Chapter 3 Applying the Rules Covered Members and Other Firm Professionals

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 attest engagement team for the client 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 person3 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 substantially equivalent. 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. 3 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. 10 Do threats exist when a member is on the attest engagement team for an extended period of time? The familiarity threat exists when senior personnel are on the attest engagement team for an extended period of time. Nonauthoritative questions and answers regarding senior personnel’s long association on an attest engagement is available in the Frequently Asked Questions: General ethics questions at www.aicpa.org/interestareas/professionalethics/resources/tools/downloadabledocuments/ethicsgeneral-faqs.pdf 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 significance, 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 (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). Additionally, if comparative financial statements are being issued that include the 2015 fiscal year, you could not participate in the engagement. 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.4 4 See the section “When do my (or my family’s) financial interests impair independence?” in chapter 6, “Financial relationships,” of this guide. 11 ii. Collect and repay all loans to or from the attest client (except those specifically permitted or have transistion provisions5). 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 influence the attest engagement, the member 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 penalty6 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.7 See the “Former Employment or Association With an Attest Client” interpretation (ET sec. 1.277.010) for further details. What rules apply if i am considering employment with an attest client? 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 and employment with the client is no longer a possibility. See the “Considering Employment or Association With an Attest Client” interpretation (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, the firm’s 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 5 Also, see the “Loans and Leases With Lending Institutions” interpretation (ET sec. 1.260.020). 6 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. 7 See the section “What should I do if no specific guidance exists on my particular independence issue?” in chapter 1, “Introduction,” of this guide. 12 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 • 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.8 See the “Subsequent Employment or Association With an Attest Client” interpretation (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, the former partner 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 8 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. 13 The SEC uses the terms accounting role and financial reporting oversight role9 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 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. 9 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. 14