September 20, 2020

Volume X, Number 264

September 18, 2020

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Making Sense of Auditor Independence Issues

Auditor independence has always been a regulatory compliance priority.  Failure to comply with independence requirements has potentially serious legal and business consequences, including the risk that an audit engagement be terminated and past financial statements reaudited.

Registered investment companies (“funds”) are subject to the same auditor independence requirements as other public companies.  However, rules applicable to funds are broader and more complicated.  A number of actions by the SEC and its staff over the last several months have focused on the complex way the independence rules apply to funds and their auditors.  The actions also offer a reminder to fund boards and audit committees of the importance of reviewing independence matters with fund auditors.

As widely reported, the auditor independence rules were the subject of a no-action letter granted by the Securities and Exchange Commission (“SEC”) staff to Fidelity Management & Research Company (“Fidelity”) (the “Fidelity Letter”) in June 2016.[1]  The Fidelity Letter temporarily addresses some of the issues that have arisen under Rule 2-01(c)(1)(ii)(A) of Regulation S-X, otherwise known as the “Loan Rule.”  The Loan Rule states that an audit firm is not independent if one of its lenders owns more than ten percent of the voting securities of a fund audit client.

Although it provides important relief for funds, the Fidelity Letter left open a number of questions.  Following conversations with the SEC staff, the Investment Company Institute issued a “Frequently Asked Questions” (“ICI FAQ”) memorandum in September 2016 to clarify certain of these issues.  Also in September 2016, the SEC settled two enforcement actions regarding personal relationships that potentially compromise auditor independence.

To read the full alert, click here.

[1] Fidelity Management & Research Company, SEC No-Action Letter (June 20, 2016).

Copyright 2020 K & L GatesNational Law Review, Volume VI, Number 291


About this Author

Clifford J. Alexander, Banking, Investment Finance Attorney, KL Gates, Law Firm

Mr. Alexander concentrates in banking, investment company, broker-dealer and investment adviser law. He formerly served as Primary Outside Counsel to the National Society of Compliance Professionals, an association of investment adviser and broker-dealer compliance officers.

Mr. Alexander has had a varied financial practice that includes the organization of four national banks as limited purpose trust companies and the representation of numerous state and federally chartered banks on their trust, investment management and securities activities....

Megan W. Clement, Investment Management Associate, KL Gates, Law Firm

Megan Clement is an investment management associate in the firm’s Washington, D.C. office. She focuses her practice on advising registered investment companies, their independent board members, and registered investment advisers on legal, regulatory and compliance matters arising under the U.S. federal securities laws, particularly the Investment Company Act of 1940.

Ms. Clement has experience drafting and reviewing registration statements (for investment companies and investment advisers), proxy statements, and shareholder reports, as well as other legal documentation relating to the operation of registered investment companies. She has also negotiated the resolution of comments from Securities and Exchange Commission staff relating to SEC filings. Ms. Clement has experience preparing materials for, and attending meetings of, independent board members and shareholders. She also advises independent board members in their review of investment advisory contracts.

Shane C. Shannon, Investment Management Associate, KL Gates, Law Firm

Shane Shannon focuses his practice on representing registered investment companies, their independent board members, and investment advisers on a broad range of regulatory, transactional, and compliance matters arising under the U.S. federal securities laws, particularly the Investment Company Act of 1940, the Investment Advisers Act of 1940, and the Securities Exchange Act of 1934. He works closely with clients to adapt to new SEC rules affecting the asset management industry.

Shane regularly works with a variety of different fund structures,...