The staff of the Securities and Exchange Commission recently issued a no-action letter regarding the independence of auditors of investment companies. Under Rule 2-01 of Regulation S-X, an auditor of an investment company is not considered independent (as to the investment company) when another entity both serves as a lender to the auditor and holds more than 10 percent of the equity securities of a different fund in the same investment company complex (the auditor is not in compliance with the “Loan Provisions”). A group of Fidelity entities applied for no-action relief to avoid application of the Loan Provisions in specific circumstances, and the SEC granted the requested relief on June 20, 2016. The no-action letter temporarily shields investment companies in certain situations from SEC enforcement actions, which makes the SEC’s guidance on this issue important to all investment company complexes that use financial statements that are required to be accompanied by an audit opinion.
The SEC would object to use of an investment company’s financial statements if they are accompanied by an audit opinion produced by an auditor that is not in compliance with the Loan Provisions, unless the lending relationship is one of the following types:
- A lender to the auditor is the record holder, for the benefit of its clients or customers (for example, as an omnibus account holder or custodian), of more than 10 percent of the shares of an entity in the complex.
- An insurance company that is also a lender to the auditor holds more than 10 percent of the shares of an entity in the complex in separate accounts that it maintains on behalf of its insurance contract holders.
- A lender to the auditor acts as an authorized participant or market maker to an exchange-traded fund in the complex and holds of record or beneficially more than 10 percent of the shares of the ETF.
When these lending relationships exist, the SEC will not pursue an enforcement action as long as the auditor continues to provide required annual communications regarding independence, and the auditor concludes that, notwithstanding noncompliance with the Loan Provisions, the auditor is objective and impartial with respect to the issues encompassed within its engagement.
In addition, if a shareholder vote is solicited for the investment company’s election of trustees or directors, the appointment of an auditor, or other matters that could influence the auditor’s objectivity and impartiality, the investment company must conduct a reasonable inquiry as of the record date about the impact of the Loan Provisions. This means that investment companies that could encounter the conditions described in the no-action letter should develop policies and procedures that are reasonably designed to ensure that, when a shareholder vote is solicited for matters that could influence the auditor’s objectivity and impartiality, a reasonable inquiry is made.
The no-action relief is temporary and will expire 18 months from issuance, with no guarantee that the SEC will extend, expand or renew any portion of it.