The SEC last week issued a 21(a) Report concerning auditor independence in the context of loaned staff arrangements.  The report arose out of an investigation into KPMG’s practice of loaning non-manager level professionals to certain audit clients to perform junior level tasks related to tax compliance.  A typical task performed by the loaned staff was inputting data into federal or state tax returns using an audit client-issued computer while being supervised by a member of the client’s tax department.  KPMG’s internal guidance specifically allowed these types of arrangements.

The issue was whether KPMG’s practice of loaning staff to audit clients to perform tax work violated Rule 2-01 of Regulation S-X, which prohibits, among other things, an independent auditor from “acting as an employee” of an audit client.  In its Report, the SEC, suggesting strongly that KPMG’s practice did violate Rule 2-01, reiterated its statement from a 2000 release that “an auditor who provides services in a way that is tantamount to accepting an appointment as an … employee of the audit client cannot be expected to be independent in auditing the financial consequences of management’s decisions.”  The SEC went on to make the following additional points:

  • An auditor may not provide otherwise permissible non-audit services (such as tax services) to an audit client in a manner that is inconsistent with other provisions of the independence rules (such as the prohibition against acting as an employee of the audit client).
  • An accountant acting as an employee of the audit client need not perform any decision-making, supervisory, or ongoing monitoring functions for the audit client for Rule 2-01 to be implicated.
  • In assessing whether an accountant is “acting” as an employee, a key factor is the degree of control that the audit client exercises over audit firm personnel.  Where audit firm personnel are treated substantially similar to the audit client’s own employees, the accounting firm’s independence could be put in jeopardy.
  • That the loaned staff may be junior-level in skill or not directly paid by the audit client do not exclude loaned staff arrangements from the prohibition of Rule 2-01.
  • An audit firm can provide tax services to its audit clients without impairing the firms’s independence as there is an important difference between providing personnel, on one hand, and performing services, on the other hand.