Important Note: The Securities and Exchange Commission recently released a comprehensive revision to its auditor independence requirements (the Revision). The Revision contains provisions covering settlement of capital and retirement interests when former firm professionals join firm audit clients, which supercede the requirements described in paragraph 2.b.iv of this standard. Consequently, at the next ISB meeting, the ISB staff will recommend that the Board delete paragraph 2.b.iv of this standard. All other provisions of this standard remain in effect. The Revision can be found at the SEC’s website at www.sec.gov. Independence Standard No. 3 Employment with Audit Clients July 2000 Independence Standards Board Standard No. 3 Employment with Audit Clients July 2000 SUMMARY This standard describes safeguards that firms should implement when their professionals join firm audit clients. These safeguards are designed to assist in ensuring that: ƒ professionals who are broadly evaluating their career options will exercise an appropriate level of skepticism while performing audits prior to their departure from the firm; ƒ a former firm professional now employed by the client cannot circumvent the audit because of familiarity with its design, approach, or testing strategy; and ƒ the remaining members of the audit team maintain objectivity when evaluating the work and representations of a former firm professional now employed by the audit client. The procedures should be adapted depending on several factors, including whether the professional served as a member of the audit team, the positions he or she held at the firm and has accepted at the client, the length of time that has elapsed since the professional left the firm, and the circumstances of his or her departure. The standard also specifies the circumstances under which capital and retirement balances owed to the departing professional should be liquidated or settled to preserve the firm’s independence. The standard’s requirements are effective for employment with audit client situations arising after December 31, 2000. Independence Standards Board Standard No. 3 Employment with Audit Clients CONTENTS Paragraph Number STANDARD • Underlying Principle 1 • Safeguards 2 • Effective Date 3 BACKGROUND 4 THREATS TO INDEPENDENCE 7 BASIS FOR CONCLUSIONS 9 • Effectiveness of Safeguards 10 • Peer Review 15 • Settlement of Financial Interests 16 • The Board’s Consideration of a Mandated Cooling-Off Period • Other Matters 21 31 Independence Standards Board Standard No. 3 Employment with Audit Clients STANDARD Underlying Principle 1. An audit firm’s independence is impaired with respect to an audit client that employs a former firm professional who could, by reason of his or her knowledge of and relationships with the audit firm, adversely influence the quality or effectiveness of the audit, unless the firm has taken steps that effectively eliminate such risk. Safeguards 2. An established program of safeguards including the following procedures, when conscientiously administered, is deemed to constitute steps that effectively eliminate the risk of independence impairment: a. Pre-change in employment safeguards: i. Firm professionals are required promptly to report to the firm conversations between themselves and an audit client respecting possible employment. ii. Firm professionals engaged in negotiations respecting possible employment with an audit client are immediately removed from the audit engagement. iii. Upon removal of a professional from the audit engagement as provided above, the firm reviews the professional’s work to assess whether he or she exercised appropriate skepticism while working on the audit engagement. b. Post-change in employment safeguards: i. If a professional accepts employment with the audit client, the on-going engagement team gives active consideration to the appropriateness or necessity of modifying the audit plan to adjust for risk of circumvention. ii. When a former firm professional joins an audit client and will have significant interaction with the audit team, the firm takes appropriate steps to provide that the existing audit team members have the stature and objectivity to effectively deal with the former firm professional and his or her work. iii. When a former firm professional joins an audit client within one year of disassociating from the firm and the professional has significant interaction with the audit team, the next following annual audit is separately reviewed by a firm professional uninvolved in the audit to determine whether the remaining engagement team maintained the appropriate skepticism when evaluating the representations and work of a former firm professional. The extent of this review should be tailored based on the position that the former professional has assumed at the audit client and other facts and circumstances that would heighten or mitigate threats to independence. iv. The firm requires the prompt (1) liquidation of all capital balances of former firm partners who become employed by an audit client; (2) settlement1 of all retirement balances2 of former firm professionals who become so employed that are not both immaterial to the firm and fixed as to amount and timing of payment; and (3) settlement of retirement balances of any firm professional, regardless of the financial immateriality of such balances to the firm, when, within five years of disassociating from the firm the identity of such former firm professional as an officer or employee of the audit client is required to be disclosed in the audit client's proxy statement or annual report filed with the Securities and Exchange Commission (SEC) pursuant to its regulations. Effective Date 3. The above requirements are effective for employment with audit client situations arising after December 31, 2000. 1 In the United States, the payment of retirement benefits to the individual would immediately subject such benefits to income taxes. In some cases, this tax liability can be deferred by transferring the remaining retirement benefits to an Individual Retirement Account or similar vehicle, in which case the amounts become taxable only when paid to the individual. In other cases, the amount can be transferred to a "Rabbi Trust" which also serves to defer such income taxes. A Rabbi Trust is an irrevocable trust whose assets are not accessible to the firm until all benefit obligations have been met; however, such assets are subject to the claims of creditors in the event of the firm’s bankruptcy or insolvency. To meet the requirements of this standard, such a trust can only be used if the amounts are fixed as to amount and timing of payment (i.e., the benefits do not fluctuate based on firm results, and the present value of benefits due to the departing professional can be calculated and placed in the trust), and the bankruptcy of the firm is considered remote. 2 Retirement balances as used in this statement do not include a professional’s benefits under the firm’s defined contribution plan, such as a 401(k) plan, if the firm has no obligation to fund the individual’s benefits after he or she disassociates from the firm. BACKGROUND 4. The Board began to study the independence implications of audit firm professionals going to work for the firm's audit clients shortly after its formation. After determining that guidance was needed in these situations, the Board began the process of developing a standard concurrent with its work on a conceptual framework for auditor independence. 5. A Discussion Memorandum (DM 99-1, Employment with Audit Clients) covering the issues was prepared with the assistance of a Board oversight task force, and a broad-based project task force consisting of representatives from the investor, preparer, academic, and regulator communities, in addition to members of the auditing profession. The DM was released in March 1999 for a 90-day comment period. Comment from investors was specifically sought; the DM was mailed to several investor organizations and to 370 institutional investors in an effort to encourage responses from that constituency. Twentyeight comment letters were received. After considering these letters, and with further assistance from the project and Board oversight task forces, the Board developed a proposed standard for public comment. 6. An Exposure Draft (ED) of the proposed standard was released at the end of December 1999 with a comment period that ended on February 29, 2000. Copies of the ED were mailed to a variety of individuals and groups, including those representing investors, to encourage and solicit responses. Fourteen comment letters were received. After considering these comments, and with further assistance from the project and Board oversight task forces, the Board approved the issuance of this standard. THREATS TO INDEPENDENCE 7. The concerns expressed when professionals leave firms to join audit clients are generally threefold: a. That partners or other audit team members who resign to accept positions with audit clients may not have exercised an appropriate level of skepticism during the audit process prior to their departure. b. That the departing partner or other professional may be familiar enough with the audit approach and testing strategy so as to be able to circumvent them once he or she begins employment with the client. c. That remaining members of the audit team, who may have been friendly with, or respectful of a former partner or other professional when he or she was with the firm, would be reluctant to challenge the decisions of the former partner or professional and, as a result, might accept the client’s proposed accounting without exercising appropriate skepticism or maintaining objectivity. 8. The perceived threats to auditor independence when the former partner or professional has retirement benefits or a capital account with the audit firm are as follows: a. It may appear that ties between the audit firm and the partner or other professional have not been severed – that the firm has placed its “own man” (or woman) at the client, functioning as management, and is in effect auditing the results of its own work. b. If the retirement benefits of the former partner or other professional vary based on the firm’s profits, then the former partner or other professional may be inclined to pay the firm higher fees to inflate his or her retirement benefits (or to increase the likelihood of receiving benefits in unfunded plans). As a result, the firm may be less rigorous in its scrutiny of the client’s accounting policies because its fees are overly rich. c. If the former partner’s or other professional’s unfunded retirement benefits or other monies held by the firm are material to the firm and the firm is experiencing cash flow problems, the firm may be less rigorous in its audit of the client’s financial statements in exchange for forbearance on the amounts owed to the former partner or other professional. BASIS FOR CONCLUSIONS 9. The Board’s desire is to protect the quality and integrity of audited financial statements for the ultimate benefit of investors and other users of those statements. To accomplish this goal, the Board weighed a variety of factors, some of which are described below, in determining an appropriate approach to address the threats to auditor independence posed by situations where firm professionals join audit clients. Effectiveness of Safeguards 10. The Board believes that the safeguards described in this standard will effectively protect auditor independence in situations where firm professionals go to work for their audit clients. A requirement to review an individual’s work after he or she enters into employment negotiations with an audit client and, when appropriate, review the engagement team’s work on the subsequent audit, is expected to have a deterrent effect. First, the expectation is that professionals who are broadly evaluating their career options will be more careful to ensure that the work they perform, including the decisions they make during the audit, will withstand scrutiny when they know it will be subject to a special review if they enter into employment negotiations with the audit client. Second, the skepticism of the remaining audit team members when evaluating the statements of a former colleague or leader may be higher; knowing that their work will be reviewed, individuals will most likely be more sensitive to appearing to have acquiesced to a client’s aggressive or incorrect accounting, and will be more likely to refrain from doing so. 11. Open discussion of the client’s employment of audit firm professionals with the audit committee or board of directors, as required in certain circumstances by ISB Standard No. 1, Independence Discussions with Audit Committees, can also serve as an effective safeguard. Airing, “in the sunshine,” the potential threats to independence posed by these situations, and the safeguards employed by the firm to protect auditor independence, is likely to sensitize those involved (both the former firm professional now with the client and the remaining audit team) to these issues, and make independence impairments less likely. In addition, while auditors are responsible for upholding their own professional standards, including those related to independence, the audit committee can “set the tone at the top,” and emphasize the proper separation between management and the auditor. 