through reasonable inquiry) of the audit client's equity securities where such beneficial owner has significant influence over the audit client” instead of “substantial stockholders” would improve the rule by making it clearer and less complex. In this regard, the Commission noted that “substantial stockholder” is not currently defined in Regulation S-X, whereas the concept of significant influence is used in the Loan Provision

173

and other aspects of the auditor independence rules.

174

173

Consistent with the recently adopted amendments discussed in the Loan Provision Adopting Release, the Commission indicated that use of “significant influence” in the proposed amendments is intended to refer to the principles in the Financial Accounting Standards Board's (“FASB's”) ASC Topic 323, Investments—Equity Method and Joint Ventures.

See

Section II.C.3 of the Loan Provision Adopting Release.

174

See e.g.,

Rules 2-01(f)(4)(ii) and (iii).

The Proposing Release also included additional guidance to explain that regardless of whether the beneficial owner owns equity securities of an audit client, including an affiliate of the audit client, the independence analysis should focus on whether the beneficial owner has significant influence over the entity under audit, as business relationships with persons with such influence could be reasonably expected to affect an auditor's objectivity and impartiality.

175

See

Section II.C.2 of the Proposing Release. This guidance was limited to the analysis related to associated persons in a decision-making capacity of an audit client. This guidance was not intended to change the analysis when evaluating “any direct or material indirect business relationships with an audit client.” Under the current, proposed, and

adopted rule, any direct or material indirect business relationships with an audit client, which includes any affiliates of the audit client, would be deemed independence-impairing.

2. Comments Received

Many commenters supported the proposal to use the significant influence concept from the Loan Provision to replace the reference to substantial stockholder in the Business Relationships Rule.

176

Commenters stated that this approach would facilitate compliance by applying a concept that is well understood.

177

Some commenters indicated the proposal would more appropriately identify those relationships that are more likely to impair an auditor's objectivity and impartiality

178

and would increase the number of qualified firms from which an issuer may choose.

179

176

See e.g.,

letters from NASBA, CAQ, Deloitte, BDO, EY, KPMG, RSM, PwC, GT, Parrett, AIC, ICI/IDC, IBC, FEI, CCMC and Crowe.

177

See e.g.,

letters from CAQ, Deloitte, EY, KPMG, PwC, ICI/IDC, and Crowe.

178

See e.g.,

letters from CAQ, Deloitte, ICI/IDC, EY, FEI, KPMG, RSM, PwC, and Crowe.

179

See

letter from EY.

One commenter opposed the proposed amendment.

180

This commenter reiterated concerns regarding the concept of beneficial owner with significant influence, which the commenter previously expressed with respect to the recent amendments to the Loan Provision.

181

180

See

letter from CII.

181

See

letter from CII (June 28, 2018),

available at https://www.sec.gov/comments/s7-10-18/s71018-3969965-167120.pdf

Several commenters recommended that the Commission consider aligning the guidance in the Proposing Release with the Loan Provision Adopting Release to clarify that entities under common control with, or controlled by, the beneficial owner of the audit client's equity securities that has significant influence over the audit client would be excluded from the scope of the Business Relationships Rule.

182

See e.g.,

letters from CAQ, Deloitte, EY, AIC, CCMC, PwC, and Parrett. FEI also requested alignment with the Loan Provision Adopting Release, but did not specify the common control issue.

One commenter requested that the Commission provide examples of the types of business relationships that would be “problematic” based on consultations received.

183

See

letter from GT. We have not provided examples of problematic business relationships as requested by the commenter. The changes to the Business Relationships Rule set forth in this release are narrow and consistent with the Loan Provision. Providing examples or additional guidance on the broader application of Rule 2-01(c)(3) is beyond the scope of this rulemaking. As noted in Section II.A.1.a.iii and consistent with the introductory paragraph to amended Rule 2-01, registrants and auditors may consult with the Commission's Office of the Chief Accountant.

In the Proposing Release, the Commission requested comment on whether additional amendments are needed to address multi-company relationships. Commenters provided their views concerning multi-company relationships, including, for some, the application of Rule 2-01(b) to these situations.

184

These commenters suggested that the Commission consider these discussions and examples when considering whether to provide future guidance in this area. Some commenters explicitly noted that they do not believe further amendments are required to identify whether the auditor's objectivity and impartiality would be impaired.

