[Federal Register Volume 85, Number 239 (Friday, December 11, 2020)]
[Rules and Regulations]
[Pages 80508-80542]
[FR Doc No: 2020-23364]

Vol. 85

Friday,

No. 239

December 11, 2020

Part VI

Securities and Exchange Commission

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17 CFR Part 210

Qualifications of Accountants; Final Rule

Federal Register / Vol. 85 , No. 239 / Friday, December 11, 2020 /
Rules and Regulations

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 210

[Release No. 33-10876; 34-90210; FR-88; IA-5613; IC-34052; File No. S7-
26-19]
RIN 3235-AM63

Qualifications of Accountants

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') is adopting amendments to update certain auditor independence
requirements. These amendments are intended to more effectively focus
the independence analysis on those relationships or services that are
more likely to pose threats to an auditor's objectivity and
impartiality.

DATES:
    Effective date: June 9, 2021.
    Compliance dates: See Section II.G for further information on
transitioning to the final amendments.

FOR FURTHER INFORMATION CONTACT: Duc Dang, Senior Special Counsel, or
Natasha Guinan, Chief Counsel, Office of the Chief Accountant, at (202)
551-5300; Alexis Cunningham, or Jenson Wayne, Assistant Chief
Accountants, Chief Accountant's Office, Division of Investment
Management, at<PHONE_NUMBER>, or Pamela K. Ellis, Senior Counsel,
Brian McLaughlin Johnson, Assistant Director, Investment Company
Regulation Office, or Sirimal R. Mukerjee, Branch Chief, Investment
Adviser Regulation Office, Division of Investment Management, at (202)
551-6792, U.S. Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549.

SUPPLEMENTARY INFORMATION: We are adopting amendments to 17 CFR 210.2-
01 (``Rule 2-01'') of 17 CFR 210.01 et seq. (``Regulation S-X'').\1\
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    \1\ Hereinafter, all references to Rule 2-01 and any paragraphs
included within the rule refer to Rule 2-01 of Regulation S-X.
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Table of Contents

I. Introduction
II. Amendments
    A. Amendments to Definitions
    1. Amendments to the Definitions of Affiliate of the Audit
Client and the Investment Company Complex
    2. Amendment to the Definition of Audit and Professional
Engagement Period
    B. Amendments to Loans or Debtor-Creditor Relationships
    1. Amendment To Except Student Loans
    2. Amendment To Clarify the Reference to ``A Mortgage Loan''
    3. Amendment To Revise the Credit Card Rule To Refer to
``Consumer Loans''
    C. Amendments to the Business Relationships Rule
    1. Proposed Amendment to the Reference to ``Substantial
Stockholder''
    2. Comments Received
    3. Final Amendments
    4. Conforming Amendments to the Loan Provision
    D. Amendments for Inadvertent Violations for Mergers and
Acquisitions
    1. Proposed Amendment
    2. Comments Received
    3. Final Amendments
    E. Miscellaneous Amendments
    1. Proposed Miscellaneous Amendments
    2. Comments Received
    3. Final Amendments
    F. Other Comments Received
    G. Transition
III. Other Matters
IV. Economic Analysis
    A. Introduction
    B. Baseline and Affected Parties
    C. Potential Costs and Benefits
    1. Overall Potential Costs and Benefits
    2. Costs and Benefits of Specific Amendments
    a. Amendments to the Definition of an Affiliate of the Audit
Client and Investment Company Complex
    b. Amendment to the Definition of Audit and Professional
Engagement Period
    c. Amendments to Loans or Debtor-Creditor Relationships
    d. Amendments to the Business Relationships Rule
    e. Amendments for Inadvertent Violations for Mergers and
Acquisitions
    D. Effects on Efficiency, Competition and Capital Formation
    E. Alternatives
V. Paperwork Reduction Act
VI. Final Regulatory Flexibility Act Analysis
    A. Need for, and Objectives of, the Final Amendments
    B. Significant Issues Raised by Public Comment
    C. Small Entities Subject to the Proposed Rules
    D. Projected Reporting, Recordkeeping and Other Compliance
Requirements
    E. Agency Action to Minimize Effect on Small Entities
VII. Codification Update
VIII. Statutory Basis