12. In developing the standard, the Board allowed for flexibility in adapting the safeguards to the facts and circumstances of the employment situation. The Board believes, for example, that the concerns one would have when a partner joins a client would exist, but to a lesser extent, when professionals with lower levels of responsibility join clients. These concerns would also vary depending on the nature and level of responsibilities assumed by the professional in his or her new role at the client. In addition, the issues may vary for active versus retired partners and other professionals, those leaving the firm voluntarily versus those terminated, and engagement professionals versus firm professionals having little or no direct prior professional relationship with the client. Therefore, the Board believes that an effective standard must establish principles that contemplate a variety of situations, especially as the structure of firms change, and more professionals are given new responsible, non-partner roles in firms. 13. The safeguards proposed in the ED contemplated a review of the former firm professional’s work upon employment by the audit client. After further consideration, the Board determined that the trigger for this review should be instead the commencement of employment negotiations between the firm professional and the audit client. The Board believes that the concerns about the work of an audit team member contemplating employment with his or her audit client would exist regardless of whether the firm professional eventually accepted a position at the client. Audit team members in employment negotiations with an audit client should be returned to the engagement only if negotiations cease and employment is no longer sought. 14. When a former firm professional joins an audit client within one year of disassociating from the firm and the professional has significant interaction with the audit team, the standard requires an additional review of the next annual audit following the professional’s acceptance of employment. This review is meant to determine whether the audit team had an appropriate level of skepticism when evaluating the work and representations of the former firm professional. Some asked whether such a review should always be performed prior to the firm’s “sign-off” on the audit. The Board concluded that the primary benefit of the review is its deterrent effect. That is, members of the audit team, knowing that their work will be subject to an additional review, will be less likely to acquiesce to questionable client proposals. Further, mandating such a review prior to issuance of the audit report could result in deferring for a significant period of time release of the audited financial statements. Such a delay could impose a significant cost to users of financial statements and the Board did not consider the additional benefits, if any, of a pre-issuance review to justify such costs. Peer Review 15. The ED proposed a requirement that firms have their compliance with the provisions of the standard evaluated in a peer review. The Board believes that peer review of firms’ compliance with all auditing and quality control standards, including independence standards, is an important component of the profession’s self-regulation. The Board ultimately concluded, however, that the scope or content of established peer review programs should be left to those that administer them, and that mandating participation in such a program should be left to other groups in the profession’s regulatory system. Settlement of Financial Interests 16. The Board considered the necessity of a “full-payout” requirement in situations where capital account and retirement obligations are immaterial to the firm, and fixed as to amount and timing of payment. The Board believes that a former partner of an audit firm who is employed by the firm’s audit client should not remain an equity investee in the firm. Accordingly, the standard requires the firm to liquidate all capital accounts prior to the employment of the professional by the audit client, regardless of their materiality. 17. With respect to retirement obligations, the standard requires the firm to settle such obligations prior to employment by the client in all situations where a professional’s benefits are not immaterial to the firm, and fixed as to amount and timing of payment. The Board concluded, however, that retirement obligations owed to a former professional that are both fixed and immaterial to the firm are not likely to impinge on the firm’s independence. On the other hand, it recognized that unsettled amounts may present an “appearance” concern when a former firm professional joins an audit client in a visible position where his or her former employment at the client’s audit firm is likely to be disclosed or known. Therefore, the standard mandates settlement of even immaterial retirement obligations when a former firm professional joins an audit client within five years of disassociating from the firm in a position where his or her name is required to be disclosed in the company’s proxy statement or annual report to the SEC. However, because the character of retirement benefits is different from capital balances, the Board concluded that settlement of retirement obligations could be done through a "Rabbi Trust" or similar vehicle in certain circumstances. 18. In reaching its conclusions regarding retirement balances, the Board was concerned that a requirement to settle all obligations could create significant tax or other liabilities for the departing partner in either the United States or in a foreign country. In addition, such a requirement might jeopardize the tax status of certain qualified plans if all plan participants were not treated equally. Such a result could serve to either actively discourage the partner from accepting the employment position, require the client to engage a new audit firm, or drive firms to reduce benefits provided under its plans because of accelerated funding requirements. The Board did not believe such consequences were in the public interest except for benefits that were not both fixed and immaterial to the firm, and in the limited circumstances involving former partners identified in an SEC filing, as described in paragraph 2(b)(iv). 19. Some expressed concern that a former firm professional could join a large, multinational audit client several years after leaving the firm, perhaps at a foreign location. In these circumstances, it is possible that the firm would not be aware of the former professional’s new position at the audit client, and may not have liquidated capital balances, or retirement benefits that are not both immaterial and fixed. The Board does not intend that an inadvertent and isolated failure to comply with these settlement provisions be deemed an impairment of independence. It does expect, however, that firms will impose conditions on former professionals who have remaining capital accounts or other than immaterial and fixed retirement benefits with the firm. One of those conditions should be to advise the firm when they are contemplating a change in employment, to allow the firm to determine if the new employer is a client subject to this standard. These arrangements should eliminate the need to implement elaborate and burdensome partner and employee tracking systems to comply with the provisions of the standard – a concern of some of the respondents to the ED. However, any inadvertent failures to comply should be corrected as soon as identified. 20. In reaching these conclusions, the Board considered making several distinctions, suggested by respondents to the DM, in determining when standards should require a full-payout of retirement benefits. These respondents suggested that a settlement requirement distinguish between defined contribution plan benefits and defined benefit plan benefits, fully funded benefits versus unfunded amounts, fixed benefits versus those that vary based on profits, and other criteria. The Board concluded that benefits which are other than immaterial to the firm, or that vary based on, for example, firm profitability, should always be settled, regardless of the amount of time that has elapsed since the professional’s departure from the firm. In addition, the Board concluded that the settlement requirement should not extend to defined contribution plan benefits such as those in a 401(k) plan if the firm has no ongoing obligation to fund the individual’s benefits. The Board’s Consideration of a Mandated Cooling-Off Period 21. In studying these issues, the Board considered and rejected a mandated “cooling-off period” – a rule deeming an impairment of the firm’s independence when certain firm professionals join an audit client. The Board concluded the costs of such a rule would exceed its benefits. 22. A cooling-off approach would mean either deeming independence to be impaired if any firm professional accepted an employment offer from an audit client, or specifying which types of persons would be included in such a rule and which would not. The former course seemed unnecessary, and the latter very complex or arbitrary, since the types of individuals who might represent threats would presumably depend upon their positions in the firm, their roles in the audit, and the positions they would be assuming at the audit client. Generalizing when that combination might constitute a threat to auditor independence and when it would not seemed to be a daunting task which should not be undertaken when an effective alternative is available. 23. The Board believes that with the appropriate safeguards in place, as called for by this standard, the threats to auditor independence are slight. In addition, the Board believes that the benefits to society and the profession of allowing firm professionals to accept employment with audit clients, without fear of jeopardizing their former firm’s independence, outweigh the costs. In reaching this conclusion, the Board recognizes that a mandatory cooling-off period may promote the appearance of independence more completely, and might eliminate the risk that the audit team could be unduly influenced by a former colleague, but it believes the differences in actual threats to independence under the two approaches are insignificant. 24. The Board recognizes that the attraction of future employment opportunities draws talented and ambitious recruits to the profession. Turnover at public accounting firms can be quite high, and many recruits do not intend to stay long enough to be promoted to partner. Furthermore, they join public accounting firms because of the broad experience they expect to gain at the firm, and the contacts they expect to make in industry. In addition, turnover within the partner ranks has increased in the last few years. If the future employment prospects of recruits and experienced auditors now working for audit firms were limited by a mandated cooling-off period, the Board is concerned that the caliber of professional attracted to public accounting might decline. 