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News January 25, 2010 Issue

How (And When) To Find Your Independent Public Accounting Firm

The custody rule amendments have roped you into new responsibilities, and now youíre scrambling to retain an independent public accountant for your surprise audit or your internal controls report, or both.

So whatís an "independent public accountant" for purposes of complying with the rule?

Helpfully, footnote 73 of the custody ruleís adopting release reminds us that "the Commissionís standards for the independence of accountants is set forth in Article 2, Rule 2-01 of Regulation S-X." This rule was adopted in January 2003, prior to the last round of custody rule amendments in September 2003. Footnote 32 of the "old" custody ruleís adopting release also refers advisers to Rule 2-01 for guidance.

Rule 2-01 is dense, but not as inaccessible as some regulation can be. It "is designed to ensure that auditors are qualified and independent of their audit clients both in fact and in appearance. Accordingly, the rule sets forth restrictions on financial, employment, and business relationships between an accountant and an audit client and restrictions on an accountant providing certain non-audit services to an audit client." So says the preamble.

As you might suspect, the rule describes independence as a facts and circumstances analysis. It also encourages consulting with the SECís Office of the Chief Accountant before you sign a contract if youíre not sure.

The Commission looks first to see whether a relationship or service provided "creates a mutual or conflicting interest between the accountant and the audit client; places the accountant in the position of auditing his or her own work; results in the accountant acting as management or an employee of the audit client; or places the accountant in a position of being an advocate for the audit client."

The rule offers lots of guidance to get you started, outlining big-picture no-nos and situations that might flag the possible compromise of independence. For example, financial relationships such as investment in or loans to an audit client can erode independence. So too, can the provision of non-audit services such as bookkeeping "or other services related to the accounting records or financial statements of the audit client."

The rule describes relationships that can potentially compromise independence as extending beyond the accounting firm as a whole to employee and family member relationships in certain circumstances. Brokerage accounts, insurance policies and credit cards with balances over $10,000 maintained by the firm or related individuals such as spouses and children (as defined in the rule) can disrupt independence. Even an auditorís savings and checking accounts, if the accounts exceed FDIC limits, can conflict out a prospective bank client unless the institutionís likelihood of experiencing financial difficulties is "remote." (In these times, just what bank would that be?)

The rule sets forth certain express situations, for example "An accountant is not independent if, at any point during the audit and professional engagement period, the accountant has an employment relationship with an audit client," such as when a member of the accounting firm serves on the audit clientís board of directors.

The rule also provides for exceptions, de minimus circumstances, and carve-outs in various places. Depending on your situation, youíll definitely want to consult with your favorite lawyer.

Once you ascertain that your accountant of choice is independent and the contract is inked, the accounting firm comes under a series of obligations, such as engagement partner rotation, to ensure that it remains independent throughout the relationship. The SEC has published a set of frequently asked questions to assist with meeting those obligations.

Oh yeah, and about that contract.

How much time do you really have to find your independent public accountant?

For firms newly subject to the surprise audit and/or internal controls report requirement, the following deadlines apply. Surprise audits must be completed by the end of the calendar year. Internal controls reports must be completed within six months of March 12, the ruleís effective date. Thatís September 12 by our calculation.

So when should you have contracted with the independent public accountant?

"If youíre contracting for a surprise audit, and you donít do it until December, the audit wonít be much of a surprise now, will it?" observed one senior industry attorney. For the surprise audit alone, the attorney suggested a two- to six-month window from the final ruleís release for contracting with an accountant. However, the attorney also cautioned that accountants are grappling with new protocols and procedures in the guidance issued along with the release. They will need time to implement the guidance and apply it to individual firm circumstances. "Maybe the window for contracting is closer to two months than six months," the attorney said.

Another big-firm lawyer agreed. Definitely not more than about two months after the ruleís effectiveness for the internal controls report, the second attorney added. That work can be scheduled, but in a firm six-month window, accountants need time to do the job and do it right.