In opening remarks at the 2017 SEC/NASAA Annual Section 19(d) Conference on May 9, 2017 (the Conference), SEC Commissioner Michael Piwowar stated that he directed the SEC staff to begin working on amendments to the socalled "Loan Provision" in order to "address unnecessary compliance issues and instead focus attention on lending relationships that actually threaten auditor independence." Commissioner Piwowar added 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 by 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.
Loan Provision Compliance Challenges
In his remarks at the Conference, Commissioner Piwowar noted that the Loan Provision "is triggered even in situations where a lender may not be able to assert any influence over the entity whose shares it owns, including certain instances in which the lender holds the securities as a custodian or an omnibus account holder for its customers without beneficial ownership." He added that "these situations may not have any effect on an auditor's objectivity and impartiality, because the lender does not have significant influence over the audit client. Yet these compliance challenges threaten to disrupt the operation of the asset management industry, which is relied upon to manage and invest trillions of dollars of investors' retirement savings."
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 at least 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 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.
The transcript of Commissioner Piwowar's remarks is available at: https://www.sec.gov/news/speech/piwowar-openingremarks-sec-nasaa-2017-19d-conference.