25. The Board agreed with several corporate officials and others responding to the DM who argued that companies benefit from the ability to hire staff at all levels from their audit team. An auditor who has worked for several years on an engagement is often thoroughly familiar with the client’s systems, and knows most of the client’s key people and their responsibilities. Beyond familiarity with the hiring company, the auditor brings broad experience “to the table” from working at a variety of companies, and sometimes in a variety of industries. In addition, partners and professionals in public accounting firms are generally recognized as experts in accounting, financial reporting, and internal control matters – skills needed by companies with financial reporting responsibilities to investors. 26. A mandated cooling-off period might force a client to choose between, for example, its audit partner and its audit firm, knowing that if the partner was hired, the audit firm would have to be replaced. The Board recognizes that replacement of an audit firm carries costs to firms, clients, and investors. There is a learning curve on a first-year audit; auditors spend significantly more time and resources on them (developing audit programs, familiarizing themselves with the system of internal controls, etc.), and client personnel spend more time answering the auditors’ questions and producing documentation previously provided to the prior auditors. And because the Board believes that audits are strengthened by institutional continuity, rotation of auditors and the increased risk that the first-year audit poses carries a cost to investors. 27. The Board acknowledges the counter-argument that a fresh look by a new audit team may carry some benefits that cannot be achieved with the same audit team and approach year after year. The consideration of a requirement that companies change audit firms periodically, however, is beyond the scope of this project. 28. The Board also concluded that a restriction on hiring former audit partners or other professionals may be a heavier burden to smaller corporations in need of the accounting expertise provided by someone familiar with their business and industry, and to smaller firms. Smaller corporations may be at a disadvantage in recruiting personnel when competing with larger companies with strong national or regional name recognition. Restricting these smaller companies from hiring directly from their audit firm (from among those who know the company well) may hurt them disproportionately. 29. Professionals from smaller accounting firms may face the same difficulties when competing in the job market with professionals from large, well-known firms. A rule that impairs the ability to go from an audit firm directly to a client, where management knows you and you have had a chance to demonstrate your abilities, may be more of a burden if you work for a smaller firm. 30. Finally, the Board concluded that a mandatory cooling-off period would be ineffective in preventing fraud or collusion between the auditor and client. If the firm professional and client management were intent on committing fraud, the professional might remain with the firm rather than risk turning the engagement over to another individual who may uncover the conspiracy. In addition, if management wanted to compensate a firm professional for his or her role in a fraud, a ban on hiring the professional for a certain period of time would not prevent the company from providing payments to the professional, after he or she resigns from the firm, via consulting contracts or other means. Other Matters 31. The Board concluded that the threats to auditor independence described in this standard are in many respects different from those that arise when former firm professionals are elected as non-executive members of the Board of Directors. Existing rules cover these non-executive director situations and remain in effect. 32. This standard was adopted unanimously by the Board. Members of the Independence Standards Board William T. Allen, Chair John C. Bogle Stephen G. Butler Robert E. Denham Manuel H. Johnson Philip A. Laskawy Barry C. Melancon James J. Schiro Copyright © Independence Standards Board Hello writer, the professor gave us a verbal assignment in which discuss if there is an independence violation by a board member of the ACCA. The case is as follows: Board members of the ACCA were invited by ACCA to an annual meeting in China. The mentioned country was chosen given the fact that a significant number of members are from such country. The association paid for travel expenses of all its members like (flight, hotel and stay). During such travel one of the board members decided that after ACCA meeting hours he was going to proceed with a personal business marketing plan, where he was to meet important businesspeople in China. Questions: 1. Is the mentioned board member violating any independence rule (independence in fact or independence in appearance) when taking advantage of the ACCA meeting to promote personal business agendas? 2. Is this member acting ethically when meeting future clients during his ACCA annual meeting? 3. If you believe that he was violating independence or not acting ethically what sanction do you consider is appropriate to apply to this person given the fact that he is a board member for such a prestigious Association? 1 Notice to Readers This publication is designed to provide illustrative information with respect to the subject matter covered. It does not establish standards or preferred practices. The material was prepared by AICPA staff and has not been considered or acted upon by senior technical committees or the AICPA board of directors and does not represent an official opinion or position of the AICPA. It is provided with the understanding that the staff and publisher are not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. The staff and publisher make no representations, warranties, or guarantees about, and assume no responsibility for, the content or application of the material contained herein and expressly disclaim all liability for any damages arising out of the use of, reference to, or reliance on such material. ©2017, AICPA 2 Preface Purpose of This Guide The purpose of the AICPA Plain English Guide to Independence is to help you understand independence requirements under the AICPA Code of Professional Conduct (the code) and, if applicable, other rule-making and standard-setting bodies. Independence generally implies one’s ability to act with integrity and exercise objectivity and professional skepticism. The AICPA and other rule-making bodies have developed rules that establish and interpret independence requirements for the accounting profession. We use the term rules broadly to mean rules, standards, interpretations, laws, regulations, opinions, policies, or positions. This guide discusses in plain English the independence requirements of the principal rule-making bodies in the United States, so you can understand and apply them with greater confidence and ease. This guide is intentionally concise; it does not cover all the rules (some of which are complex), nor does it cover every aspect of the rules. Nonetheless, this guide should help you identify independence issues that may require further consideration. Therefore, you should always refer directly to the rules, in addition to your firm’s policies on independence, for complete information. Conventions and Key Terms This guide uses the following conventions to enhance your reading: • The word “Note” in boldface italics emphasizes important points, highlights applicable government regulations, or indicates a rule change may soon occur. • The AICPA interpretations to the code are linked the first time they appear in a chapter. • Terms that are defined in the code appear in italic. The first time a defined term appears in a chapter, it will also be linked. • Internet addresses (URLs) and hyperlinks to other sources of information are provided. • Information on additional resources appears at the end of this guide to help you resolve your independence issues. (See the section “Where Can I Find Further Assistance with My Independence Questions?” in chapter 11, “Further Assistance,” of this guide.) We describe the rules of the SEC and the PCAOB—that is, those that apply to audits of SEC registrants and issuers—in boxed text (like this one) and provide citations to specific rules. Generally, we provide these descriptions when the SEC and the PCAOB impose either additional requirements or their rules otherwise differ from the AICPA rules. For purposes of this guide, a SEC registrant is an issuer filing an initial public offering, a registrant filing periodic reports under the securities laws, a sponsor or manager of an investment fund, or a foreign private issuer that is (or is in the process of becoming) an SEC registrant. In this guide, SEC audit client means an SEC registrant and its affiliates, as defined in the SEC rules. For purposes of this guide, an issuer is an entity filing an initial public offering, a registrant filing periodic reports under the securities laws, a sponsor or manager of ©2017, AICPA 3 an investment fund, or a foreign private issuer that is (or is in the process of becoming) an SEC registrant. In this guide, SEC audit client means an SEC registrant and its affiliates, as defined in the SEC rules. Note: The auditors of all registered broker-dealers must be registered with the PCAOB. ©2017, AICPA 4 TABLE OF CONTENTS Preface ........................................................................................................................... 3 Purpose of This Guide ............................................................................................................................ 3 Conventions and Key Terms .................................................................................................................. 3 Chapter 1—Introduction ............................................................................................... 8 What Is Independence? .......................................................................................................................... 8 What Should I Do If No Specific Guidance Exists on My Particular Independence Issue? ................... 8 When Is Independence Required, and Who Sets the Rules? ................................................................ 9 In Addition to the AICPA, Who Else Sets Independence Rules? ........................................................... 9 Chapter 2—Applying the Rules—Attest Client and Affiliates .................................. 11 Do I Need to Remain Independent From Just My Attest Client or From Other Entities As Well? ....... 11 What Entities Are Considered Affiliates of My Financial Statement Attest Client? .............................. 11 What Do I Do If a Financial Statement Attest Client’s Affiliates Can’t Be Identified? ........................... 12 What If My Financial Statement Attest Client Is Acquired After I Begin the Engagement? ................. 12 Are There Any Other Exceptions to the Affiliate Rules?....................................................................... 12 Is There Any Additional Guidance to Help Me Understand How to Apply the Affiliate Definition and Related Interpretation? ........................................................................................................... 13 Is There a Visual Aid to Help Me Understand the Affiliate Definitions? ............................................... 14 Is There an Executive Summary of the Interpretation? ........................................................................ 15 Chapter 3—Applying the Rules—Covered Members and Other Firm Professionals ...................................................................................................................................... 16 How Do the Independence Rules Apply to Me? ................................................................................... 16 Do Any of the Rules Apply to Me If I Am Not a Covered Member? ..................................................... 