I. Introduction

    On December 30, 2019, the Commission proposed amendments to Rule 2-
01 to update certain auditor independence requirements, including by
focusing the requirements on those relationships and services that are
more likely to threaten an auditor's objectivity and impartiality in
light of current market conditions and industry practice.\2\
Specifically, the Commission proposed amendments to the definitions of
``affiliate of the audit client,'' ``investment company complex,'' and
``audit and professional engagement period'' in Rule 2-01. The
Commission also proposed amending requirements relating to certain
loans or debtor-creditor relationships in 17 CFR 210.2-01(c)(1) (``Rule
2-01(c)(1)'') and the reference to ``substantial stockholders'' in 17
CFR 210.2-01(c)(3) (``Rule 2-01(c)(3)'' and the ``Business
Relationships Rule''). Finally, the Commission proposed amendments to
address inadvertent violations of the independence requirements as a
result of mergers and acquisitions and to make certain miscellaneous
updates.
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    \2\ Amendments to Rule 2-01, Qualifications of Accountants,
Release No. 33-10738, Dec. 30, 2019 [85 FR 2332 (Jan. 15, 2020)]
(the ``Proposing Release'').
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    The Commission has long recognized that an audit by an objective,
impartial, and skilled professional contributes to both investor
protection and investor confidence.\3\ If investors do not perceive
that the auditor is independent from the audit client, investors will
derive less confidence from the auditor's report and the audited
financial statements. As such, the Commission's auditor independence
rule, as set forth in Rule 2-01, requires auditors \4\ to be
independent of their audit clients both ``in fact and in appearance.''
\5\
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    \3\ See Revision of the Commission's Auditor Independence
Requirements, Release No. 33-7919 (Nov. 21, 2000) [65 FR 76008 (Dec.
5, 2000)] (``2000 Adopting Release'').
    \4\ We use the terms ``accountants'' and ``auditors''
interchangeably in this release.
    \5\ See current Preliminary Note 1 to Sec.  210.2-01 and 17 CFR
210.2-01(b) (``Rule 2-01(b)''). See also United States v. Arthur
Young & Co., 465 U.S. 805, 819 n.15 (1984) (``It is therefore not
enough that financial statements be accurate; the public must also
perceive them as being accurate. Public faith in the reliability of
a corporation's financial statements depends upon the public
perception of the outside auditor as an independent
professional.'').
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    As the Commission noted in the Proposing Release, except for
revisions made in connection with amendments required by the Sarbanes-
Oxley Act of 2002 (``Sarbanes-Oxley Act'') \6\ and the recent
amendments related to certain debtor-creditor relationships,\7\ many of
the provisions from the 2000 Adopting Release have remained unchanged
since adoption. The amendments we are adopting maintain the bedrock
principle that auditors must be independent in fact and in appearance
while improving the relevance of the Commission's auditor independence
standards in light