185

184

See e.g.,

letters from CAQ, Deloitte, EY, KPMG, RSM, and PwC.

185

See e.g.,

letter from EY and KPMG.

One commenter suggested a broad re-examination of the Business Relationships Rule due to the changes in the business environment and multi-company relationships.

186

Another commenter stated that Rule 2-01(c)(3) currently precludes many private equity firms from investing in certain multi-company relationships and that the proposed amendments do not address this issue.

187

This same commenter also noted that its recommendation to apply a dual materiality threshold in determining if a sister entity is an affiliate of the audit client would significantly alleviate the concerns around the Business Relationships Rule.

186

See

letter from PwC.

187

See

letter from AIC.

With respect to the additional guidance in the Proposing Release, many commenters expressed their support for the clarification that the focus of the significant influence analysis, as it relates to persons in a decision-making capacity, should be on the entity under audit.

188

Commenters also recommended that the Commission reiterate this guidance in the adopting release or revise the rule text to incorporate it.

189

188

See e.g.,

letters from NASBA, CAQ, Deloitte, BDO, EY, KPMG, PwC, GT, CCMC, and Crowe.

189

See e.g.,

letters from CAQ, Deloitte, KPMG, Crowe, CCMC, PwC, and GT.

Two commenters requested that the Commission clarify whether this “entity under audit” guidance applies to officers and directors as referenced in the Business Relationships Rule.

190

See

letters from EY and PwC.

3. Final Amendments

After considering the public comments and recommendations received, we are adopting amendments to the Business Relationships Rule substantially as proposed with one modification. We are modifying the proposal to incorporate the guidance in the Proposing Release regarding the reference to “audit client” when identifying associated persons in a decision-making capacity, including beneficial owners. Under this approach, the independence analysis focuses on whether the associated person has decision-making capacity over the entity under audit rather than the audit client. We continue to believe that providing internal consistency between the Loan Provision and the Business Relationships Rule by leveraging the concept of “beneficial owners (known through reasonable inquiry) of the audit client's equity securities where such beneficial owner has significant influence” will foster compliance and consistency in application.

Regarding the comments seeking consistency with the Loan Provision in other areas, we do not agree with the recommendation that entities controlled by or under common control with the beneficial owner of the audit client's equity securities, where such beneficial owner has significant influence over the entity under audit, should be excluded from the scope of the Business Relationships Rule. We view business relationships as presenting different threats to an auditor's objectivity and impartiality than those presented by lending relationships. We also believe the focus on beneficial owners having significant influence over the entity under audit instead of the audit client properly focuses the independence analysis on the significant threats to an auditor's objectivity and impartiality—and identifying associated persons with such influence should not impose an undue compliance burden.

We agree with commenters that requested we codify the additional guidance from the Proposing Release to provide more certainty regarding the application of the final amendment to beneficial owners of equity securities of an affiliate of the audit client. As such, the final amendment to the Business Relationships Rule has been modified to refer to “beneficial owners (known through reasonable inquiry) of the audit client's equity securities where such beneficial owner has significant influence over the

entity under audit

” (emphasis added). Further, in response to comments seeking clarification regarding the application of the Business Relationships Rule to officers and directors, we are also amending the Business Relationships Rule to refer to “an audit client's officers or directors that have the ability to affect decision-

making at the entity under audit.” This amendment clarifies that the Business Relationships Rule applies to relationships with officers or directors at an affiliate of the audit client when such person has the ability to affect decision-making at the entity under audit. This amendment does not change the application of the rule as it applies to the officers or directors of the entity under audit. Such persons are deemed to have the ability to affect decision-making at the entity under audit.

Although we requested comment on the need to address multi-company arrangements, after further consideration, we have determined that addressing such arrangements is beyond the scope of this rulemaking, which is focused on aligning the Business Relationships Rule with the Loan Provision and providing clarification regarding persons in a decision-making capacity. For similar reasons, we are not providing examples of problematic business relationships, as requested by one commenter. We also agree with the commenter that indicated that the proposed amendments to the affiliate of the audit client definition should significantly alleviate concerns around the Business Relationships Rule.