17 What If I Was Formerly Employed by an Attest Client or I Was a Member of the Attest Client’s Board of Directors? ........................................................................................................................ 17 What Rules Apply If I Am Considering Employment With an Attest Client? ........................................ 18 What If I Accept Employment or a Board Position With an Attest Client? ............................................ 18 What If I Am Employed as an Adjunct Faculty Member at an Educational Institution That Is an Attest Client? ............................................................................................................................................ 20 Chapter 4—Applying the Rules—Network Firms and Firm Mergers and Acquisitions ................................................................................................................. 21 What Is a Network Firm? ...................................................................................................................... 21 How Do I Apply the Network Firm Rules? ............................................................................................ 21 How Do I Apply the Rules in a Merger or Acquisition?......................................................................... 22 ©2017, AICPA 5 Chapter 5—Applying the Rules—Family Members .................................................. 25 When Is My Family Subject to the Rules? ............................................................................................ 25 What About My Other Relatives? ......................................................................................................... 26 Chapter 6—Financial Relationships .......................................................................... 28 When Do My (or My Family’s) Financial Interests Impair Independence? ........................................... 28 What If My Immediate Family or I Receive a Financial Interest as a Result of an Inheritance or a Gift? ....................................................................................................................................................... 30 What Are the Rules That Apply to My Mutual Fund Investments (and Those of My Family) If My Firm Audits Those Mutual Funds? ........................................................................................ 30 Which Rules Pertain to My Mutual Fund Investments (and Those of My Family) If My Firm Audits Companies Held in Those Mutual Funds?......................................................... 30 May I Have a Joint Closely Held Investment With an Attest Client? .................................................... 31 May My Family or I Borrow Money From, or Lend Money to, an Attest Client? ................................... 31 May I Have a Brokerage Account With an Attest Client? ..................................................................... 32 May I Have a Bank Account With an Attest Client? ............................................................................. 32 May I Have an Insurance Policy With an Attest Client? ....................................................................... 33 May I Give Gifts or Entertainment to, or Accept Gifts or Entertainment From, an Attest Client? ......... 33 Chapter 7—Business Relationships .......................................................................... 34 Which Business Relationships With an Attest Client Impair Independence? ...................................... 34 Chapter 8—Nonattest Services .................................................................................. 36 Which Rules Describe the Nonattest Services That My Firm and I May or May Not Provide to Attest Clients? .......................................................................................................................................... 36 AICPA General Requirements .............................................................................................................. 38 General Requirement 1 .................................................................................................................. 38 General Requirement 2 .................................................................................................................. 39 General Requirement 3 ........................................................................................................ 39 Are Preparing Financial Statements, Cash-to-Accrual Conversions, and Reconciliations Considered Nonattest Services? ....................................................................................................................... 39 What Are the Rules Concerning Performing Bookkeeping Services for an Attest Client?................... 39 May My Firm Provide Internal Audit Services to an Attest Client? ....................................................... 40 May My Firm Manage a Project for an Attest Client? ........................................................................... 41 May My Firm Provide Valuation, Appraisal, or Actuarial Services to an Attest Client? ........................ 41 May My Firm Provide Investment Advisory Services to an Attest Client?............................................ 42 May My Firm Design or Implement an Information System for an Attest Client? ................................ 43 ©2017, AICPA 6 May My Firm Provide an Attest Client With Training Services? ........................................................... 43 Chapter 9—Breach of an Independence Interpretation ........................................... 45 What Do I Do If I’m Not in Compliance With an Independence Interpretation? ................................... 45 Chapter 10—Fee Issues .............................................................................................. 46 What Types of Fee Arrangements Between My Firm and an Attest Client Are Prohibited? ................ 46 When Are Referral Fees Permitted? .................................................................................................... 47 Is Independence Affected When an Attest Client Owes the Firm Fees for Professional Services the Firm Has Already Provided? .......................................................................................................... 47 Does Being Compensated for Selling Certain Services to Clients Affect My Independence? ............. 48 Does It Matter If a Significant Proportion of My Firm’s Fees Come From a Particular Attest Client? .. 48 Factors to Consider in Identifying Significant Attest Clients ................................................................. 49 Chapter 11—Further Assistance ................................................................................ 51 Where Can I Find Further Assistance With My Independence Questions? ......................................... 51 AICPA Resources ................................................................................................................................. 51 SEC Resources .................................................................................................................................... 52 PCAOB Resources ............................................................................................................................... 52 GAO Resources.................................................................................................................................... 52 Department of Labor Resources .......................................................................................................... 52 Banking Regulators’ Resources ........................................................................................................... 52 International Federation of Accountants Resources ............................................................................ 52 ©2017, AICPA 7 Chapter 1—Introduction What Is Independence? Independence is defined as follows: a. Independence of mind is the state of mind that permits a member to perform an attest service without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism. b. Independence in appearance is the avoidance of circumstances that would cause a reasonable and informed third party, who has knowledge of all relevant information, including safeguards applied, to reasonably conclude that the integrity, objectivity, or professional skepticism of a firm or member of the attest engagement team is compromised. This definition should not be interpreted as an absolute. For example, the phrase “without being affected by influences that compromise professional judgment” is not intended to convey that the member must be free of all influences that might compromise objective judgment. Instead, the member should determine whether such influences, if present, create a threat that is not at an acceptable level that a member would not act with integrity and exercise objectivity and professional skepticism in the conduct of a particular engagement or would be perceived as not being able to do so by a reasonable and informed third party with knowledge of all relevant information. This definition reflects the long-standing professional requirement that members who provide services to entities for which independence is required be independent both in fact (that is, of mind) and in appearance. What Should I Do If No Specific Guidance Exists on My Particular Independence Issue? According to the “Application of the Conceptual Framework for Independence and Ethical Conflicts” interpretation (AICPA, Professional Standards, ET sec. 1.200.005) of the “Independence Rule” (AICPA, Professional Standards, ET sec. 1.200.001), in the absence of an interpretation of the “Independence Rule” that addresses a particular relationship or circumstance, a member should apply the “Conceptual Framework for Independence” interpretation (AICPA, Professional Standards, ET sec. 1.210.010). The “Conceptual Framework for Independence” interpretation recognizes that it is impossible for the AIPCA Code of Professional Conduct (the code) to identify all circumstances in which the appearance of independence might be questioned. When threats to independence are not at an acceptable level, the member must apply safeguards to eliminate the threats or reduce them to an acceptable level. If threats to independence are not at an acceptable level and require the application of safeguards, the member must document the threats identified and the safeguards applied to eliminate the threats or reduce them to an acceptable level. Failure to prepare the required documentation would be considered a violation of the “Compliance With Standards Rule” (AICPA, Professional Standards, ET sec. 1.310.001) rather than the “Independence Rule” if the member can demonstrate that safeguards were applied that eliminated or reduced significant threats to an acceptable level. ©2017, AICPA 8 The “Conceptual Framework for Independence” interpretation provides a valuable tool to help you comply with the “Independence Rule” when a specific circumstance or relationship is not addressed in the code. To assist with implementing the interpretation, the Professional Ethics Division developed a toolkit. When Is Independence Required, and Who Sets the Rules? AICPA professional standards require your firm, including the firm’s partners and professional employees, to be independent in accordance with the “Independence Rule” whenever your firm performs an attest engagement for an attest client. A compilation is an attest engagement. Although performing a compilation of an attest client’s financial statements does not require independence, if a non-independent firm issues a compilation report, the accountant is required to indicate the accountant’s lack of independence in a final paragraph of the accountant’s compilation report, pursuant to paragraph .22 of AR-C section 80, Compilation Engagements (AICPA, Professional Standards). You and your firm are not required to be independent to perform services that are not attest services (for example, financial statement preparation, tax preparation or advice or consulting services, such as personal financial planning) if they are the only services your firm provides to a client. Note: You should familiarize yourself with your firm’s independence policies, quality control systems, and list or database