A CPA firm that audits an SEC registrant, or reviews or attests to financial information filed with the SEC, must meet the SEC's independence rule in addition to the AICPA Code and PCAOB requirements. The rule is Rule 2-01 of Regulation S-X (17 CFR 210.2-01), titled Qualifications of accountants. It is stricter than the AICPA Code in several areas, and firms that handle both private and public clients often discover the gap late, for example when a private client files a registration statement. This page walks through the rule's structure and the points that matter in practice. For the AICPA framework, see the AICPA Code guide.
What is the general standard?
Rule 2-01(b) says 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 the accountant is not, capable of exercising objective and impartial judgment on all issues encompassed within the engagement. The Commission considers all relevant circumstances, including all relationships between the accountant and the audit client, and not only those relating to reports filed with the SEC.
The preamble to the rule says it is designed to ensure auditors are qualified and independent both in fact and in appearance, and that the listed circumstances in paragraph (c) are not exclusive. A relationship that is not on the list can still impair independence under the general standard.
Rule 2-01(a) also provides that the Commission will not recognize a CPA who is not duly registered and in good standing under the laws of the place of residence or principal office.
When does the independence period apply?
The rule applies at any point during the audit and professional engagement period. Paragraph (f)(5) defines it as two periods: the period covered by the financial statements being audited or reviewed, and the professional engagement period. The professional engagement period begins when the accountant signs an initial engagement letter or begins audit, review or attest procedures, whichever is earlier, and ends when the client or the accountant notifies the Commission that the client is no longer the accountant's audit client.
For a company that is going public, periods ended before the first day of the last fiscal year before it first filed or was required to file a registration statement or report are excluded, provided there was full compliance with applicable independence standards in earlier periods covered by the filing. The practical effect is that a firm should check services provided in the periods covered by the filing, not only in the year of the engagement letter.
What relationships impair independence?
Paragraph (c) lists specific circumstances:
- (c)(1) Financial relationships. A direct financial interest or a material indirect financial interest in the audit client, along with loans and certain other financial ties.
- (c)(2) Employment relationships. An employment relationship with an audit client, including certain relationships of covered persons and their immediate family members.
- (c)(3) Business relationships. A direct or material indirect business relationship between the firm or a covered person and the audit client.
- (c)(4) Non-audit services. The services in the next section.
- (c)(5) Contingent fees. Providing any service or product to an audit client for a contingent fee or a commission, or receiving a contingent fee or commission from an audit client.
- (c)(6) Partner rotation. Time-on-engagement limits.
- (c)(7) Audit committee administration. Pre-approval of services for issuers.
- (c)(8) Compensation. Audit partner compensation tied to selling services to the client.
Covered persons are defined in paragraph (f)(11). They include the audit engagement team, the chain of command, any other partner, principal, shareholder or managerial employee who has provided ten or more hours of non-audit services to the audit client during the specified period, and any other partner, principal or shareholder from the office in which the lead audit engagement partner primarily practices in connection with the audit.
Which non-audit services are prohibited?
Under (c)(4), an accountant is not independent if it provides any of the following to an audit client:
- Bookkeeping or other services related to the accounting records or financial statements. Maintaining or preparing accounting records, preparing financial statements filed with the SEC or forming their basis, or preparing or originating source data. The prohibition applies unless it is reasonable to conclude the results will not be subject to audit procedures.
- Financial information systems design and implementation. Operating the client's information system or managing its network, or designing or implementing a hardware or software system that aggregates source data underlying the financial statements, subject to the same audit-procedures exception.
- Appraisal or valuation services, fairness opinions, or contribution-in-kind reports, unless the results will not be subject to audit procedures.
- Actuarial services involving determination of amounts recorded in the financial statements, other than assisting a client in understanding the methods, models, assumptions and inputs.
- Internal audit outsourcing services relating to internal accounting controls, financial systems or financial statements.
- Management functions, such as acting as a director, officer or employee, or performing any decision-making, supervisory or ongoing monitoring function.
- Human resources, including searching for prospective executive candidates, formal testing, reference checks for executive or director positions, negotiating on the client's behalf, and recommending a specific candidate for a specific job.
- Broker-dealer, investment adviser or investment banking services.
- Legal services that could be provided only by someone licensed to practice law.
