Industry divided over SEC auditor independence reforms

The US Securities and Exchange Commission (SEC)’s reforms to the Auditor Independence Framework have exposed deep divisions in the sector over where the audit profession is heading.

On October 16, the SEC announced changes to the Auditor Independence Framework which set out to relax rules around conflict of interest, allowing audit firms greater discretion over what constitutes a conflict of interest.

The reforms were passed by the regulator by three votes to two, with the two Democrats, Commissioner Allison Herren Lee and Commissioner Caroline Crenshaw voting against the proposals and releasing a statement entitled: ‘Who watches the watchers?’.

The statement of dissent concluded: “We are concerned that the dial for auditor independence is turning in only one direction, and that is towards loosening standards and reducing transparency. We cannot support introducing greater opportunity for error and uncertainty into auditor independence standards while decreasing visibility into how auditors are actually making these judgments.”

Kyle Gibbons, managing director Europe for audit tech vendor, Confirmation (part of Thomson Reuters) says the relaxation of the rules presents a “risk” for the sector even though the reforms might be good for audit quality and competitiveness.

“There’s a risk in these circumstances, where you’re giving more power to the audit firm to determine if a conflict is or isn’t present. Though their motives may be impeccable, there is an incentive introduced to overlook real conflicts to independence. In a context where auditors’ independence is being questioned, in an environment where auditors are not typically picking up on frauds and where their role is being questioned, the timing of this change and the way it can be perceived outside of the profession, is not good. And you can’t at all times rely on auditors, or companies to be able to make that judgement as to whether there’s a conflict of interest,” Gibbons says.

The FT reported that all of the Big Four had welcomed the reforms from when they were first proposed in December 2019. At Grant Thornton’s US division, the national partner-in-charge of Ethical Standards, Anna Dourdourekas says the firm are “very supportive” of the “reasonable” and “fair” new measures.

“These rules do modernize the rules a bit. But it does allow the auditors to focus more of their time more effectively on independence analysis and relationships or services that could potentially pose an independence threat to an auditor’s objectivity or impartiality.”

Gibbons explains that it gives the biggest US audit firms “greater scope” to determine whether or not they are conflicted.

“It’s giving greater discretion to the audit firm to determine, ‘are we conflicted here or not?’ And certainly, there are some cases where you could argue there’s no real conflict of interest happening in reality.”

However, he feels a likely fallout of the reforms is that smaller firms will lose business. With the reforms essentially making it easier for firms to say they are not conflicted, a small firm who may only have gotten work because those above it are conflicted will likely find it harder to keep those contracts, he says.

“That scenario could prove beneficial to audit quality, since the better firm could now perhaps compete for the audit where previously they wouldn’t have been able to,” Gibbons adds.

But as audit faces a crisis of trust against the backdrop of years of audit scandal across the world, from Enron to Carillion to Wirecard, Commissioners Lee and Crenshaw warned against the SEC taking steps which “relaxes auditor independence rules for the second time in as many years”.