of attest clients. In Addition to the AICPA, Who Else Sets Independence Rules? Many clients are subject to oversight and regulation by governmental agencies. For example, the Government Accountability Office sets independence rules that apply to entities audited under Government Auditing Standards (also referred to as the Yellow Book). For these clients (and others, such as those subject to regulation by the SEC or Department of Labor), you and your firm also must comply with the independence rules established by those agencies. The SEC regulates SEC registrants and issuers and establishes the qualifications of independent auditors. This guide refers to these independence rules as SEC rules. The PCAOB, a private standard-setting body whose activities are overseen by the SEC, is authorized to set, among other things, auditing, attestation, quality control, ethics, and independence standards for accounting firms that audit issuers and broker dealers. The PCAOB adopted interim ethics standards based on the following provisions of the code, as in existence on April 16, 2003, to the extent not superseded or amended by the board: • Rule 102, Integrity and Objectivity • Rule 101, Independence • Interpretations and rulings under Rules 102 and 101 It also adopted Independence Standards Board (ISB) Independence Standard No. 2, Certain Independence Implications of Audits of Mutual Funds and Related Entities, and No. 3, Employment with Audit Clients, as well as ISB Interpretation 99-1, Impact on Auditor Independence of Assisting Client in the Implementation of FAS 133. To the extent that the SEC’s rules are more or less restrictive than the PCAOB’s interim independence standards, registered public accounting firms must comply with the more restrictive requirements. ©2017, AICPA 9 In addition to its detailed rules, the SEC looks to its general standard of independence and four basic principles to determine whether independence is impaired. The general standard is an appearance standard that considers whether a reasonable investor with knowledge of all relevant facts and circumstances would conclude that an accountant is independent. Under the four basic principles, an auditor cannot function in the role of management, audit his or her own work, serve in an advocacy role for the client, or have a mutual or conflicting role with the client. Other organizations establish independence requirements that may be applicable to you and your firm. You should contact the following organizations directly for further information: • State boards of accountancy • State CPA societies • Federal and state agencies Note: Generally, the AICPA independence rules will apply to you in all situations involving an attest client. If an additional set of rules governing an engagement also applies, you should comply with the most restrictive rule or the most restrictive portions of each rule. Once you determine that your firm provides attest services to a client and which rules apply, the next step is to determine how the rules apply to you. ©2017, AICPA 10 Chapter 2—Applying the Rules—Attest Client and Affiliates Do I Need to Remain Independent From Just My Attest Client or From Other Entities As Well? Although we think of our attest clients as the entity for which we are performing an attest engagement, in some instances, you will need to remain independent from other entities. Specifically, if the engaging party is not the entity you are performing the attest engagement on, the AICPA Code of Professional Conduct (the code) requires that you also remain independent of the engaging party. In addition, the code requires you to remain independent of affiliates of any financial statement attest client. A financial statement attest client is considered to be any entity whose financial statements are audited, reviewed, or compiled when the member’s compilation report does not disclose a lack of independence. What Entities Are Considered Affiliates of My Financial Statement Attest Client? The “Client Affiliates” interpretation (AICPA, Professional Standards, ET sec. 1.224.010) of the “Independence Rule” (AICPA, Professional Standards, ET sec. 1.200.001) requires that when a client is a financial statement attest client, members should apply the “Independence Rule” and related interpretations applicable to the financial statement attest client to their affiliates. The following entities will need to be considered affiliates of your financial statement attest client: a. An entity (for example, subsidiary, partnership, or LLC) that a financial statement attest client can control. b. An entity in which a financial statement attest client or an entity controlled by the financial statement attest client has a direct financial interest that gives the financial statement attest client significant influence over such entity and is material to the financial statement attest client. c. An entity (for example, parent, partnership, or LLC) that controls a financial statement attest client when the financial statement attest client is material to such entity. d. An entity with a direct financial interest in the financial statement attest client when that entity has significant influence over the financial statement attest client, and the interest in the financial statement attest client is material to such entity. e. A sister entity of a financial statement attest client if the financial statement attest client and sister entity are each material to the entity that controls both. f. A trustee that is deemed to control a trust financial statement attest client that is not an investment company. g. The sponsor of a single employer employee benefit plan financial statement attest client. h. Any entity, such as a union, participating employer, or a group association of employers, that has significant influence over a multiemployer employee benefit plan financial statement attest client and the plan is material to such entity ©2017, AICPA 11 i. The participating employer that is the plan administrator of a multiple employer employee benefit plan financial statement attest client. j. A single or multiple employer employee benefit plan sponsored by either a financial statement attest client or an entity controlled by the financial statement attest client. All participating employers of a multiple employer employee benefit plan are considered sponsors of the plan. k. A multiemployer employee benefit plan when a financial statement attest client or entity controlled by the financial statement attest client has significant influence over the plan and the plan is material to the financial statement attest client. l. An investment adviser, a general partner, or a trustee of an investment company financial statement attest client (fund) if the fund is material to the investment adviser, general partner, or trustee that is deemed to have either control or significant influence over the fund. When considering materiality, members should consider investments in, and fees received from, the fund. What Do I Do If a Financial Statement Attest Client’s Affiliates Can’t Be Identified? If after expending your best efforts to obtain the information to identify the affiliates of a financial statement attest client, you are unable to do so, all the following steps must be taken: • Discuss the matter, including the potential effect on independence, with those charged with governance. • Document the results of the discussion with those charged with governance. • Document the efforts taken to obtain the information to identify the affiliates of the financial statement attest client. • Obtain written assurance from the financial statement attest client that it is unable to provide the member with the information necessary to identify its affiliates. What If My Financial Statement Attest Client Is Acquired After I Begin the Engagement? Although the interpretation requires members to apply the independence provisions applicable to their financial statement attest clients to any affiliates, it was determined that an exception was necessary when a financial statement attest client is acquired while you are performing an attest engagement. The exception would only be applicable if the attest engagement covers periods prior to the acquisition and provided you will not continue to perform financial statement attest services to the acquirer. Are There Any Other Exceptions to the Affiliate Rules? It was also deemed appropriate that members need not apply the independence provisions applicable to their financial statement attest clients to any affiliates in four other situations. The first situation involves loans and applies to all affiliates. The code currently prohibits a covered member from making a loan to, or having a loan from, an individual who is an officer, a director, or a 10 percent or more owner of an attest client. If this provision were applied to affiliates any time a member had a loan to or from an individual, especially one that is only an investor and not in a position of governance, he or she would need to take steps to ensure the individual was not in one of these positions at an affiliate. Accordingly, the exception concludes that only when the covered member has knowledge that the individual is in such a position with an affiliate of a financial statement attest client, ©2017, AICPA 12 the covered member should be required to consult the “Conceptual Framework for Independence” interpretation (AICPA, Professional Standards, ET sec. 1.210.010), because without knowledge, the familiarity, undue influence, and financial self-interest threats would be at an acceptable level. The second, third, and fourth exceptions may not be applied by those described as an affiliate under (a) or (b); rather, they may only be applied to those described as an affiliate under (c)–(j). The next exception involves the provision of prohibited nonattest services (that is, nonattest services that would impair a member’s independence). Specifically, when it is reasonable to conclude that the prohibited nonattest services do not create a self-review threat because the results of the nonattest services will not be subject to financial statements attest procedures, and any other threats that are created by the provision of the nonattest service (for example, management participation threats) that are not at an acceptable level are eliminated or reduced to an acceptable level by the application of safeguards, members should not be prohibited from providing these services to entities described as an affiliate under (c)–(j). This exception does not apply to those entities described as an affiliate under (a) or (b). The third exception involves subsequent employment at an affiliate. The code (that is, the “Subsequent Employment or Association With an Attest Client” interpretation [AICPA, Professional Standards, ET sec. 1.279.020]) requires the application of specific safeguards when a former partner or employee becomes employed at an attest client in a key position. Under the interpretation, if no exception were provided, these safeguards would need to be applied when a former partner or employee becomes employed or associated with an affiliate in a key position. It was determined that it is not necessary to apply these safeguards to entities described as an affiliate under (c)–(j) if the individual’s position does not allow the individual to be in a key position with respect to the financial statement attest client. Again, this exception does not apply to those entities described as an affiliate under (a) or (b). The final exception involves immediate family members and close relatives who are employed at those entities described as an affiliate under (c)–(j). Similar to the third exception previously described, covered members need only be concerned with employment positions their immediate family members and close relatives have with such affiliates when these positions put them in a key position with respect to the financial statement attest client at those defined as an affiliate under (a) and (b). Is There Any Additional Guidance to Help Me Understand How to Apply the Affiliate Definition and Related Interpretation? The Ethics Division issued a nonauthoritative frequently asked questions (FAQ) document, “Application