SOX compliance: Title II Auditor independence

Title II of the Sarbanes-Oxley (SOX) Act of 2002 establishes stringent standards to ensure the independence of external auditors, aiming to mitigate conflicts of interest. It introduces standards for auditor approval, partner rotation, and reporting, while mandating a clear separation of duties between auditing and non-compliance services. It imposes restrictions on auditor approval and reporting, while also prohibiting audit firms from offering additional services to their audit clients.

Section 201: Services outside the scope of practice of auditors

• Section 201 of the Securities Exchange Act of 1934—amended by the SOX Act—prohibits registered public accounting firms from providing certain non-audit services to audit clients, including bookkeeping, financial information system design, valuation services, and others.
• Exceptions to this prohibition require pre-approval from the audit committee of the issuer.
• The Board established by the SOX Act has the authority to grant exemptions on a case-by-case basis, subject to review by the Commission.

Section 202: Pre-approval requirements

• Section 202 of the Securities Exchange Act of 1934 introduces pre-approval requirements for auditing and non-auditing services provided to issuers by their auditors. These requirements mandate that all such services be pre-approved by the issuer's audit committee, except for specific exceptions related to the amount and nature of non-auditing services provided.
• Approved services must be disclosed to investors, and the audit committee can delegate pre-approval authority to designated members.
• Audit services within the scope of engagement are automatically pre-approved.

Section 203: Audit partner rotation

• Section 203 of the Securities Exchange Act of 1934 imposes restrictions on registered public accounting firms regarding audit services provided to issuers.
• It prohibits these firms from offering audit services to an issuer if certain key audit partners—including the lead or coordinating partner or the partner responsible for reviewing the audit—have worked on audits for that issuer continuously for the past five fiscal years.

Section 204: Auditor reports to audit committees

• Section 204 of the Securities Exchange Act of 1934 requires registered public accounting firms to report critical accounting policies and practices to issuer audit committees.
• It mandates the disclosure of alternative financial treatments discussed with management and their ramifications, along with the preferred treatment by the accounting firm.
• It necessitates the reporting of other significant written communications between the accounting firm and issuer management, such as management letters and schedules of unadjusted differences.
• These reporting requirements aim to enhance transparency and accountability in audit processes, ensuring that audit committees are informed of key financial and accounting decisions.

Section 205: Conforming amendments

• Section 205 of the Securities Exchange Act of 1934 introduces key amendments focused on enhancing regulatory clarity and consistency in auditing.
• It provides a formal definition for what an audit committee is, delineating it as either a dedicated committee established by an issuer's board of directors or the entire board in the absence of such a committee.
• The section standardizes auditor terminology by substituting independent public accountant with registered public accounting firm across relevant sections of the Securities Exchange Act, aligning with the SOX Act.
• References to independent public accountants in various Act sections are updated to registered public accounting firms for consistency.
• A conforming amendment within Section 10A(f) defines issuer and establishes criteria for entities subject to regulatory standards, fostering clarity and adherence in auditing practices.

Section 206: Conflicts of interest

• Section 206 of the Securities Exchange Act of 1934 outlines restrictions on registered public accounting firms regarding conflicts of interest in audit services.
• It prohibits firms from conducting audits for issuers if key personnel within the issuer had been employed by the accounting firm and participated in the audit process within the past year.

Section 207: Study of mandatory rotation of registered public accounting firms

• Section 207 mandates a study and review by the Comptroller General of the United States concerning the potential effects of requiring the mandatory rotation of registered public accounting firms.
• The Comptroller General is required to submit a report to the Senate Committee on Banking, Housing, and Urban Affairs and the House Committee on Financial Services within one year of the Act's enactment detailing the findings of the study.
• Mandatory rotation is defined within this section as the limitation imposed on the number of years during which a specific registered public accounting firm can serve as the auditor of record for a particular issuer.

Section 208: Commission authority

• Section 208 mandates the Securities and Exchange Commission (SEC) to issue final regulations within 180 days of the Act's enactment to implement subsections (g) through (l) of section 10A of the Securities Exchange Act of 1934.
• It prohibits any registered public accounting firm or associated person from preparing or issuing an audit report for any issuer if they engage in activities prohibited by subsections (g) through (l) of section 10A or any rules or regulations issued by the SEC or the PCAOB under those subsections.

Section 209: Considerations by appropriate state regulatory authorities

• Section 209 urges appropriate State regulatory authorities overseeing non-registered public accounting firms and their associated individuals to determine suitable standards independently, considering factors such as the size and nature of both the accounting firms and their clients' businesses.
• It emphasizes that the standards set by the PCAOB under the Act should not automatically apply to small and medium-sized non-registered public accounting firms for the purposes outlined in this section.