191

If auditors or their clients have specific questions related to multi-company arrangements, as noted in the introductory paragraph to amended Rule 2-01, they may consult with the Commission's Office of the Chief Accountant.

191

See

letter from AIC.

4. Conforming Amendments to the Loan Provision

The additional guidance provided in the Proposing Release regarding beneficial owners with significant influence set forth the Commission's view of the appropriate application of the Loan Provision. For clarity, we are adopting conforming amendments to the Loan Provision to reflect our view of how it applies to loans to or from officers or directors of affiliates of the audit client and beneficial owners of an affiliate of the audit client's equity securities.

D. Amendments for Inadvertent Violations for Mergers and Acquisitions

1. Proposed Amendment

For the reasons discussed in the Proposing Release,

192

the Commission introduced a transition framework to address inadvertent independence violations where the independence violation arises as a result of a corporate event, such as a merger or acquisition, and the services or relationships that are the basis for the violation would not have run afoul of applicable independence standards prior to the corporate event. The proposed amendments would require an auditor to:

192

See

Section II.D of the Proposing Release.

• Be in compliance with the applicable independence standards related to the services or relationships when the services or relationships originated and throughout the period in which the applicable independence standards apply;

• Correct the independence violations arising from the merger or acquisition as promptly as possible under relevant circumstances associated with the merger or acquisition; and

• Have in place a quality control system as described in 17 CFR 210.2-01(d)(3) (“Rule 2-01(d)(3)”) that has the following features:

○ Procedures and controls that monitor the audit client's merger and acquisition activity to provide timely notice of a merger or acquisition; and

○ Procedures and controls that allow for prompt identification of potential violations after initial notification of a potential merger or acquisition that may trigger independence violations, but before the transaction has occurred.

2. Comments Received

Many commenters supported the proposed transition framework to allow audit firms and their clients to transition out of services or relationships that will become violations due to a merger or acquisition.

193

Commenters indicated that these inadvertent violations would not typically impair an auditor's objectivity and impartiality.

194

Some commenters also noted the potential for significant disruption when these situations arise through no action of the audit firm.

195

One commenter discussed disruption in the context of the private equity space.

196

Another commenter stated that the proposed transaction framework may increase the number of auditors a potential audit client may select or retain.

197

193

See e.g.,

letters from NASBA, CAQ, Deloitte, BDO, EY, KPMG, RSM, PwC, GT, Parrett, AIC, ICI/IDC, IBC, FEI, CCMC, and Crowe.

194

See e.g.,

letters from Deloitte, KPMG, Crowe, AIC, and GT.

195

See e.g.,

letters from CAQ, Deloitte, EY, ICI/IDC, FEI, and AIC.

196

See

letter from AIC.

197

See

letter from KPMG.

A few commenters opposed the proposed transition framework.

198

One commenter indicated that it generally does not view a delay in mergers and acquisitions due to independence matters as a “possible detriment” to investors because auditor independence is critical to investor protection and investor confidence and it believes that “many, if not most, mergers and acquisitions ultimately do not enhance long-term shareholder value.”

199

Another commenter indicated that it could not support the proposal “without additional guardrails.”

200

This commenter suggested that the relationship or service triggering the inadvertent violation should either be terminated before the merger or acquisition is effective, or within a specified period of time (

e.g.,

three months) from the announcement date of the merger or acquisition. The commenter further stated that the “as promptly as possible” provision is susceptible to abuse and that these situations are better addressed by the staff on a case by case basis as the issue arises.”

198

See e.g.,

letters from CII and NYSSCPA.

199

See

letter from CII.

200

See

letter from NYSSCPA.

One commenter recommended that the proposed transition framework should be applicable to all financial statement periods subject to compliance with Rule 2-01, such as where an entity anticipating an IPO makes an acquisition in the year subject to the one-year look-back provision as proposed.

201

The commenter's recommendation would allow a private company that engages in a merger or acquisition transaction to be able to rely on the transition framework to satisfy its independence requirements when it engages in an IPO in the following year.

201

See

letter from KPMG.

Commenters generally supported the proposed quality control criteria or noted that they are sufficiently clear.

202

One commenter stated that the quality control requirement should acknowledge the applicability of the general standard with respect to the independence evaluation of the services and relationships with the new affiliate—both individually and in the aggregate.

