Independence Rules, SOX-404
Professional Accountants – Independence Rules, SOX-404 in public practice should be independent in fact and appearance when providing auditing and other attestation services. If you provide attestation or assurance services to clients, a conflict of interest may prevent you from also providing investment advisory services.
AICPA rules state that an accountant’s independence will be impaired if the accountant:
- makes investment decisions on behalf of audit clients or otherwise has discretionary authority over an audit client’s investments.
- executes a transaction to buy or sell an audit client’s investment.
- has custody of assets of the audit client, such as taking temporary possession of securities purchased by the audit client.
Accountants may provide certain advisory services to audit clients without impairing independence. Accountants can:
- recommend the allocation of funds that an audit client should invest in various asset classes, based on the client’s risk tolerance and other factors.
- provide a comparative analysis of the audit client’s investments to third-party benchmarks.
- review the manner in which the audit client’s portfolio is being managed by investment managers.
Reporting Environment of the Nonpublic Company
Because auditor objectivity is such an important part of the financial reporting process, the argument can be made that independence rules should be the same regardless of whether the audit client is a public company. In considering this argument, it is beneficial to consider two ways in which the reporting environment of the closely held nonpublic company differs from the public company:
- The users of the financial statements. In a publicly traded company, there is a distinct separation between shareholders and management. In contrast, the shareholders and management of the nonpublic company are often the same people.
- The requester of the audit. Public companies obtain an audit to comply with the reporting practices of the SEC. Nonpublic companies do not usually require an audit unless it is specifically requested by an interested party, such as a lender. Such organizations are often more sophisticated than the average investor, and possess significant knowledge about the audit client from sources other than the financial statements.
It is commonly understood that an external auditor must be independent in both fact and appearance. Recent audit failures have increased the importance of how the public perceives auditor independence. As a result, the Sarbanes-Oxley Act prohibited auditors from performing certain services considered incompatible with the audit function. An important question is whether this deterioration of perceived auditor independence has also occurred in the nonpublic company environment.
Section 404 – Management Assessment of Internal Controls
Section 404 is the most complicated, most contested, and most expensive to implement of all the Sarbanes Oxley Act sections for compliance. All annual financial reports must include an Internal Control Report stating that management is responsible for an “adequate” internal control structure, and an assessment by management of the effectiveness of the control structure. Any shortcomings in these controls must also be reported. In addition, registered external auditors must attest to the accuracy of the company management assertion that internal accounting controls are in place, operational and effective.