The staff of the Securities and Exchange Commission (SEC) Division of Investment Management provided temporary relief to the fund industry in connection with audit firm independence and Regulation S-X Rule 2-01(c)(1)(ii)(A) (the “Loan Rule”) on June 20, 2016. The Loan Rule provides that an audit firm is not independent if the firm, any covered person in the firm or any of their immediate family members have a loan to or from an audit client or the record or beneficial owners of more than 10 percent of the audit client’s equity securities.1 The no-action letter, issued to Fidelity Management and Research Company (“Fidelity”), was in response to concerns raised by the SEC that certain lending relationships among shareholders and audit firms could impair auditor independence under the Loan Rule. The no-action letter was set to expire 18 months from the date of its issuance, on December 20, 2017; however, on September 22, 2017, the Division of Investment Management issued a letter extending the no-action relief until the SEC amends the Loan Rule to address concerns expressed in the no-action letter.
Conditions of the Fidelity No-Action Letter
The Fidelity no-action letter provides that the staff of the Division of Investment Management would not recommend enforcement against the applicant if it continued to fulfill its regulatory requirements under the federal securities laws by using audit services performed by an audit firm that is not in compliance with the Loan Rule, so long as the following conditions are met:
- The audit firm has provided the client’s audit committee with written disclosure regarding relationships between the audit firm and the client that may bear on the audit firm’s independence and discussed the potential impact of those relationships on audit independence with the audit committee on at least an annual basis;
- The non-compliance of the audit firm is with respect to certain lending and ownership relationships; and
- Notwithstanding the lending relationship, the audit firm has concluded that it is objective and impartial with respect to its engagement.
The relief was based on the representation by the audit firm that the lending institution is unable to impact the impartiality of the audit firm or assert any influence over the fund whose shares the institution owned or its investment adviser. The no-action letter also imposes more stringent requirements in connection with certain shareholder votes.
Extension of Fidelity No-Action Relief
The Fidelity no-action letter stated that the assurances were temporary and would expire 18 months from the date of its issuance. In a letter dated September 22, 2017, the Division of Investment Management wrote to Fidelity to provide an extension of the relief past the December 20, 2017 expiration. The letter notes that the extension will be withdrawn upon the effectiveness of any amendments to the Loan Rule that are designed to address the concerns of the Fidelity no-action letter.
Earlier this year in a speech at the 2017 SEC/NASAA Annual Conference, SEC Commissioner Michael Piwowar spoke about the Loan Rule and emphasized that the SEC staff is working on amendments to address any unnecessary compliance issues and to focus on lending relationships that truly threaten auditor independence. The extension of the relief indicates that the SEC is still continuing to develop a more permanent solution.
Practice Points and Tips
Audit committees should continue discussing the Loan Rule and its implications with their auditors and consider whether written policies and procedures should be developed to ensure that a reasonable inquiry is made with respect to audit firm lending relationships. Funds and their audit committees should monitor for any amendments to the Loan Rule that would nullify the effectiveness of the no-action relief and require compliance with the Loan Rule.