According to the SEC’s updated 2017 regulatory agenda, a potential amendment to the so-called “Loan Provision” of Regulation S-X, regarding the impact of loans or debtor-creditor relationships on auditor independence, is in the “final rule stage,” with the SEC’s Office of Chief Accountant considering issuing a recommendation that the SEC amend the Loan Provision. The regulatory agenda, which is available on the “Reginfo.gov” website maintained by the Office of Information and Regulatory Affairs (part of the Office of Management and Budget), is a nonbinding indicator of the rulemaking plans of the SEC’s chairman and staff.
As we have previously reported, SEC Commissioner Michael Piwowar gave a speech in early May 2017 in which he stated that he directed the SEC staff to begin working on amendments to the Loan Provision to “address unnecessary compliance issues and instead focus attention on lending relationships that actually threaten auditor independence.” At that time, Commissioner Piwowar noted that “this rulemaking is consistent with my view that the Commission evaluate whether the rules and policies the agency implements are indeed achieving their intended objectives.”
As a reminder, Rule 2-01(c) under Regulation S-X sets forth a non-exclusive list of circumstances that are considered inconsistent with the “independence” of a registered public accounting firm (an Audit Firm), including the Loan Provision. The Loan Provision provides that an Audit Firm is not independent when the Audit Firm has a loan from “record or beneficial owners of more than ten percent of the audit client’s equity securities.” An “audit client,” in turn, is defined to include any affiliate of the audit client and, when the audit client is an entity within an “investment company complex” (as defined in Regulation S-X), it also includes every entity within the investment company complex, regardless of whether the Audit Firm actually provides audit services to those other entities.
Temporary No-Action Relief on Auditor Independence and the Loan Provision
On June 20, 2016, the staff of the SEC’s Division of Investment Management, in consultation with the Office of the Chief Accountant and the Division of Corporation Finance, issued a no-action letter to Fidelity Management & Research Company (FMR) assuring that, for 18 months from the issuance date, and subject to certain conditions set forth in the letter, the staff would not recommend enforcement action to the SEC if a registered fund or other entity in its investment company complex employs an Audit Firm that has relationships causing technical non-compliance as a result of the Loan Provision. Thus, although the no-action letter issued to FMR helped alleviate some of the compliance challenges faced by mutual funds with respect to the Loan Provision, it did not provide a “permanent fix.”
Any further developments on the Loan Provision will be addressed in a future issue of the Regulatory Update.