of existing market conditions by more effectively focusing the
independence analysis on those relationships or services that are more
likely \8\ to threaten an auditor's objectivity and impartiality.
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    \6\ See Strengthening the Commission's Requirements Regarding
Auditor Independence, Release No. 33-8183 (Jan. 28, 2003) [68 FR
6005 (Feb. 5, 2003)].
    \7\ See Auditor Independence With Respect to Certain Loans or
Debtor-Creditor Relationships, Release 33-10648 (June 18, 2019) [84
FR 32040 (July 5, 2019)] (``Loan Provision Adopting Release''). In
this release, references to the ``Loan Provision'' mean 17 CFR
210.2-01(c)(1)(ii)(A) (``Rule 2-01(c)(1)(ii)(A)'').
    \8\ As compared to the relationships and services that are
deemed independence-impairing under existing Rule 2-01, but are
unlikely to threaten an auditor's objectivity and impartiality and
would no longer be deemed independence-impairing pursuant to the
final amendments.
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    Many commenters broadly supported the objectives of the proposed
amendments or were generally in favor of the proposals.\9\ A few
commenters did not support the proposals.\10\ One of these commenters
expressed the view that the proposals could negatively affect investor
protection and capital formation and suggested that, in lieu of the
proposals, more should be done to strengthen auditor independence
standards and the enforcement of such standards.\11\
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    \9\ See, e.g., letters from American Investment Council (Mar.
16, 2020) (``AIC''), Investment Company Institute and Independent
Directors Council (Mar. 16, 2020) (``ICI/IDC''), EQT AB (Mar. 13,
2020) (``EQT''), Financial Executives International (Mar. 16, 2020)
(``FEI''), Center For Capital Markets Competitiveness--U.S. Chamber
of Commerce (Mar. 16, 2020) (``CCMC''), National Association of
State Boards of Accountancy (Feb. 25, 2020) (``NASBA''), New York
State Society of Certified Public Accountants (Mar. 13, 2020)
(``NYSSCPA''), Center for Audit Quality (Mar. 16, 2020) (``CAQ''),
American Institute of Certified Public Accountants (Mar. 16, 2020)
(``AICPA''), Deloitte LLP (Mar. 4, 2020) (``Deloitte''), BDO USA,
LLP (Mar. 10, 2020) (``BDO''), Ernst & Young LLP (Mar. 13, 2020)
(``EY''), KPMG LLP (Mar. 13, 2020) (``KPMG''), RSM LLP (Mar. 16,
2020) (``RSM''), PricewaterhouseCoopers LLP (Mar. 16, 2020)
(``PwC''), Grant Thornton LLP (Mar. 16, 2020) (``GT''), Crowe LLP
(Mar. 16, 2020) (``Crowe''), and William G. Parrett (Mar. 16, 2020)
(``Parrett''). The comment letters on the Proposing Release are
available at https://www.sec.gov/comments/s7-26-19/s72619.htm.
    \10\ See, e.g., letters from Council of Institutional Investors
(Mar. 16, 2020) (``CII''), Consumer Federation of America (May 4,
2020) (``CFA''), Center for American Progress, et al (May 26, 2020)
(``CAP''), and Roy T. Van Brunt (July 23, 2020) (``Van Brunt'').
    \11\ See letter from CFA.
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    While commenters were largely supportive of the proposals, we also
received recommendations for modifying or clarifying certain aspects of
the proposed amendments. After reviewing and considering the public
comments and recommendations received, we are adopting the amendments
largely as proposed. As we discuss further below, in certain cases we
are adopting the proposed amendments with modifications that are
intended to address comments received.

