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As the demand for consulting services provided by Public Accounting (CPA) firms rises and business transactions become increasingly intricate, regulatory bodies are expressing heightened concerns about auditor independence. Noteworthy cautionary reminders have been issued, regulatory actions have been initiated against both CPA firms and individuals, and global regulatory authorities have updated auditor independence rules. The U.S. Securities & Exchange Commission (SEC) is intensifying its enforcement efforts, issuing disciplinary actions, and urging all involved parties, including auditors, audit committees, and executive leadership, to maintain a vigilant stance in overseeing independence.

The C-suite holds a pivotal role in recognizing and addressing situations that could compromise independence, particularly in the context of mergers and acquisitions (M&A). The SEC has issued alerts to audit firms due to the substantial growth in consulting work, which has more than doubled since 2010, coinciding with a notable surge in corporate M&A activities. Global M&A value, as per reports, witnessed a surge of over 25% between 2016 and 2021. The SEC is concerned for the prospect of auditors engaging in prohibited work for audit clients, prompting the introduction of new initiatives to scrutinize potential independence violations.

Heightened Scrutiny on Auditor Independence

Recent statements from prominent regulators suggest an escalation in the SEC’s efforts to enforce violations related to auditor independence. The SEC’s enforcement director, Gurbir Grewal, emphasized in December 2021 that the SEC is steadfast in targeting deficient auditing, auditor independence breaches, and cases related to earnings management.

The SEC’s Miami office took action by seeking information on auditor independence from both the Big Four and smaller public accounting firms. The inquiries encompassed aspects like liability contracts and contingency fees contingent upon specific outcomes.

The seriousness of the SEC’s stance on independence rule violations is underscored by actions taken in October 2021. The SEC’s chief accountant, Paul Munter, issued a press release urging vigilance regarding auditor independence to all key stakeholders in the financial reporting ecosystem, including auditors, management, and audit committees. He stressed that responsibility for independence lies with the audit committee, the client, and the auditor.

Citing examples related to non-audit services and business combinations, the need is even more emphasized for proactive monitoring by management, the audit committee, and the auditor to prevent situations that could compromise auditor independence before business combinations occur.

Munter clarified that, as all listed firms are mandated to engage an independent auditor, the responsibility is shared. In this context, the C-suite, as the client, plays a distinct role in overseeing independence issues arising from consulting engagements and M&A activities. Given their executive-level responsibilities in setting and implementing organizational strategy, the C-suite possesses direct insight into factors that could impact auditor independence.

To reaffirm this stance, Munter issued a similar public statement in June 2022, emphasizing the continuous need for accountants, audit firms, registrants, and their audit committees to assess and address auditor independence considerations under Rule 2-01(b) of Regulation S-X when initiating or continuing audit engagements.

Key Element of Intensified SEC Scrutiny: Personal Accountability

An integral component of the heightened SEC scrutiny involves the practice of naming individuals. In SEC enforcement actions, not only are CPA firms explicitly identified and disciplined, but individual audit professionals also face identification and sanctions.

This trend extends beyond the firms themselves. In a 2021 case, where both the audit firm and audit partners were charged with violating auditor independence rules, the SEC went further by also charging the issuer’s then-chief accounting officer (CAO) for involvement in the misconduct. The SEC underscores the expectation that client executives, particularly those in the C-suite, share the responsibility for maintaining independence. Consequently, C-suite executives are urged to exercise vigilance, as they can be held accountable for any independence violations.

Recent enforcement actions serve as tangible evidence of the SEC’s renewed emphasis on auditor independence breaches. While few SEC enforcement actions have specifically named firm executives as the culprits of violations thus far, at least one recent case identified the CAO, setting a tone that reflects the prevailing regulatory climate.

Key Insights

In summary, the SEC is clearly demonstrating an escalated commitment to enforcing auditor independence violations. The significance of maintaining independence is paramount, as any lapse, when combined with other oversights in due diligence, raises questions about intent in the event of errors. The SEC expressly calls upon the audit committee and firm executives to actively contribute to preserving auditor independence. The C-suite, with its strategic perspective, is uniquely positioned to monitor and identify potential scenarios that might compromise auditor independence, particularly in the context of business combinations.

For CPA firms and their executives, violating independence rules carries substantial consequences, including SEC fines, sanctions, and damage to reputation. Fortunately, there are practical and actionable measures available to help firm executives navigate the evolving landscape of auditor independence.