The Acting Chief Accountant of the Securities and Exchange Commission, Paul Munter, recently released a statement regarding critical points to consider when contemplating an audit firm restructuring. In recent years, audit firms have been increasingly involved in complex business arrangements, such as selling a portion of their business to a third party while retaining an equity interest in that business or divesting the accounting firm’s consulting practice, in whole or in part, to a third-party. These business arrangements can increase the challenges associated with an audit firm’s maintenance of its independence, both in fact and appearance, with respect to its audit clients. In particular, Munter points to the importance of considering the definition of “accounting firm” in Rule 2-01 of Regulation S-X when entering into these transactions. An “accounting firm” includes “the organization’s departments, divisions, parents, subsidiaries and associated entities [emphasis added], including those outside of the United States.” The SEC has not defined “associated entity” but when making a determination as to whether a third party investor or purchaser would be considered an associated entity, it is the view of the staff of the Office of the Chief Accountant (“OCA Staff”) that the following be considered: (i) the third party’s financial interest in the accounting firm; and (ii) the third party’s ability to influence the accounting firm’s operating or financial decisions.
These considerations are of particular importance in transactions involving private equity firms. Private equity structures can be complex and include entities that have influence over portfolio companies. Therefore, each entity within the contemplated structure should be evaluated to determine if the entity is an “associated entity” and if so, whether the entity would be considered a part of the accounting firm and be subject to auditor independence requirements. In addition to determining which entities meet the definition of accounting firm, the accounting firms need to comply with Rule 2-01(b) Regulation S-X (the general standard of auditor independence). It is the OCA Staff’s view that it would be a “high hurdle” for an accounting firm to comply with this rule if it provides any audit, review, or attestation services to any entities within the private equity structure. Auditor independence may also be at risk due to private equity firms generally having a “continuously evolving universe of entities.”
In addition to these private equity investment concerns, Munter notes the potential for auditor independence violations when an individual investor is involved in a transaction. If an individual, other than an audit firm partner, directly invests in the accounting firm, then such investor’s interests would need to be evaluated to determine if they fall under the “covered person” definition of Rule 2-01. If so, the investor must also comply with auditor independence rules. Last, Munter notes the OCA Staff’s expectations regarding divestitures. If an accounting firm divests all or part of its business and the divested entity is no longer part of the accounting firm post-transactions, the OCA Staff expects certain actions to be taken to maintain independence. This includes, but is not limited to, adopting separate corporate and financial structures, terminating all interests between the accounting firm and the divested entity and not having any profit sharing between the accounting firm and the divested entity. See the full text of the Acting Chief Accountant’s remarks here.