of the Independence Rules to Affiliates of Employee Benefit Plans.” The FAQ document is designed to help you better understand how the definitions and guidance provided in the “Client Affiliates” interpretation apply to affiliates of employee benefit plans subject to the Employee Retirement Income Security Act. ©2017, AICPA 13 Is There a Visual Aid to Help Me Understand the Affiliate Definitions? A visual aid was created to help explain how the first five entities, (a)–(e) identified in the affiliate definition, could be related to Entity Z, the financial statement attest client. The letters used in the visual aid correspond with the letters used in the affiliate definition. X Ultimate Parent Z is not material to X C1 and C2 are subsidiaries C1 C1 is not C2’s sister C2 is not material to X X C2 K (investor) a D has signific e nt influnce over Z and Z is material to D E Subsidiary of C2 K is not material to C2 K is not E or Z’s sister A2 (Subsidiary) A2 is material to Z Legend: D Parent ofParent Ultimate K, E and Z Z isisnot C2 material material to to XX C1isand Z material C2 are to subsidiaries C2 Y (investor) a Y has signific e nt influnce over Z but Z is not material to Y Z Subsidiary of C2 E is material to C2 E is Z’s sister Subsidiary of C2 Financial Statement Attest Client Z is material to C1 and D1 B (investor) a Z has signific e nt influnce over B and B is material to Z I (investor) a Z has signific e nt influnce over I and I is immaterial to Z I (investor) a Z does not have signific e nt influnce over 1 I is immaterial to Z B is material to Z Financial Statement attest clienti Affilat e of a Financial Statement Attest Clienti Not an affilat e of a Financial Statement Attest Client FirstiFive Entities t Identifie in the Affilat e De f ini ion a. An entity (for example, subsidiary, partnership, or LLC) thataa finnci al statement attest client can control b. An entity in which a a finnci al statement attest client or an entity controlled by theafinnci al statement attest client has a direct a finnci al interest that gives theafinnci al statementaattest client signific e nt influnce over such entity and that is material to thea finnci al statement attest client c. An entity (for example, parent, partnership, or LLC) that controls a a finnci al statement attest client when theafinnci al statement attest client is material to such entity d. An entity with a direct a finnci al interest in theafinnci al statementaattest client when that entity has signific e nt influnce over theafinnci al statement attest client, and the interest in theafinnci al statement attest client is material to such entity e. A sister entity a of a finnci al statement attest client if theafinnci al statement attest client and sister entity are each material to the entity that controls both ©2017, AICPA 14 Is There an Executive Summary of the Interpretation? Tick Mark Key P: The independence provisions contained in the AICPA Code of Professional Conduct should be applied to this affiliate. PS: A member may have a loan to or from an individual who is an officer, a director, or a 10 percent owner of an affiliate; however, if the covered member has knowledge of the individual’s relationship with the affiliate, he or she should consult the “Conceptual Framework for Independence” interpretation (AICPA, Professional Standards, ET sec. 1.210.010). A: The firm will have to apply safeguards outlined in paragraph .02 of the “Subsequent Employment or Association With an Attest Client” interpretation (AICPA, Professional Standards, ET sec. 1.279.020), if the former employee is in a key position at the affiliate. Even if position is a non-key position, when considering employment, the individual must report the consideration to the appropriate person in the firm and be removed from the engagement. R: Immediate family members and close relatives of a covered member may be employed at an affiliate, as long as their position does not put them in a key position with respect to the financial statement attest client. NSA: Services are permitted if not subject to audit; see the second exception for details. N/A: The relationship is not applicable. Affiliate Definitions Affiliate A: Entity that a financial statement attest client can control. Affiliate B: An entity in which a financial statement attest client or an entity controlled by the financial statement attest client has a direct financial interest that gives the financial statement attest client significant influence over such entity and is material to the financial statement attest client. Affiliate C: An entity that controls a financial statement attest client when the financial statement attest client is material to entity. Affiliate D: An entity with a direct financial interest in the financial statement attest client when that entity has significant influence over the financial statement attest client, and the interest in the financial statement attest client is material to such entity. Affiliate E: Sister entity of a financial statement attest client if the financial statement attest client and sister are material to the entity that controls both. Affiliate F: Trustee that is deemed to control a trust financial statement attest client that is not an investment company. Affiliate G: Sponsor of a single employer employee benefit plan financial statement attest client. Affiliate H: Union or participating employer having significant influence over a multiple or multiemployer employee benefit plan financial statement attest client. Affiliate I: Employee benefit plan sponsored by either a financial statement attest client or an entity controlled by the financial statement attest client. Affiliate J: Investment adviser, general partner, and trustee of an investment company financial statement attest client (the fund) if the fund is material to the investment adviser, general partner, or trustee, and they are deemed to have either control or significant influence over the fund. 15 Chapter 3—Applying the Rules—Covered Members and Other Firm Professionals How Do the Independence Rules Apply to Me? Whenever you are a covered member, you become subject to the full range of independence rules with regard to a specific attest client. You are a covered member if you are any of the following: a. An individual on the client’s attest engagement team b. An individual in a position to influence the attest engagement c. A partner, partner equivalent, or manager who provides more than 10 hours of nonattest services to the attest client d. A partner or partner equivalent in the office in which the lead attest engagement partner primarily practices in connection with the client’s attest engagement e. The firm, including the firm’s employee benefit plans f. An entity whose operating, financial, or accounting policies can be controlled by any of the individuals or entities described in items (a)–(e) or by two or more such individuals or entities if they act together. The SEC uses the term covered person1 to describe the individuals in a firm who are subject to SEC independence rules. This term is largely consistent with the AICPA’s term covered member. The only difference between the two definitions is that of classification. The AICPA considers consultants to be in a position to influence the engagement (the SEC uses the term chain of command), whereas the SEC considers these persons to be on the attest engagement team. Overall, the definitions are the same. Note: This guide uses the term covered member (and covered person with respect to SEC rules) extensively in explaining the “personal” independence rules (for example, rules that apply to you and your family’s loans, investments, and employment). Therefore, it is important that you understand these terms before proceeding. Also, remember to check your firm’s policies to determine whether they are more restrictive than the AICPA or SEC rules. 1 See Rule 2-01(f)(11). Also, see the definition of covered persons in the firm in Section IV(H)(9) of the SEC’s Final Rule Release, Revision of the Commission’s Auditor Independence Requirements. 16 Do Any of the Rules Apply to Me If I Am Not a Covered Member? Yes, these rules apply in certain circumstances, even if you are not a covered member. Due to their magnitude, two categories of relationships impair independence, even if you are not a covered member. These relationships are defined as follows: • Director, officer, or employee (or in any capacity equivalent to a member of management) of the client, promoter, underwriter, voting trustee, or trustee of any of the client’s employee benefit plans • Owner of more than 5 percent of an attest client’s outstanding equity securities (or other ownership interests) The independence rules prohibit these relationships if you are a partner or professional employee in a public accounting firm. The 5 percent prohibition also extends to immediate family members. See paragraph .03 of the “Overview of Financial Interests” interpretation (AICPA, Professional Standards, ET sec. 1.240.010) for further details. What If I Was Formerly Employed by an Attest Client or I Was a Member of the Attest Client’s Board of Directors? You must be aware of a number of things, including the following: a. You may not participate in the client’s attest engagement or be in a position to influence the engagement for any periods covering the time you were associated with the attest client. So, for example, if you worked for the attest client during its 2015 fiscal year, you would be prohibited from serving on the attest client’s audit engagement for the fiscal year 2015 financial statements. You also could not serve in a position that would allow you to influence the fiscal year 2015 engagement (for example, you could not directly or indirectly supervise the audit engagement partner). b. Before becoming a covered member, you must do the following: i. Dispose of any direct financial interests or material indirect financial interests in the attest client.2 ii. Collect and repay all loans to or from the attest client (except those specifically permitted or grandfathered3). iii. Cease active participation in the attest client’s employee health and welfare plans (except for benefits under the Consolidated Omnibus Budget Reconciliation Act of 1985). iv. Cease to participate in all other employee benefit plans by liquidating or transferring all vested benefits in the attest client’s defined benefit plans, defined contribution plans, share-based compensation arrangements, deferred compensation plans, and other similar arrangements at the earliest date permitted under the plan. When the covered member does not participate on the attest engagement team or is not an individual in a position to 2 See the section “When Do My (or My Family’s) Financial Interests Impair Independence?” in chapter 6, “Financial Relationships,” of this guide. 