Independence and affiliates
Non-audit services
Auditor confirmation of independence
Auditor independence diligence

Any company undertaking an initial public offering (IPO), or a high-yield offering that will result in a subsequent registered exchange offer, should ensure it has engaged independent auditors. The confirmation of auditor independence should be done early in the offering process. The following is a brief discussion on some of the issues related to the auditor independence requirement.

Independence and affiliates

After the adoption of the Sarbanes-Oxley Act of 2002, it is a fundamental requirement that a company that is filing a registration statement, or a company that is already public, provide financial statements that have been audited by an independent registered public accounting firm. Rule 2-01 of Regulation S-X under the Securities Act of 1933 (as amended) and Rule 3520 ("Auditor Independence") of the Public Company Accounting Oversight Board (PCAOB) require that a company's registered public accounting firm be considered independent from its audit clients throughout the audit and professional engagement period. For these purposes, an audit client is not only the issuer and its subsidiaries, but also any affiliates of the issuer, including entities under common control. For an issuer that is a private equity portfolio company, this means that the auditor must be independent not only for the issuer, but also for the private equity investor and every other portfolio company that is an affiliate of the private equity investor.

Non-audit services

Rule 2-01 specifies certain types of non-audit services that an accounting firm may provide to a client or its affiliate that could render the accounting firm not independent. Examples of such services include:

  • contingent fee arrangements;
  • bookkeeping, or other services related to the accounting records or financial statements of the audit client;
  • human resource functions;
  • financial information systems design and implementation;
  • management functions; and
  • legal services.

Many companies, particularly those domiciled in Europe or Asia, use accounting firms to provide these types of services. Accordingly, if the issuer is a portfolio company of a large global private equity fund, then it is important to confirm that its auditor has not provided any of these services to any of the fund's other portfolio companies.

Auditor confirmation of independence

An auditor is required to confirm its independence to a company's audit committee at the time of the initial engagement and periodically throughout the engagement period. As part of that process, the public accounting firm should confirm that it has not provided any prohibited services to the issuer, the private equity sponsor or any of the other affiliates in the private equity investor's portfolio. A public accounting firm should self-report any independence issues to the audit committee, as well as to the Securities and Exchange Commission (SEC).

Auditor independence diligence

Given the importance of auditor independence in the offering context, it is important to determine that there are no independence issues early in the offering process. Therefore, issuers, investment bankers and counsel should consider the following steps as part of the offering process.

Don't ignore independence issues
If you become aware of any potential auditor independence issues, raise them immediately with the audit committee, SEC counsel and the auditors. Even minor issues can lead to a determination that an auditor is not independent and thus result in an issuer having to retain a new audit firm prior to filing a registration statement.

Scrutinise the auditor's process for reviewing independence
Ensure that the auditor has a robust independence review process - this includes confirming that the auditor has examined its independence at the issuer, the private equity sponsor and the portfolio company levels. Enquire as to the procedures that the auditor undertakes in establishing its independence, and determine whether they seem adequately designed to identify independence issuers for the issuer and its affiliates.

Establish that all affiliates have been identified
If the issuer is a portfolio company, ensure that the private equity sponsor has identified all of its affiliates and provided the list to the auditor. In addition, ask the sponsor whether the auditor has provided any non-audit services to any of its portfolio companies.

Review the auditor's correspondence to the audit committee and the SEC
A registered public accounting firm is required to confirm its independence and provide the audit committee with a letter pursuant to PCAOB Rule 3526 confirming its independence. Review those letters and any related correspondence or disclosure, and actively pursue any independence issues identified by the auditors in those letters.

Ensure that the audit committee has determined that the auditors are independent
The audit committee is obligated to make its own independence determination. Accordingly, review any audit committee discussions and determinations regarding independence issues, and discuss the independence review process.

Confirm whether the SEC has reviewed any identified independence issues
In the event that an independence issue has been identified, confirm that the audit firm has reported the issue to the SEC, and that the SEC has determined that there are no independence issues and will not object to the auditor's continued role. Make sure that any required SEC review occurs early in the process so that it does not delay a filing and there is enough time to retain a new auditor, if necessary.

Don't assume that the SEC will overlook the issue
The SEC takes auditor independence issues seriously and has limited authority to make exceptions to the independence requirements. You should not assume that a relatively minor issue will not lead to a determination that the auditor is not independent. In certain circumstances, the SEC has not objected to the existence of independence issues - such as in the case of a newly acquired affiliate for which the existing auditor had provided prohibited services, or for the inadvertent provision of a limited amount of prohibited services for a subsidiary or affiliate of a large conglomerate. However, in most of these instances, the auditor had audited the issuer's financial statements for some time and the issuer was already public. The SEC typically will not overlook the existence of independence issues in an IPO context when there are other public accounting firms with no independence issues available to provide audit services to the issuer. This also applies if the audit firm is new to the issuer.


As IPO and leverage buy-out activity increases, it is important that auditor independence be firmly established early in any process that involves a private company, or a newly acquired company, filing a registration statement with the SEC. Auditor independence can be complex in the private equity portfolio context. Issuers and underwriters should confirm that the auditor is independent with respect to the issuer, the private equity investor and the other companies in the private equity portfolio. In addition, counsel should review the auditor's process for determining whether it has provided any prohibited services to the issuer, the private equity fund or any other portfolio companies. Lastly, counsel should review all correspondence relating to auditor independence with the issuer, the audit committee and the SEC, and should confirm that the auditor has not reported any independence issues to the SEC or that the SEC will not object to the auditor's continued involvement.

For further information on this topic please contact Alexander Lynch or Kevin Yung at Weil, Gotshal & Manges LLP's New York office by telephone (+1 212 310 8000), fax (+1 212 310 8007) or email ([email protected] or [email protected]).