203

Another commenter recommended that the Commission provide further guidance on the terms “timely notice” and “prompt identification” and its expectations of the procedures and controls that audit clients should have in place to inform auditors of pending transactions.

204

202

See e.g.,

letters from Deloitte, BDO, KPMG, and RSM.

203

See

letter from KPMG.

204

See

letter from EY.

In the Proposing Release, the Commission requested comment on whether certain services or relationships

should continue to be deemed independence-impairing, for example, if they result in the auditor auditing its own work. Some commenters indicated that Rule 2-01(b) appropriately addresses any threat to an auditor's objectivity and impartiality in situations where an inadvertent violation from a merger or acquisition could result in an audit firm auditing its own work.

205

Another commenter stated that the threat of auditing one's own work is mitigated by the proposed requirement to comply with applicable independence standards prior to the transaction and because periods prior to the transaction are not included in the accounting acquirer's financial statements.

206

However, several commenters expressed the view that “under no circumstances should the auditor be permitted” to audit its own work.

207

205

See e.g.,

letters from Deloitte, EY, and KPMG.

206

See

letter from RSM.

207

See e.g.,

letters from NASBA and CII.

Some commenters stated that a merger or acquisition that is in substance more like an IPO should be addressed by the proposed change to the definition of the “audit and professional engagement period,” as the compliance challenges are similar to an IPO situation.

208

However, other commenters asserted that all mergers or acquisitions should be covered by the proposed transition framework, including transactions in which private companies merge into a public shell, as these types of reverse mergers can occur with much less notice than a traditional IPO.

209

208

See e.g.,

letters from Deloitte and RSM.

209

See e.g.,

letters from EY and KPMG.

In the Proposing Release, the Commission requested comment on the requirement to correct inadvertent violations as “promptly as possible” and indicated that such correction should not occur more than six months after the consummation of the merger or acquisition. Many commenters supported the maximum six-month transition period.

210

A few commenters recommended that the final rule expressly reference the six-month transition period.

211

One commenter expressed concern that the “maximum six-month transition period will become the acceptable standard in practice.”

212

One commenter suggested a 12- to 18-month maximum

213

while another commenter stated that a maximum period of time should not be specified.

214

210

See e.g.,

letters from CAQ, Deloitte, BDO, EY, KPMG, PwC, GT, AIC, ICI/IDC, and Crowe.

211

See e.g.,

letters from PwC and EY.

212

See

letter from NASBA.

213

See

letter from IBC.

214

See

letter from RSM.

Several commenters suggested the Commission clarify that the framework applies where the triggering relationship or service is identified at or after the transaction closing but still addressed within the six-month window.

215

A few of these commenters noted that the quality control systems described in Rule 2-01(d)(3) may not, at times, identify independence-impairing relationships or services until after the close of a merger or acquisition.

216

Relatedly, some commenters indicated that there are challenges in obtaining relevant information prior to the closing of mergers or acquisitions.

217

215

See e.g.,

letters from CAQ, EY, PwC, GT, Crowe, AIC, ICI/IDC, FEI, CCMC, and KPMG.

216

See e.g.,

letters from EY and KPMG.

217

See e.g.,

letters from PwC, GT, and FEI.

Several commenters questioned whether compliance with the proposed transition framework should still result in an independence violation, and stated their belief that parties that adhere to the framework should not be viewed as having incurred an independence violation.

218

Some of these commenters requested that the Commission use terms other than “violation” and “lack of independence” when discussing potentially independence-impairing relationships or services prior to the closing of a transaction.

219

One of these commenters noted that since the relationships or services are identified before the closing, it does not appear they should be called violations, since they are not technically violations until the merger or acquisition closes.

220

218

See e.g.,

letters from CAQ, Deloitte, BDO, EY, CCMC, KPMG, Crowe, and PwC.

219

See e.g.,

letters from Crowe and KPMG.

220

See

letter from KPMG.

A few commenters requested guidance on how matters covered by the proposed transition framework should be communicated to an audit committee.

221

One commenter indicated that if these matters are not deemed violations, then the matters would not be communicated to the audit committee.

222

However, other commenters asserted that even if these matters are not deemed violations, the matters should still be communicated to the audit committee.