II. Amendments

A. Amendments to Definitions

1. Amendments to the Definitions of Affiliate of the Audit Client and
the Investment Company Complex
    The term ``audit client'' \12\ is defined as ``the entity whose
financial statements or other information is being audited, reviewed or
attested'' \13\ and ``any affiliates of the audit client.'' \14\ The
current definition of affiliate of the audit client includes, in part,
``[a]n entity that has control over the audit client, or over which the
audit client has control, or which is under common control with the
audit client, including the audit client's parents and subsidiaries''
and ``[e]ach entity in the investment company complex when the audit
client is an entity that is part of an investment company complex.''
\15\
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    \12\ 17 CFR 210.2-01(f)(6) (``Rule 2-01(f)(6)'').
    \13\ The term ``entity under audit'' as used herein and in the
final amendments refers to this part of the Rule 2-01(f)(6)
definition of audit client.
    \14\ See Rule 2-01(f)(6). For purposes of 17 CFR 210.2-
01(c)(1)(i) (``Rule 2-01(c)(1)(i)'') (Investments in Audit Clients),
entities covered by 17 CFR 210.2-01(f)(4)(ii) (``Rule 2-
01(f)(4)(ii)'') or 17 CFR 210.2-01(f)(4)(iii) (``Rule 2-
01(f)(4)(iii)'') are not considered affiliates of the audit client,
as they are already addressed by 17 CFR 210.2-01(c)(1)(i)(E).
    \15\ 17 CFR 210.2-01(f)(4)(i) (``Rule 2-01(f)(4)(i)'') and 17
CFR 210.2-01(f)(4)(iv) (``Rule 2-01(f)(4)(iv)'').
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    Under current Rule 2-01, the requirement to identify and monitor
for potential independence-impairing relationships and services applies
to affiliated entities, including sister entities,\16\ regardless of
whether the sister entities are material to the controlling entity.\17\
This same requirement to identify and monitor for potential
independence-impairing relationships and services applies to entities,
including sister entities that are part of an investment company
complex (``ICC'').\18\
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    \16\ See 17 CFR 210.2-01(f)(4) (``Rule 2-01(f)(4)'') and Rule 2-
01(f)(6). We use the term ``sister entities'' to refer to entities
that are under common control with the entity under audit.
    \17\ See Rule 2-01(f)(4).
    \18\ Id. and 17 CFR 210.2-01(f)(14) (``Rule 2-01(f)(14)'').
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    The Proposing Release noted the challenges in practical application
that are associated with the current definitions of affiliate of the
audit client and ICC.\19\ In particular, the Proposing Release noted
how these definitions can result in relationships with and services to
certain sister entities that are less likely to threaten an auditor's
objectivity and impartiality being deemed independence-impairing under
our rules.\20\ To address those challenges, the Commission proposed
amendments to the definitions of both affiliate of the audit client and
ICC. After considering the public comments and recommendations
received, we are adopting amendments to both definitions with
modifications, as discussed in further detail below.
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    \19\ See Section II.A.1 of the Proposing Release.
    \20\ Id.
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a. Amendments With Respect to Common Control and Affiliate of the Audit
Client
i. Proposed Amendments
    The Commission proposed amending the definition of an affiliate of
the audit client set forth in Rule 2-01(f)(4)(i) to include a
materiality qualifier with respect to operating companies, including
portfolio companies, under common control \21\ and to clarify the
application of this definition to operating companies and direct
auditors of an investment company or investment adviser or sponsor to
the ICC definition.\22\ In the Proposing Release, the Commission
discussed challenges related to applying the current affiliate of the
audit client and ICC definitions, including challenges related to the
limited pool of available qualified auditors, ongoing monitoring for
independence, and related costs.\23\
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    \21\ See Proposed Rule 2-01(f)(4)(i)(B).
    \22\ See Proposed Rule 2-01(f)(4)(ii). Specifically, the ``and''
between the second significant influence provision would be replaced
by an ``or.'' Consistent with footnote 18 of the Proposing Release,
the term ``operating company'' in this release refers to entities
that are not investment companies, investment advisers, or sponsors,
and the term ``portfolio company'' refers to an operating company
that has investment companies or unregistered funds in private
equity structures among its investors. In Section II.A.1.a of the
Proposing Release, the Commission expressed its belief that it would
be appropriate to identify the affiliates of the audit client for a
portfolio company under audit using the proposed affiliate of the
audit client definition, rather than the proposed ICC definition,
because portfolio companies are a type of operating company that are
often unrelated to each other, even though they are controlled by
the same entity in the private equity structure or ICC.
    \23\ See Section II.A.1.a of the Proposing Release.
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    Under the proposal, a sister entity would be deemed an affiliate of
the audit client ``unless the entity is not material to the controlling
entity.'' The Proposing Release set forth the Commission's view that it
is appropriate to exclude sister entities that are not material to the
controlling entity from being considered affiliates of the audit client
because an auditor's relationships and services with such sister
entities do not typically pose a threat to the auditor's objectivity
and impartiality and their exclusion would allow auditors and audit
clients to focus on those relationships that are more likely to
threaten the auditor's objectivity and impartiality.