3 Also, see the “Loans and Leases With Lending Institutions” interpretation (AICPA, Professional Standards, ET sec. 1.260.020). ©2017, AICPA 17 influence the attest engagement, he or she is not required to liquidate or transfer any vested benefits if such an action is not permitted under the terms of the plan or if a penalty4 significant to the benefits is imposed upon such liquidation or transfer. v. Assess if you have any other relationships with the attest client to determine if such relationships create threats to independence that would require the application of safeguards to reduce the threats to an acceptable level.5 See the “Former Employment or Association With an Attest Client” interpretation (AICPA, Professional Standards, ET sec. 1.277.010) for further details. What Rules Apply With an Attest Client? If I Am Considering Employment If an attest client offers you employment, or you seek employment with an attest client, you may need to take certain actions. If you are on that client’s attest engagement team or can otherwise influence the engagement, you must promptly report any employment negotiations with the attest client to the appropriate person in your firm. You cannot participate in the engagement until your negotiations with the attest client end. See the “Considering Employment or Association With an Attest Client” interpretation (AICPA, Professional Standards, ET sec. 1.279.010) for further details. What If I Accept Employment or a Board Position With an Attest Client? Being employed by an attest client or member of the attest client’s board of directors impairs independence. However, even if you leave your firm to take a position with an attest client, independence still may be affected. This would be the case if you accept a key position with the attest client, which means you prepare financial statements or accounting records or are otherwise able to influence the attest client’s statements or records. A few examples of key positions are controller, CFO, or treasurer. Remember that the substance, not only the position title, determines whether a position is considered “key.” If you meet the following conditions, having a key position with an attest client will not impair your firm’s independence: • The amounts the firm owes you (capital balance or retirement benefits) are based on a fixed formula and not material to the firm. • You cannot influence the firm’s operations or financial policies. • You do not participate or appear to participate in the firm’s business or professional activities. Your firm must consider whether it should apply additional procedures to ensure that your transition to the attest client has not compromised the firm’s independence and that independence will be maintained going forward. The firm should consider 4 A penalty includes an early withdrawal penalty levied under the tax law but excludes other income taxes that would be owed, or market losses that may be incurred, as a result of the liquidation or transfer. 5 See the section “What Should I Do If No Specific Guidance Exists on My Particular Independence Issue?” in chapter 1, “Introduction,” of this guide. ©2017, AICPA 18 • whether you served on the engagement team and for how long. • positions you held with the firm and your status. • your position and status with the attest client. • the amount of time that has passed since you left the firm. Based on these factors, the firm may decide to • adjust the audit plan to reduce the risk that your knowledge of the plan could lessen the audit’s effectiveness. • reconsider the successor engagement team to ensure that it has sufficient stature and experience to deal effectively with you in your new position. • perform an internal technical review of the next attest engagement to determine whether engagement personnel exercised the appropriate level of professional skepticism in evaluating your work and representations.6 See the “Subsequent Employment or Association With an Attest Client” interpretation (AICPA, Professional Standards, ET sec. 1.279.020) for further details. Under SEC rules, if a former partner will be in an accounting role or financial reporting oversight role with an SEC audit client, he or she may not have the following: • A capital balance with the firm • A financial arrangement with the firm (for example, retirement benefits) that is not fully funded by the firm • Influence over the firm’s operations or financial policies The SEC uses the terms accounting role and financial reporting oversight role7 in its rules; taken together, these terms are consistent with the AICPA term key position. The SEC also requires a one-year cooling-off period for members of the audit engagement team of an issuer who assume a financial reporting oversight role with the client. In other words, if an engagement team member who participated on the audit of the current (or immediately preceding) fiscal year goes to work for a client, the firm’s independence would be impaired. Only members who provided fewer than 10 hours of services of audit, review, or other attest services to the client (and did not serve as either the lead or concurring partner 6 An objective professional with the appropriate stature and expertise should perform this review, and the firm should take any recommendation(s) that result from the review. 7 Accounting role or financial reporting oversight role means a role in which a person is in a position to or does exercise more than minimal influence over the contents of the accounting records or anyone who prepares them or exercise influence over the contents of the financial statements or anyone who prepares them, such as when the person is a member of a board of directors or similar management or governing body, CEO, president, CFO, general counsel, chief accounting officer, controller, director of internal audit, director of financial reporting, treasurer, vice president of marketing, or any equivalent position. ©2017, AICPA 19 for the client) would be excluded from the audit engagement team for purposes of this rule. This rule applies to an issuer and its consolidated entities. What If I Am Employed as an Adjunct Faculty Member at an Educational Institution That Is an Attest Client? This is the one and only exception to the prohibition of being employed at an attest client. Although being employed by an attest client as an adjunct faculty member still raises threats to independence, when certain specified safeguards are in place, threats can be reduced to an acceptable level, and independence can be maintained. The specific safeguards are that a partner or professional employee must not • be in a key position at the educational institution. • participate on the attest engagement team. • be an individual in a position to influence the attest engagement. • participate in any employee benefit plans sponsored by the educational institution, unless participation is required. • assume any management responsibilities or set polices for the educational institution. ©2017, AICPA 20 Chapter 4—Applying the Rules—Network Firms and Firm Mergers and Acquisitions What Is a Network Firm? CPA firms frequently form associations with other firms and entities and cooperate with them to enhance their capabilities to provide professional services. On occasion, such cooperation creates the appearance that firms are closely aligned or connected. Such appearance exists when one or more of the following characteristics are present: • The use of a common brand name (including common initials) as part of the firm name • Common control among the firms through ownership, management, or other means • Profits or costs, excluding costs of operating the association; costs of developing audit methodologies, manuals, and training courses; and other costs that are immaterial to the firm • Common business strategy that involves ongoing collaboration among the firms whereby the firms are responsible for implementing the association’s strategy and are held accountable for performance pursuant to that strategy • Significant part of professional resources • Common quality control policies and procedures that firms are required to implement and that are monitored by the association When a firm participates in such an association, and one or more of the preceding characteristics are present, the firm is considered a network firm. Any entity the firm controls by itself or through one or more of its owners is also considered a network firm. In addition, any entity that can control the firm or that the firm is under common control with would also be considered a network firm. It is possible that not all firms in the association will meet one of the preceding characteristics. In such situations, only the subset of firms that meet one or more of the characteristics would be considered network firms. How Do I Apply the Network Firm Rules? The “Networks and Network Firms” interpretation (AICPA, Professional Standards, ET sec. 1.220.010) under the "Independence Rule" (AICPA, Professional Standards, ET sec. 1.200.001) explains that when your firm is considered a network firm, your firm is required to remain independent of other network firms’ audit and review clients and vice versa. Thus, a network firm may provide audit or review services for a client only insofar as other network firms are independent of the client. For example, other network firms could not provide prohibited nonattest services (that is, services that would impair independence under the “Nonattest Services” subtopic [AICPA, Professional Standards, ET sec. 1.295] of the “Independence Rule”) for that client or have any prohibited relationships, such as investments by the firm in the client, or loans to or from that client. For all other attest clients, members of network firms should consider any threats the firm knows or has reason to believe may be created by network firm interests and relationships. If those threats are not at an acceptable level, the member should apply safeguards to eliminate the threats or reduce them to an acceptable level. ©2017, AICPA 21 However, when a foreign network firm (a firm or entity that is part of the network that is located outside of the United States) departs from the "Independence Rule," the domestic network firm’s independence is not impaired provided the foreign network firm has at a minimum, complied with the independence requirements set forth in the International Ethics Standards Board for Accountants’s Code of Ethics for Professional Accountants. When determining if a network exists, the SEC would look at all the facts and circumstances, especially how the firms treat one another when referring audit work (that is, do they place reliance on the work received by another firm, or do they treat the work the same as if an unaffiliated firm performed the work). At the SEC-PCAOB conference on December 10, 2007, it was noted that the SEC staff continue to follow the guidance issued in the SEC’s January 2001 independence rulemaking regarding its definitions of firm and affiliate, meaning the staff will consider specific facts and circumstances, including the following: • Does the primary auditor refer to another network firm in his or her audit opinion? • Do the firms have common ownership, profit-sharing, or cost-sharing agreements? • Do the firms share management, have a common brand name, or use shared professional resources? • Do the firms have common quality control policies and procedures? How Do I Apply the Rules in a Merger or Acquisition? The "Firm Mergers and Acquisitions" interpretation (AICPA, Professional Standards, ET sec. 1.220.040) under the "Independence Rule" (AICPA, Professional Standards, ET sec. 1.200.001) provides guidance in situations where independence with respect to an attest client may become impaired as a result of a firm merger or acquisition. The guidance would apply when either (1) a member's firm merges with or acquires another firm or entity or all or part of the business thereof or (2) a member’s firm, or all or part of the business thereof, is merged with or acquired by another firm. The interpretation focuses on two types of relationships that could impair independence: employment or association with an attest client and the provision of nonattest services that would impair independence (prohibited nonattest services). Employment or Association With an Attest Client The interpretation requires certain safeguards to be in place in order for independence to be maintained when a partner or professional employee of one firm is employed by or associated with an attest client of the other firm. Such safeguards require that the partner or professional employee terminate the relationship prior to the closing date of the merger or acquisition and be prohibited from participating on the attest engagement team or being an individual in a position to influence the attest engagement if the engagement covers any period in which the partner or employee was employed or associated with the attest client. The partner or employee must also comply with any applicable safeguards under the provisions of the “Former Employment or Association With an Attest Client” ©2017, AICPA 22 interpretation regarding disassociation from an attest client, such as the safeguard that requires any covered member to cease participation in the attest client’s employee benefit plans. The interpretation also requires that a responsible individual within the firm (for example, an individual with responsibility for the policies and procedures relating to independence) should assess the prior relationship that the partner or professional employee had with the attest client as well as the