The Securities and Exchange Commission (SEC) has taken a particularly active interest in relationships between audit firms and their public company clients. After large accounting scandals like Enron, the Sarbanes-Oxley Act (SOX) placed additional regulations around public company financial reporting and controls.

In the years since SOX passed, SEC staff observed that certain independence rules did not need to be applied in numerous situations when the objectivity of an auditor was not impacted. This is the case with a variety of independence rules that sometimes led to technical violations, when applied to an auditor for an annual financial statement audit. A new rule change from the SEC reflects this migration and may make it easier for companies, particular those preparing for an initial public offering (IPO) to connect with a broader pool of potential accounting providers.


Public companies and companies preparing for an IPO must select an audit firm that is deemed to be independent from the company under SEC standards, and where there is no potential conflict of interest. To help mitigate the risk of an independence issue, public company audit committees have a requirement to rotate audit partners at least every five years.

The SEC has been moving to modernize some of the requirements around the auditor independence rules to provide public companies and those preparing for an IPO more options for selecting an audit firm. Among other things, this rule change, which is set to go into effect on June 9, 2021 (180 days after its publication in the Federal Register), clarifies the definition of affiliates, lookback periods for companies preparing for an IPO, and the interplay of student loans in independence matters. The Public Company Accounting Oversight Board (PCAOB) has also issued revised amendments relating to independence standards to align with the recently revised independence changes from the SEC. In combination with other rule changes, updates to independence rules will allow more choices in selection of an audit provider, especially in a climate where funds may seek a greater diversity of capital investments and funding sources.

Definition of Affiliates

The definition of a company’s affiliates will change, a move that should benefit public companies subject to SEC reporting rules. The change provides for a materiality analysis when determining whether another portfolio company owned by the same fund is material to the fund. Previous guidance would have classified all portfolio companies owned by the same private fund as affiliates.

Inserting the materiality threshold will improve choice of auditor for private equity firms with public portfolio companies. The business relationship rule will also be revised in order to provide clarity as to which persons and entities associated with a company are subject to the rule, which governs who an auditor may and may not have business relationships with. This is extremely helpful for companies with complex ownership structures and particularly relevant for companies that need to meet specific financing goals before going public.

Independence Rules for Companies Undergoing an IPO

The lookback period for an auditor’s independence evaluation will be reduced to one year from the previous rule that required auditor independence under SEC independence rules for two or three years for U.S. companies, depending on the circumstances and the years represented in the initial registration statement. This will accelerate the period in which companies can register as well as adjust the previous penalties that resulted in companies losing an auditor due to this independence issue. Under this rule, the auditor need only be independent from the company under the SEC/PCAOB definitions for the last year included in the initial registration statement as long as the auditor was independent under American Institute of Certified Public Accountants (AICPA) or other applicable independence rules for the other periods included.

Student Loans and Independence

The new rule clarifies that auditors who have obtained student loans from a public company client before the auditor was considered a covered person are not independence violations. This is a change from the previous standard, which flagged auditors with students loans obtained before employment.

Potential for Future Developments

The new Congress and Biden administration have indicated they may put a pause on recently enacted regulations to allow additional time for review. This may end up affecting the June 9, 2021 effective date. As of the time of this publication, it is uncertain whether any additional changes to the auditor independence rule will be affected. Our team is monitoring the situation closely and will keep you up-to-date as more developments occur.

For more information about how the SEC rule change could benefit your organization, please contact Stuart Starr or a member of our team.

Published on February 02, 2021