SEC's Independence Plan Closes Door, Opens Window

The U.S. Securities and Exchange Commission (SEC) has exposed for comment a lengthy and innovative auditor independence proposal. This proposal will result in lower revenues for some firms because it closes the door on some tax services. But it also opens a window in the sense that other provisions could open up new opportunities that bring in more revenues.

The key revenue-related proposals include a ban on certain tax services and introduce the use of forensic audits to help evaluate the work of the financial statement auditors.

  • Tax Services. The SEC hasn't tried to prohibit "bread-and-butter" tax services that have been pre-approved by a company's audit committee. But it is considering prohibiting some specialized tax services in its interpretation of the Sarbanes-Oxley Act. The rule proposal questions the acceptability of three types of expert tax services that result in the accounting firm acting as an advocate for the audit client: (1) providing representation before a tax court, (2) formulating tax strategies (e.g., tax shelters) designed to minimize a company's tax obligations, and (3) providing a tax opinion for the use of a third party in connection with a business transaction between the audit client and the third party.

  • Forensic audits. Forensic audits are seen as way to help audit committees evaluate audit firms and perhaps provide a basis for an exemption from the partner rotation rules. These rules would subject more partners to mandatory rotation, decrease the number of years an audit partner can serve an audit client from seven years to five years, and increase the "cooling-off" period from two years to five years. Because these changes might subject audit firms to talent crunches for clients that require specialized knowledge, the SEC asks if mandatory forensic audits would eliminate or reduce the need for the rotation requirements. A forensic audit is defined as one that would "evaluate the work of the existing auditor, the condition of the company’s internal controls, the company's accounting and reporting practices, and other matters."

The SEC is asking for comments on which tax services should be prohibited and whether rules should be established that would require periodic forensic audits by a firm other than the audit firm.

Download the rule proposal.

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