223

221

See e.g.,

letters from GT and Crowe.

222

See

letter from PwC.

223

See e.g.,

letters from EY and CCMC.

3. Final Amendments

After considering the public comments and recommendations received, we are adopting amended 17 CFR 210.2-01(e) (“amended Rule 2-01(e)”) substantially as proposed to include a transition provision for inadvertent independence violations where the independence violation arises as a result of a corporate event, such as a merger or acquisition, involving audit clients. We are adopting modifications from the proposed amendments to address comments received regarding the reference to “lack of independence” and “violation” in the proposed amendment that we found persuasive. For clarity, we also are replacing “before the transaction has occurred” with “before the effective date of the transaction.” The effective date of a merger or acquisition is typically identified in the transaction documents and often made public. This change is not intended to alter the application of the rule from the proposal, but only to provide clarity and consistency with commonly used terms.

We continue to believe it is appropriate to provide, in a manner consistent with investor protection, a transition framework for mergers and acquisitions to address inadvertent violations as a result of such transactions so the auditor and its audit client can transition out of services and relationships that would currently trigger an independence violation in an orderly manner. As stated in the Proposing Release, the transition framework follows the consideration of the audit firm's quality controls similar to Rule 2-01(d)(3).

224

As proposed, we are adopting the requirements associated with the transition framework.

224

The Commission adopted 17 CFR 210.2-01(d) (“Rule 2-01(d)”) as a limited exception to address a covered person's violations in certain circumstances that would be attributed to an entire firm. The effect of Rule 2-01(d) is that an accounting firm with “appropriate quality controls will not be deemed to lack independence when an accountant did not know of the circumstances giving rise to the impairment, and upon discovery, the impairment is quickly resolved.”

See

2000 Adopting Release, at 65 FR 76052.

As noted above, the Commission requested comment regarding mergers and acquisitions that are similar to IPOs. After considering the feedback received, we believe that the adopted transition framework should not apply to merger or acquisition transactions that are in substance similar to IPOs. For example, where a shell company, reporting pursuant to Sections 13 or 15(d) of the Exchange Act, engages in a merger with a private operating company, the auditor of the financial statements to be included in a Commission filing resulting from such transaction will not be able to rely on the transition framework in amended Rule 2-01(e).

Instead, such auditor should evaluate independence compliance using the look-back period contained within the “audit and professional engagement period” definition, as amended.

225

Consistent with the introductory paragraph in amended Rule 2-01, registrants and auditors may also consult with the Commission's Office of the Chief Accountant.

225

See

Section II.A.2.c.

a. Amended Rule 2-01(e)(1)—Compliance With All Applicable Independence Standards

Regarding this first provision, amended 17 CFR 210.2-01(e)(1) (“amended Rule 2-01(e)(1)”), the auditor must be in compliance with any independence standards that are applicable to the entities involved in the merger or acquisition transaction from the origination of the relationships or services in question and throughout the period in which the applicable independence standards apply.

b. Amended 17 CFR 210.2-01(e)(2)—Prompt Transition

We expect that the independence-impairing service or relationship, in most instances, should and could be addressed before the effective date of the merger or acquisition. However, we understand there may be situations where it might not be possible for the audit client and the auditor to transition the independence-impairing service or relationship in an orderly manner without causing significant disruption to the audit client. In those situations, we expect the relationship or service to be addressed promptly after the effective date of the merger or acquisition.

Whether a post-transaction transition occurs promptly will depend on all relevant facts and circumstances. However, as stated in the Proposing Release, we expect any necessary actions would be taken no later than six months after the effective date of the merger or acquisition. We have not included a reference to the six-month maximum transition period in amended Rule 2-01(e), as suggested by some commenters, because we do not intend, nor do we believe it would be appropriate, for audit clients and audit firms to apply this timeline to address such services or relationships in every merger or acquisition scenario. In this regard, we agree with the commenter who suggested that specifying such a timeline in the final rule could result in it becoming the standard practice in all situations, even when a shorter transition may be reasonably attainable and more appropriate.

