Auditor Independence Guidelines Released
October 11, 1999
Auditors of mutual funds may shortly have new guidelines for when personal investments in mutual funds are permissible.
Public accounting firms and mutual fund companies are now reviewing the guidelines and have until Oct. 31 to submit comments.
The Independence Standards Board, the 2 1/2-year-old organization charged by the SEC with establishing industry-wide standards for preserving auditor independence and objectivity, in mid-September released its preliminary draft of guidelines for those who audit mutual funds and related entities. The report was issued by a special task force.
The new guidelines represent the first time fund auditor independence standards have been systematically assessed based on potential risks and threats to auditor objectivity, said Rick Towers, staff technical director of the ISB.
"There were rulings before, but past [private letter] rulings were not easy to find," said Towers.
"This is one area where there has been lots of confusion," said Edmund Coulson, director of assurance and advisory services for the auditing practice of Ernst & Young in New York. Auditor independence standards need to be "modernized and made more realistic," he said.
In its proposed guidelines, the board has reiterated that those auditors who comprise the audit engagement team as well as partners and other managerial employees working in offices which significantly participate in individual fund audits, should be prohibited from investing in the individual funds being audited. That has always been the standard practice as mandated by the SEC, industry accountants say.
But the standards board has now recommended prohibiting these same individuals from investing in other "sister funds" which are not being directly audited by that accounting firm. The standards board defines sister funds as those individual mutual funds that share a common investment adviser.
The board also proposed that those employees not involved in fund audits be allowed to invest in sister funds that are not audit clients of the accounting firm.
The board further recommends that when an accounting firm is auditing an investment advisory firm, audit partners and other key personnel should be prohibited from personally investing in any of the funds managed by that investment adviser. The same prohibition extends to an investment adviser's parent company and to other subsidiaries of the parent company.
For accounting firm-sponsored retirement plans, the board proposed a two-pronged approach. The board agreed that to preserve independence, those mutual funds being directly audited should not be included on the plan's menu of investment choices available to audit personnel. But, the board proposed that sister funds, funds not directly audited by the firm, would not be subject to the prohibition.
The board drew a sharp distinction between defined benefit and defined contribution plans. In the case of an accounting firm-sponsored defined benefit plan, in which the accounting firm would be the ultimate beneficiary of a mutual fund's investment performance, investments into sister funds would be prohibited. But in the case of accounting firm-sponsored defined contribution plans (such as 401(k) plans) in which the direct beneficiary of investment performance is an employee, partners and staff who are not party to the fund audit should be allowed to invest in a sister mutual fund, the board recommends. That flexibility would not impair the independence of the auditors, the board said in its draft.
The board also clarified when family members of audit firm employees can invest in mutual funds offered within their own employer-sponsored retirement plans. Current rules prohibit close relatives of fund auditors from investing in any mutual funds offered under their own individual employer-sponsored retirement plan if these funds are also audit clients. The board is suggesting instead that spouses and other family members of audit employees be allowed the flexibility to invest through their employer-sponsored retirement plans in funds that are being audited by the accounting firm.
"...the risk that such investments will adversely affect audit quality appears trivial," the board draft said.
Several accountants and fund executives said they were supportive of the board's efforts to clarify mutual fund auditor independence. But some said they are reserving judgement until after they analyze the details of the proposal.
The board's initiatives are good and certainly warranted, said Sandy Kasahara, director of internal audit at American Century Investments in Kansas City, Mo.
"But the jury's still out on whether these are the right proposals," said Kasahara through a fund company spokesperson.
One industry accountant who declined to be named, said that the new guidelines are, at best, confusing and still leave issues unanswered. Specifically, relationships between mutual funds and sub-advisers need to be more adequately addressed, as do circumstances in which affiliated firms exist, said the accountant.