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Auditor Independence Proposal Should Foster More Competition for Fund Audits


The SEC has proposed amendments to the auditor independence rules that would not preclude fund audits by firms that also provide services to portfolio companies.  Amendments to Rule 2-01 would modernize the definition of affiliate relationships so that minor engagements with portfolio companies would not violate the auditor independence rules for the fund engagement.  The proposal would also allow audit partners to carry student loans and de minimis consumer loans without impairing independence.  The proposal also adds a governance framework to address inadvertent independence violations resulting from merger and acquisition transactions.

Modernizing the auditor independence rules will facilitate more competition and hopefully drive down audit costs.  Also, rigid auditor independence rules oftentimes exclude an audit firm that may be best positioned through knowledge or experience to conduct an audit. 

CPA Firm Sanctioned for Audits of Broker-Dealers Where Daughter Served as FINOP


The SEC upheld sanctions against a broker-dealer because the concurring partner’s daughter served as the subjects’ financial operations principal, thereby violating independence requirements.  The auditing firm, a solo practice, hired an independent contractor to serve as Engagement Quality Reviewer (EQR) with respect to 14 audits of 7 broker-dealers over a 2-year period.  Although the firm knew that the EQR’s daughter served as FINOP of the broker-dealers, the SEC opines that the respondents acted at least recklessly by failing to understand that the relationship violated independence rules.  The SEC faulted the respondents for failing to consult either the regulators or private advisors.  The SEC also rejected the argument that the financial statements complied with applicable rules, because the failure to ensure independence is itself a violation of accounting rules.  The SEC notes the close relationship between the EQR and his daughter, who learned the business from her father and assumed several FINOP engagements following her father’s withdrawal due to FINRA sanctions.

Accounting firms cannot provide FINOP services for the broker-dealer clients for whom they also provide auditing services.  In case there was any doubt, this case makes clear that the EQR is part of the engagement team, and a close familial relationship with the FINOP violates independence. 

Big 4 Firm Fined $50 Million for Stealing Exam Answers

The SEC fined a Big 4 audit firm $50 Million for misappropriating information from the PCAOB concerning impending inspections. Several members of firm management were also terminated and charged. The firm obtained the confidential exam information from employees that previously worked at the PCAOB as well as PCAOB employees being recruited by the firm. Information included lists of audit engagements that the PCAOB planned to inspect, specific criteria used for the inspection, and the focus areas. The SEC alleges that the firm also reviewed and revised work papers to avoid deficiencies. Separately, the firm was also charged with sharing answers and adjusting scores so that internal personnel could more readily pass internal continuing education courses. The SEC charges the firm with failing to comply with ethics and integrity standards, AICPA conduct rules, and PCAOB quality control standards. In addition to the fine, the firm agreed to retain an independent consultant.

The SEC relies on the securities markets gatekeepers, such as the large audit firms, to police the industry. When the gatekeepers act without integrity, it undermines the SEC’s ability to protect investors. This case once again raises the issue whether government officials should observe a cooling-off period before going to work for the companies they previously regulated.

Accounting Firm Caused Custody Rule Violations

The SEC censured and fined an accounting firm and its engagement partner for improper audits that caused the client to violate the Advisers Act’s custody rule (206(4)-2).  The SEC maintains that the audits failed the independence requirements because the accounting firm prepared the work papers that it audited.  The SEC also asserts that the firm delivered an unmodified audit opinion despite knowing about related party transactions.  The SEC also charges the firm with failing to meet professional auditing standards because the audit team had limited experience, knowledge and training in SEC requirements.  The SEC previously charged the audit firm’s asset management client.  

Only retain service providers that have specialized knowledge and experience in asset management.  You wouldn’t hire a family physician to perform surgery, so why would you hire a general practice accounting firm to conduct specialized regulatory audits?  The same rationale applies to your lawyers, administrators, and compliance consultants. 

Accounting Firm Followed the Wrong Independence Standards

 An accounting firm was fined and barred from any engagement arising from an SEC rule because it violated independence rules by auditing funds and firms for which it also prepared financial statements.  The SEC charges that the accounting firm prepared financials including preparing draft statements for management review, converting from cash to GAAP accounting, proposing accounting adjustments, and drafting notes.  Regulation S-X prohibits a firm that provides bookkeeping or other accounting services from auditing the same financial statements.  According to the SEC, the firm wrongly applied AICPA independence rules rather than Regulation S-X, which applies to private fund and broker-dealer audits.  The SEC charges the firm with causing its clients violations of the securities laws.

OUR TAKE: Performing audits of registered advisers, broker-dealer, or public companies involves a thorough understanding of the applicable securities laws and accounting standards.  Accounting firms should not undertake engagements without retaining a compli-pro that can help navigate the regulatory waters.  Advisers and broker-dealers should not retain a firm that lacks a track record of practicing in this area.

SEC Sues Audit Engagement Partner for Ignoring Client Misconduct


The SEC has instituted enforcement proceedings against an audit firm engagement partner for failing to follow professional standards, thereby allowing a venture fund manager to loot the fund by taking unearned management fees.  The SEC alleges that the venture fund manager, in order to meet cash needs for affiliates, advanced unearned management fees in amounts that would never be earned.  The SEC charges that the respondent and the audit team knew about the unearned fees but failed to fully investigate the payments and further failed to properly disclose the payments in the financial statements.  Instead, the audit firm issued unqualified opinions over a 4-year period.  The SEC also asserts that the audit partner removed relevant financial statement disclosure when management objected.

OUR TAKE: As a key securities market gatekeeper, the auditor performs a critical control function upon which investors rely.  The SEC will hold audit firms and their senior personnel accountable when clients engage in observable unlawful behavior.  The same rationale will apply to other gatekeepers including administrators, lawyers, and consultants.