- Expert services unrelated to the audit, such as advocating the client's interests in litigation or a regulatory proceeding.
Tax services are not on the list, which is why audit firms commonly prepare tax returns for SEC audit clients, but they are subject to audit committee pre-approval and the general standard.
What are the partner rotation limits?
Under (c)(6), an accountant is not independent when the lead partner or the engagement quality reviewer serves for more than five consecutive years, or when other defined audit partners serve for more than seven consecutive years. After reaching the limit, the partner has a cooling-off period: five consecutive years for the lead partner or engagement quality reviewer and two consecutive years for the other defined services. A firm with fewer than five issuer audit clients and fewer than ten partners is exempt from the rotation requirement, provided the PCAOB inspects each affected engagement at least once every three years.
What does the audit committee do?
Paragraph (c)(7) makes an accountant not independent of an issuer unless the audit committee pre-approves audit and non-audit services, either specifically or under detailed pre-approval policies and procedures, with a narrow waiver for non-audit services. The waiver requires that all such services total no more than five percent of the revenues the client paid its accountant in the fiscal year, that the client did not recognize them as non-audit services at the time of engagement, and that they are promptly brought to the audit committee and approved before the audit is completed. The rule applies to issuers other than asset-backed issuers and certain investment companies.
What if a covered person is not independent?
Paragraph (d) says a firm's independence is not impaired solely because a covered person is not independent of an audit client, provided the person did not know of the circumstances, the lack of independence was corrected as promptly as possible, and the firm has a quality control system that provides reasonable assurance, covering at least all employees and associated entities participating in the engagement. A firm that audits more than 500 registrants must have the specific system features the paragraph lists, such as written policies, an automated system to identify investments, training, annual testing and a disciplinary mechanism.
How is this different from the AICPA Code?
- The AICPA Code allows bookkeeping and payroll services for an attest client under conditions (1.295.120). Rule 2-01 prohibits those services for an SEC audit client unless the results will not be subject to audit procedures.
- The AICPA contingent fee rule is limited to certain services (see the Code guide). Rule 2-01(c)(5) bars any service or product provided for a contingent fee or commission.
- Rule 2-01 adds audit committee pre-approval and time-on-engagement limits, which the AICPA Code does not impose.
- A firm that is independent under the AICPA Code is not necessarily independent under Rule 2-01.
What should a CPA firm with private clients do?
- Identify any client that has registered securities, filed a registration statement, or plans to. Ask at acceptance and annually.
- Check non-audit services provided during the audit period for those clients, especially bookkeeping, valuation and systems work.
- Keep the independence policies from SQMS 1 up to date for issuer work. See SQMS 1.
- Use the independence confirmation form and the firm independence confirmation tracker.
Common problems
Practice observations, not requirements:
- A private client files a registration statement and the firm discovers it prepared the accounting records for the prior period.
- Fee arrangements with a success component, for instance on a tax refund claim for an audit client.
- Lead partner rotation tracked by engagement letter date rather than service years.
- Valuation work accepted at the client's request for goodwill impairment testing, with the audit team relying on it.
FAQ
Does Rule 2-01 apply to a private company audit?
No, it applies when the client is an issuer or otherwise an audit client of an engagement subject to the SEC's rules, such as financial statements filed with the Commission. The AICPA Code governs private company audits.
Can a firm prepare the financial statements of an SEC audit client?
Not if the results will be subject to audit procedures. Preparing financial statements filed with the SEC, or maintaining accounting records, is a prohibited service under (c)(4)(i).
Does the SEC prohibit tax services?
Tax services are not on the (c)(4) prohibited list, but they remain subject to the general standard and, for issuers, audit committee pre-approval.
How long is the cooling-off period for a lead partner?
Five consecutive years after serving the maximum period, under (c)(6)(i).
Sources
- eCFR, 17 CFR 210.2-01, Qualifications of accountants (paragraphs (a) through (f)): https://www.ecfr.gov/current/title-17/chapter-II/part-210/subpart-A/section-210.2-01
- AICPA, Code of Professional Conduct, 1.295.120 and 1.510.001 (for the comparison): https://pub.aicpa.org/codeofconduct/ethics.aspx
Related
Part of CORAA University · SEC reporting and PCAOB audits: related guides, calculators and templates.
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