We also are not specifying a longer maximum transition period as several commenters recommended. We continue to believe that six months is an appropriate limit for transitioning to compliance with our independence rules, which as noted above, are important for investor protection and to promote investor confidence. As stated in the Proposing Release, audit firms and audit clients already manage to this timeline as it is consistent with international ethics and independence standards for accountants.

226

See

The International Code of Ethics for Professional Accountants (including International Independence Standards), section titled, “Mergers and Acquisitions” under, “Part 4A-Independence for Audit and Review Engagements” available at

https://www.ifac.org/system/files/publications/files/Final-Pronouncement-The-Restructured-Code_0.pdf

In response to comments, we are removing references to the services and relationships identified as a result of a merger or acquisition as a “lack of independence” or “violation.” We agree that if the requirements in amended Rule 2-01(e) are met, then the relationships and services are not independence violations. As such, referring to independence violations or lack of independence may be confusing. The transition framework is intended to allow an auditor and its audit client sufficient opportunity to transition out of services and relationships in an orderly manner without impairing the auditor's independence. With respect to comments regarding whether these services or relationships should be communicated to the audit committee, auditors should follow PCAOB Rule 3526,

Communication with Audit Committees Concerning Independence

. PCAOB Rule 3526 requires communications of all relationships that may reasonably be thought to bear on independence.

c. New 17 CFR 210.2-01(e)(3)—Quality Control System

We considered comments received requesting elimination of the proposed requirement for an accounting firm to have procedures and controls to identify independence-impairing services and relationships before the transaction has occurred in order to allow for post-transaction identification. We are not adopting this suggestion. The Commission continues to stress that having a robust quality control system is paramount to maintaining auditor independence and, ultimately, investor protection.

We believe that it is reasonable to expect that an auditor and an audit client intending to rely on the benefits of the transition framework have in place robust procedures and controls that will identify services and relationships that would result in an independence violation prior to the effective date of the triggering transactions. As such, we are adopting the transition framework, as proposed, with a slight modification regarding the reference to “effective date” discussed above, so that it applies to services and relationships that are identified prior to the effective date of a merger or acquisition transaction.

In situations where a service or relationship resulting in an independence violation is identified subsequent to the effective date of the transaction, an audit firm and the audit client's audit committee will need to take into account all relevant facts and circumstances in their evaluation of the auditor's objectivity and impartiality in carrying out an audit of the financial statements of the combined entity. Consistent with the introductory paragraph in amended Rule 2-01, registrants and auditors may also consult with the Commission's Office of the Chief Accountant.

Regarding the suggestion that the quality control requirement acknowledge the applicability of Rule 2-01(b), we do not feel this is necessary. Rule 2-01(b) applies in all cases and expressly requires the consideration of all relevant facts and circumstances. As a result, if the transition framework is followed but the nature, extent, relative importance, or other aspect of the service or relationship impairs the auditor's objectivity and impartiality, then that service or relationship would be considered an independence violation. For example, if an auditor is found to be auditing its own work over a significant amount of the acquired business as part of the audit of the financial statements, that fact most likely would affect the auditor's independence under Rule 2-01(b).

E. Miscellaneous Amendments

1. Proposed Miscellaneous Amendments

As discussed in Section II.E of the Proposal, the Commission proposed three miscellaneous amendments to:

• Make conforming amendments throughout Rule 2-01 to replace references to “concurring partner” with the term “Engagement Quality Reviewer” to be consistent with current auditing standards that use the term “Engagement Quality Reviewer” or

“Engagement Quality Control Reviewer;”

• Convert the existing Preliminary Note to § 210.2-01 into introductory text to Rule 2-01, consistent with

Federal Register

drafting requirements; and

• Delete the outdated transition provisions in existing Rule 2-01(e), which were added as part of the Commission's 2003 amendments

227

to address the existence of relationships and arrangements that predated those amendments.

227

See supra

note 6.

2. Comments Received

Commenters that addressed this aspect of the proposal supported the proposed miscellaneous amendments.

228

No commenters expressed opposition to any of the three proposed miscellaneous amendments. Related to our technical amendment to re-designate the Preliminary Note to § 210.2-01, one commenter requested we repeat at the adopting stage our discussion in the Proposing Release that the amendment does not affect the application of the auditor independence rules.

229

228

See e.g.,

letters from NASBA, Deloitte, BDO, EY, KPMG, RSM, PwC, GT, and CCMC.