position that the individual will hold at the firm to determine if threats are at an acceptable level. If threats are determined not to be at an acceptable level, the responsible individual will need to be satisfied that safeguards are applied that will eliminate or reduce threats to an acceptable level. The interpretation further requires that in situations where the partner or professional employee will have interaction with the attest engagement team or where the attest engagement team will evaluate work performed by the partner or professional employee while he or she was employed or associated with the attest client, an individual within the firm with the appropriate stature, expertise, and objectivity must review the subsequent attest engagement, prior to issuing the attest report, to determine whether the attest engagement team maintained integrity, objectivity, and as appropriate, professional skepticism. Finally, the interpretation requires that the nature of the relationship and any safeguards that were applied be discussed with those charged with governance and that such discussion take place as soon as practicable under the circumstances but before issuing the attest report and encourages the substance of the discussions be documented. Nonattest Services The interpretation also provides independence guidance in situations where one firm provided prohibited nonattest services to an attest client of the other firm. The interpretation acknowledges that the significance of the threats differ depending upon whether the prohibited nonattest services were provided by the “acquiring firm” with respect to an attest client of the acquired firm or by the “acquired firm” with respect to an attest client of the acquiring firm. In situations where the acquiring firm provided prohibited nonattest services to an attest client of the acquired firm during the period of the professional engagement or the period covered by the financial statements, threats would be so significant that they could not be reduced to an acceptable level. For example, in the situation where the acquired firm’s attest client would become an attest client of the acquiring firm (that is, the surviving firm) upon the merger or acquisition and any prohibited nonattest services performed by the acquiring firm for such an attest client would impair independence if the attest engagement were to continue. Alternatively, when the acquired firm provided the prohibited nonattest services to an attest client of the acquiring firm during the period of the professional engagement or the period covered by the financial statements, the acquiring firm’s independence will not be impaired provided certain steps are taken. One step is for the acquired firm to either terminate the prohibited nonattest services or modify the nonattest services such that the services will no longer be considered to impair independence. Another step is for the firm to perform an evaluation to determine if threats are either at an acceptable level or can be reduced to an acceptable level by the application of safeguards. The extent of the evaluation performed would be based on whether or not the prohibited nonattest services will be attributable to the acquiring firm. The nonattest services will be considered attributable to the acquiring firm if the acquiring firm will assume responsibility (that is, be held liable or accountable, or both) for the results of the prohibited nonattest services performed by the acquired firm. ©2017, AICPA 23 In evaluating the significance of any threats, the interpretation provides various factors that should be considered and where threats are determined not to be at an acceptable level, the interpretation provides examples of possible safeguards to be applied. In cases where no safeguards exist that can eliminate or reduce threats to an acceptable level, independence would be impaired. The interpretation also requires a responsible individual within the firm discuss with those charged with governance the nature of any prohibited services performed that are subject to the evaluation, along with any safeguards applied, and encourages documentation of such discussion. ©2017, AICPA 24 Chapter 5—Applying the Rules—Family Members When Is My Family Subject to the Rules? If you are a covered member with respect to an attest client, members of your immediate family (your spouse or equivalent and dependents) generally must follow the same rules you follow. For example, your spouse’s investments must be investments you could own under the rules. This rule applies even if your spouse keeps the investments in his or her own name or with a different broker. In addition, when materiality is a factor, the covered member’s and immediate family member’s financial interests are combined. This general rule has exceptions for certain employment situations and employee benefit plans: a. Your immediate family member’s employment with an attest client would not impair your firm's independence, provided he or she is not in a key position. b. Immediate family members in permitted employment positions may participate in certain employee benefit plans (other than certain share-based arrangements or nonqualified deferred compensation plans) that are attest clients or sponsored by an attest client, provided the plan is offered to all employees in comparable positions, and the immediate family member does not serve in a position of governance for the plan or have the ability to supervise or participate in the plan’s investment decisions or selection of investment options. c. Immediate family members of certain covered members may invest in an attest client through employee benefit plans that aren’t considered share-based compensation arrangements or nonqualified deferred compensation arrangements (for example, retirement or savings accounts), provided the immediate family member has no other investment options available for selection, and when such option becomes available, the immediate family member selects the option and disposes of any financial interest in the attest client. d. Immediate family members in permitted employment positions of certain covered members may participate in share-based compensation arrangements and nonqualified deferred compensation plans, provided certain safeguards are implemented. e. The covered members whose families may invest or participate in the plans described in items (c)–(d) are i. partners and managers who provide only nonattest services to the attest client. ii. partners or partner equivalents who are covered members only because they practice in the same office where the attest client’s lead attest partner practices in connection with the engagement. At no time may any direct or material indirect financial interests in an attest client permitted by the preceding exceptions exceed 5 percent of the attest client’s outstanding equity securities or other ownership interests. If you are not a covered member, see the section “Do any of the Rules Apply to Me If I Am Not a Covered Member?” in chapter 3, “Applying the Rules-Covered Members and Other Firm Professionals,” of this guide. ©2017, AICPA 25 The SEC rules concerning holding unexercised stock options requires the immediate family member to exercise or forfeit vested stock options as soon as the closing market price of the underlying stock equals or exceeds the exercise price. The AICPA rule recognizes that a privately held entity may not have a ready market for its shares or that thinly traded securities may have volatile markets. Therefore, the triggering event requiring an immediate family member to exercise his or her vested stock options occurs when the market price of the underlying stock equals or exceeds the exercise price for 10 consecutive days Alternatively, the SEC’s rules concerning employee stock ownership plans (ESOPs) are more restrictive than the AICPA’s rules in that the immediate family member must dispose of the publicly traded shares received as soon as possible. Because the AICPA rules deal exclusively with private-sector securities, it is possible that when the immediate family member receives shares from an ESOP, he or she may not be able to dispose of the shares because there is not a ready market for the shares. Accordingly, the AICPA’s rules allow the immediate family member to require the employee to exercise his or her put option for the employer to repurchase the shares as soon as permitted by the ESOP terms. If the employer does not pay for the repurchase shares within 30 days, the repurchase obligation must be immaterial to the covered member during the payout period. What About My Other Relatives? The close relatives (siblings, parents, and nondependent children) of most covered members are subject to some employment and financial restrictions. Your close relative’s employment by an attest client in a key position impairs independence, except for covered members who provide only nonattest services to an attest client. Rules pertaining to your close relatives’ financial interests differ depending on why you are considered a covered member: • • If you are a covered member because you participate on the client’s attest engagement team, your independence would be considered to be impaired if you are aware that your close relative has a financial interest in the attest client that either o was material to your relative’s net worth or o enables the relative to exercise significant influence over the attest client. If you are a covered member because you are able to influence the attest engagement or are a partner or partner equivalent in the office in which the lead attest engagement partner practices in connection with the engagement, your independence will be impaired if you are aware that your close relative has a financial interest in the attest client that o is material to your relative’s net worth and o enables your relative to exercise significant influence over the attest client. ©2017, AICPA 26 Under SEC rules, your close family members include your spouse (or equivalent) and dependents and your parents, nondependent children, and siblings. If you are a covered person, your independence is affected if your close family member • has an accounting role or financial reporting oversight role with the SEC audit client (for example, the family member is a treasurer, CFO, accounting supervisor, or controller) or • owns more than 5 percent of a client’s equity securities or controls the client. In addition, independence is considered to be impaired if any partner’s close family member controls an SEC audit client. ©2017, AICPA 27 Chapter 6—Financial Relationships When Do My (or My Family’s) Financial Interests Impair Independence? This chapter discusses various types of financial relationships and how they affect independence. Although this chapter focuses on how these rules apply to you and your family, keep in mind that your firm also is subject to the financial relationship rules (because the AICPA Code of Professional Conduct [the code] includes firms in its definition of covered member). As a covered member, you (and your spouse or spousal equivalent and dependents) are not permitted to have a • direct financial interest in an attest client, regardless of how immaterial it would be to your net worth. • material indirect financial interest in the attest client. Note: The code does not define or otherwise provide guidance on determining materiality. In determining materiality, you should apply professional judgment to all relevant facts and circumstances and refer to applicable guidance in the professional literature. Both qualitative and quantitative factors should be considered. In addition, if you commit to acquire a direct or material indirect financial interest in an attest client, your independence would be impaired. For example, if you sign a stock subscription agreement with the attest client, your independence would be considered impaired as soon as you sign the agreement. Examples of financial interests include shares of stock; mutual fund shares; debt security issued by an entity; partnership units; stock rights; options or warrants to acquire an interest in an attest client; or rights of partic...
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