May 26, 2016

Auditor Independence: Unintended Consequences of “Loan Rule” Violation

The disclosure in this Form 8-K filed by Invesco reflects a question posed to the Big 4 recently by the SEC Staff. This position by the SEC seems like it could ultimately impact clients of the Big 4 if a passive investor (eg. large bank) holds more than 10% of a company’s equity and also provides a line of credit to the auditor. It appears that this could have unintended consequences unless the ultimate goal is for companies to have more auditor options than the Big 4. At this time, I hear that the Staff was allowing companies to file 10-Qs but there still isn’t a resolution on the underlying question. Here’s an excerpt from the Invesco 8-K:

PricewaterhouseCoopers LLP (“PwC”) has advised Invesco Ltd. (the “Company”) that PwC is in discussions with the Staff of the United States Securities and Exchange Commission (the “SEC”) regarding the interpretation and application of Rule 2-01(c)(1)(ii)(A) of Regulation S-X (the “Loan Rule”) with respect to certain of PwC’s lenders who own interests in closed-end and open-end mutual funds managed by the Company’s wholly-owned investment adviser subsidiaries.

The Loan Rule prohibits accounting firms, such as PwC, from having certain financial relationships with their audit clients and affiliated entities. The Loan Rule provides, in relevant part, that an accounting firm is not independent if it receives a loan from a lender that is a “record or beneficial owner of more than ten percent of the audit client’s equity securities.” Under the SEC Staff’s interpretation of the Loan Rule, some of PwC’s relationships with lenders who own shares of certain closed-end and open-end funds within the Invesco investment company complex may be in violation of the Loan Rule, calling into question PwC’s independence with respect to such funds, such funds investment advisers and affiliated entities of such investment advisers, including the Company. PwC’s interpretation of the Loan Rule, in light of the facts of these lending relationships, leads it to conclude that there is no violation of the Loan Rule and its independence has not been impaired. PwC has advised the Company that it continues to have discussions with the SEC’s Staff to resolve this interpretive matter.

While PwC represented to the Company that it feels confident that PwC’s interpretation of the Loan Rule is correct, neither PwC nor the Company can be certain of the final outcome. In light of the circumstances described above, the Company is updating its risk factors by providing an additional risk factor set forth below.

PCAOB Inspections: Deficiencies Down at Larger Auditors (But Up for Smaller)

Recently, the PCAOB Staff released a “Staff Inspections Brief” that provides 2015 inspection observations. The number of audit deficiencies identified for annually inspected auditors (those with over 100 public clients) actually decreased. For auditors with less than 100 public clients (who are inspected every three years), the Staff found “an overall high number of audit deficiencies”…

And PCAOB Board Member Jeanette Franzel recently delivered this speech about how the PCAOB should modify its risk-based audit inspection approach to take into account the significant improvements in audit quality that have been happening…

Congress: House Passes 5-Year Audit Attestation Exemption Extension

Here’s the intro from this Cooley blog:

On Monday, the House passed the “Fostering Innovation Act of 2015,” notwithstanding this letter to Paul Ryan and Nancy Pelosi from the SEC’s Investor Advocate urging a vote against it. The bill, which presumably now moves to the Senate for consideration, amends Section 404(b) of SOX (internal controls), “to provide a temporary exemption for low-revenue issuers from certain auditor attestation requirements.”

More specifically, the bill would temporarily exempt from the SOX auditor attestation requirement — that the issuer’s auditor attest to management’s assessment of the effectiveness of the issuer’s internal control over financial reporting — any issuer that ceased to be an emerging growth company after the fifth anniversary of its IPO, had average annual gross revenues of less than $50 million as of its most recently completed fiscal year, and is not a large accelerated filer.

The issuer would become ineligible for the exemption at the earliest of the last day of its fiscal year following the tenth anniversary of its IPO, the last day of its fiscal year when its average annual gross revenues exceed $50 million, or the date on which it becomes a large accelerated filer.

Broc Romanek