229

See

letter from KPMG.

3. Final Amendments

We are adopting the three miscellaneous amendments as proposed. As noted in the Proposing Release,

230

the final amendment to convert the existing Preliminary Note to § 210.2-01 into introductory text does not affect the application of the auditor independence rules and is simply a change in rule text format.

230

See

Section II.E.2 of the Proposing Release.

F. Other Comments Received

Several commenters requested that the Commission collaborate with the PCAOB to evaluate and update the PCAOB independence rules and standards in light of the proposed amendments if the proposed amendments are adopted.

231

For example, PCAOB Rule 3500T provides that registered public accounting firms must comply with the more restrictive independence rule if there are differences between the SEC and PCAOB independence rules. As a result of the final amendments, there will be differences between the SEC and PCAOB independence rules. The PCAOB has publicly disclosed a plan to conform its independence rules in response to the final amendments.

232

231

See e.g.,

letters from CAQ, EY, GT, PwC, RSM, AIC, and CCMC.

232

See https://pcaobus.org/Standards/research-standard-setting-projects/Pages/auditor-independence.aspx.

G. Transition

Auditors currently subject to the independence requirements of Rule 2-01 are not required to apply the final amendments until June 9, 2021 in order to have sufficient time to develop and implement processes and controls based on the final amendments. Voluntary early compliance is permitted after the amendments are published in the

Federal Register

in advance of the effective date provided that the final amendments are applied in their entirety from the date of early compliance.

233

To the extent that auditors or audit clients have questions about application of the rules in connection with early compliance, they may contact staff in the Office of the Chief Accountant for additional transition guidance.

Compliance with the final amendments is required on a prospective basis from the earlier of the effective date or early compliance date if selected by an audit firm. Auditors are not permitted to retroactively apply the final amendments to relationships and services in existence prior to the effective date or the early compliance date if selected by an audit firm. Regarding the final amendments in Rule 2-01(c)(1)(ii)(A) and (E) and loans that were originated before the effective date or the early compliance date, but that comply with the conditions of the final amendments as of the effective date or early compliance date, an auditor may rely on the final amendments; such loans would not be considered independence violations provided the conditions for excepting such loans continue to be met.

III. Other Matters

If any of the provisions of these amendments, or the application of these provisions to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application. Pursuant to the Congressional Review Act,

234

the Office of Information and Regulatory Affairs has designated these amendments as [not] a “major rule,” as defined by 5 U.S.C. 804(2).

234

5 U.S.C. 801

et seq.

IV. Economic Analysis

A. Introduction

We are adopting amendments to the auditor independence requirements in Rule 2-01 that will: (1) Amend the definition of an affiliate of the audit client to address certain affiliate relationships in common control scenarios and the ICC definition; (2) shorten the look-back period for domestic first-time filers in assessing compliance with the independence requirements; (3) add certain student loans and de minimis consumer loans to the categorical exclusions from independence-impairing lending relationships; (4) replace the reference to “substantial stockholders” in the Business Relationships Rule with the concept of beneficial owners with significant influence; (5) introduce a transition framework for merger and acquisition transactions to consider whether an auditor's independence is impaired; and (6) make certain miscellaneous amendments.

We are mindful of the costs and benefits of the final amendments. The discussion below addresses the potential economic effects of the final amendments, including the likely benefits and costs, as well as the likely effects on efficiency, competition, and capital formation.

235

Section 2(b) of the Securities Act [15 U.S.C. 77b(b)], Section 3(f) of the Exchange Act [17 U.S.C. 78c(f)], Section 2(c) of the Investment Company Act [15 U.S.C. 80a-2(c)], and Section 202(c) of the Investment Advisers Act [15 U.S.C. 80b-2(c)] require the Commission, when engaging in rulemaking where it is required to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation. Further, Section 23(a)(2) of the Exchange Act [17 U.S.C. 78w(a)(2)] requires the Commission, when making rules under the Exchange Act, to consider the impact that the rules would have on competition, and prohibits the Commission from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the Exchange Act.

We note that, where possible, we have attempted to quantify the benefits, costs, and effects on efficiency, competition, and capital formation expected to result from the final amendments. In many cases, however, we are unab

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