    The Proposing Release noted that materiality is applied in the
existing affiliate of the audit client definition in Rules 2-
01(f)(4)(ii) and (iii) \24\ and that the proposed materiality qualifier
would be consistent, in part, with the definition of ``affiliate'' used
by the American Institute of Certified Public Accountants (``AICPA'')
in its ethics and independence rules.\25\ The AICPA ethics and
independence rules typically apply when domestic companies are not also
subject to the Commission and PCAOB independence requirements. Auditors
therefore have experience in applying a materiality standard when
identifying affiliates, whether applying the independence rules of the
Commission or the AICPA.
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    \24\ Rule 2-01(f)(4)(ii) includes as an affiliate of the audit
client ``an entity over which the audit client has significant
influence, unless the entity is not material to the audit client.''
Rule 2-01(f)(4)(iii) includes as an affiliate of the audit client
``an entity that has significant influence over the audit client,
unless the audit client is not material to the entity.''
    \25\ See AICPA Professional Code of Conduct, available at
https://pub.aicpa.org/codeofconduct/ethicsresources/et-cod.pdf. The
Proposing Release acknowledged that the proposed amendment may not
result in the same number of sister entities being deemed material
to the controlling entity under Commission rules and the AICPA
rules. For example, in defining control, the AICPA uses the
accounting standards adopted by the Financial Accounting Standards
Board (``FASB''), whereas the Commission defines control in Rule 1-
02(g) of Regulation S-X. Also, the AICPA affiliate definition
pertaining to common control deems a sister entity as an affiliate
if the entity under audit and the sister entity are each material to
the entity that controls both. The proposed amendment only focused
on the materiality of the sister entity to the controlling entity.
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ii. Comments Received
    Commenters generally supported the proposed changes to the
definition of the affiliate of the audit client.\26\ Consistent with
the discussion in the Proposing Release, commenters discussed the
challenges presented by the current definitions (e.g., cost, difficulty
of application, and impact on the available pool of qualified auditors)
and agreed that introducing a materiality qualifier into the analysis
would better focus the analysis on threats to an auditor's objectivity
and impartiality and address some of those challenges.\27\
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    \26\ See e.g., letters from Illinois CPA Society (Feb. 21, 2020)
(``Illinois CPA''), SEC Professional Group (Feb. 25, 2020) (``SEC
Pro Group''), International Bancshares Corporation (``Mar. 13,
2020'') (``IBC''), NASBA, CAQ, AICPA, Deloitte, BDO, EY, KPMG, RSM,
PwC, GT, Crowe, Parrett, AIC, ICI/IDC, EQT, FEI, and CCMC.
    \27\ See e.g., letters from Deloitte, GT, EQT, and CAQ.
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    A few commenters opposed the proposed materiality qualifier to the
affiliate of the audit client definition.\28\ These commenters asserted
that introducing a materiality qualifier would increase the risk that
auditors would be performing audits when they are not objective and
impartial, noting that there is evidence that auditors' materiality
judgments vary widely.\29\ One of these commenters suggested that the
Commission ``examine the evidence before changing its current
approach.'' \30\
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    \28\ See e.g., letters from CFA and CII. Both commenters
expressed their disagreement regarding the proposed materiality
qualifier within a discussion that covers both the affiliate of the
audit client and the ICC definitions.
    \29\ See letters from CFA and CII (citing Katherine Schipper et
al., Auditors' Quantitative Materiality Judgments: Properties and
Implications for Financial Reporting Reliability, 52 J. Acct. Res.
1303 (Dec. 2019), available at https://onlinelibrary.wiley.com/doi/full/10.1111/1475-679X.12286). See infra note 262 and accompanying
text.
    \30\ See letter from CFA.
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    In addition to these comments on the proposed amendments, we also
received feedback on additional changes to the definition of affiliate
of the audit client and other related changes, as discussed in more
detail below.
Comments Recommending a Dual Materiality Threshold
    Many commenters recommended that we further amend the common
control provision in the affiliate of the audit client definition to
add a materiality qualifier with respect to the entity under audit to
accompany the proposed materiality qualifier with respect to the sister
entity (a ``dual materiality threshold'').\31\ This dual materiality
threshold would result in a sister entity being deemed an affiliate of
the audit client only if the entity under audit and the sister entity
are each material to the controlling entity.\32\
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    \31\ See e.g., letters from CAQ, AICPA, Deloitte, BDO, EY, KPMG,
RSM, PwC, GT, Crowe, Parrett, AIC, CCMC, New York State Society of
Certified Public Accountants (Mar. 13, 2020) (``NYSSCPA''), and
Connecticut Society of Certified Public Accountants (Apr. 15, 2020)
(``CTCPA''). These commenters noted that analogous provisions exist
in the AICPA and the International Ethics Standards Board for
Accountants (``IESBA'') ethics and independence requirements.
    \32\ Id.
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    These commenters stated that, when the entity under audit is not
material to the controlling entity, services provided to or
relationships with sister entities typically do not create threats to
an auditor's objectivity and impartiality.\33\ For example, one
commenter stated that, in its experience, the entity under audit and
the sister entities typically have their own governance structures,
which indicates that there is no mutuality of interest between the
auditor and the audit client.\34\ Another commenter stated that the
proposed single materiality threshold would, in fact, ``increase'' the
burden on private equity firms by requiring more time and resources to
monitor the ``continuously evolving universe of entities that the
private firm would need to address . . .'' \35\ This commenter
contended that in the event the entity under audit is not material to
the controlling entity, a dual materiality threshold would alleviate
the burdens associated with a materiality analysis that would otherwise
have to be conducted on each sister entity.
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    \33\ See e.g., letters from BDO, Deloitte, EY, KPMG, PwC, Crowe,
CTCPA, CCMC, and GT.
    \34\ See letter from Deloitte.
    \35\ See letter from AIC.
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    Commenters also suggested that because a dual materiality threshold
is used by the AICPA and IESBA ethics and independence requirements,
adopting a similar threshold would ease compliance burdens associated
with the application of the affiliate definition and on-going
monitoring for audit firms and clients.\36\ A few commenters noted that
any risks associated with a potential dual materiality threshold would
be mitigated by the continued protections afforded by Rule 2-01(b).\37\
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    \36\ See e.g., letters from CAQ, Deloitte, BDO, RSM, PwC, CCMC,
GT, and CTCPA.
    \37\ See e.g., letters from BDO, AICPA, AIC, and EY.
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    One commenter that opposed the proposed amendment noted that it
also opposed the ``double trigger threshold'' of the AICPA.\38\
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    \38\ See letter from CII. This commenter cited footnote 20 of
the Proposing Release and indicated its agreement that requiring
materiality between the entity under audit and the controlling
entity may exclude, from the proposed definition, sister entities
whose relationships with or services from an auditor would impair
the auditor's objectivity and impartiality.
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Other Comments on Materiality and Monitoring
    In response to a request for comment as to whether the proposed
amendments should include a materiality assessment between the entity
under audit and sister entities, commenters generally did not support
adding such a provision.\39\ For example, one commenter stated that
concepts of financial materiality do not lend themselves to an
evaluation of relationships between sister entities, and noted that if
one entity had a material investment in the other, the other provisions
of the affiliate of the audit client definition would address such a
relationship.\40\
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    \39\ See e.g., letters from Deloitte, KPMG, RSM, and PwC.
    \40\ See letter from KPMG.
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    Some commenters suggested that a materiality qualifier also should
be applied when considering whether an entity that has control over the
entity under audit (i.e., a controlling entity) is

an affiliate under Rule 2-01(f)(4).\41\ However, another commenter
disagreed, stating that it believes parents and subsidiaries should
continue to be affiliates regardless of materiality.\42\
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    \41\ See e.g., letters from CAQ, AICPA, Deloitte, BDO, Crowe,
CTCPA, and AIC. See also supra note 25. The relevant AICPA
definition, 0.400.02, includes as an affiliate ``[a]n entity (for
example, parent, partnership, or LLC) that controls a financial
statement attest client when the financial statement attest client
is material to such entity'' (emphasis in original).
    \42\ See letter from RSM.
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    In response to a request for comment as to whether auditors and
audit clients would face challenges in applying the materiality concept
in connection with the proposed amendment and whether additional
guidance was needed, some commenters noted that the concept of
materiality already exists within Rule 2-01, and as such, indicated
that current materiality guidance is sufficient.\43\ By contrast, other
commenters suggested that there may be challenges in applying the
materiality concept in connection with the proposed amendments,\44\ and
a few commenters requested additional guidance or examples.\45\ One
commenter suggested that to ease the burden of monitoring for
compliance in connection with unforeseen changes in circumstances, the
Commission should consider establishing a framework to allow auditors
to address ``inadvertent independence violations that might arise when
a materiality threshold is crossed.'' \46\
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    \43\ See e.g., letters from Deloitte, EY, and Crowe.
    \44\ See e.g., letters from NYSSCPA and PwC. For example, one
commenter suggested the Commission define ``controlling entity.''
See letter from PwC.
    \45\ See e.g., letters from NYSSCPA, CTCPA, and AIC.
    \46\ See letter from PwC.
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    Some commenters suggested that the Commission reiterate the shared
responsibility of audit firms and their audit clients to monitor
independence, including monitoring affiliates and obtaining information
necessary to assess materiality.\47\ One commenter recommended the
Commission clarify that, once the initial materiality assessment has
been made, the auditor and audit client could satisfy their obligations
under the proposed amendments by reevaluating materiality in response
to significant transactions, Commission filings, or other information
that become known to the auditor or the audit client through reasonable
inquiry.\48\ Another commenter requested the Commission discuss
expectations regarding best efforts to obtain information and
monitoring if, for example, certain information can only be obtained
annually.\49\
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    \47\ See e.g., letters from CAQ, PwC, and EY.
    \48\ See letter from Deloitte.
    \49\ See letter from GT.
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Comments on ``Entity Under Audit''
    In the Proposing Release, the Commission used the term ``entity
under audit'' to describe the application of the proposed amendments.
The Commission explained that it was using this term to refer to the
entity ``whose financial statements or other information is being
audited, reviewed or attested.'' \50\ The quoted language is the first
clause of the definition of the term ``audit client'' in Rule 2-
01(f)(6). Because the definition of audit client also includes any
affiliates of the audit client, the Commission used the term ``entity
under audit'' to describe those entities whose financial statements
were subject to audit, review, or attestation, in an attempt to avoid
the potential confusion that may arise from using the term ``audit
client.''
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    \50\ See footnote 11 of the Proposing Release and accompanying
text.
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    In response to this discussion, some commenters suggested that Rule
2-01 incorporate more precise usage of the terms ``audit client'' and
``entity under audit,'' which may require defining the term ``entity
under audit.'' \51\ Several of those commenters recommended that the
term ``entity under audit'' be included in the definition of affiliate
of the audit client,\52\ because the term ``audit client,'' which is
defined to include affiliates in the definition of affiliate of the
audit client, may cause confusion. One of these commenters
characterized the reference to audit client in the existing affiliate
of the audit client definition as a ``circular reference.'' \53\
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    \51\ See e.g., letters from AICPA, Deloitte, EY, Crowe, PwC, and
GT.
    \52\ See e.g., letters from AICPA, Deloitte, EY, and Crowe.
    \53\ See letter from Crowe.
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Comments on ``Controlling Entity'' and ``Control''
    While we did not propose any amendments to the term ``control'' as
defined in 17 CFR 210.1-02(g) (``Rule 1-02(g)'') of Regulation S-X, a
few commenters suggested that, for private equity firms, the term
``controlling entity'' should be defined as the overall private equity
firm or the ultimate parent.\54\ One of these commenters requested
further explanation or guidance, such as through illustrative examples,
to address whether the relationship between an investment adviser and a
fund it advises should be treated as a control relationship and
suggested that the term ``control'' should be linked to the accounting
literature.\55\ While these comments pertained to entities within an
ICC, the comments are relevant when the entity under audit is not an
investment company or investment adviser or sponsor, but the entity
under audit controls or is controlled by an investment company or
investment adviser or sponsor.\56\
---------------------------------------------------------------------------

    \54\ See e.g., letters from PwC and AIC.
    \55\ See letter from PwC.
    \56\ See infra Examples 3 and 4 in Section II.A.1.a.iii.
---------------------------------------------------------------------------

iii. Final Amendments
    After considering the public comments and recommendations received,
we are adopting amended 17 CFR 210.2-01(f)(4) (``amended Rule 2-
01(f)(4)'') with certain modifications from the proposal, as described
below. We considered the comments received opposing the addition of
materiality to the common control provision, but continue to believe
that materiality is an appropriate principle to effectively focus on
relationships with and services provided to sister entities that are
more likely to threaten an auditor's objectivity and impartiality.
Dual Materiality Threshold
    In response to comments, we are modifying the proposed amendments
to Rule 2-01(f)(4)(ii) to incorporate a dual materiality threshold such
that a sister entity will be included as an affiliate of the audit
client if the sister entity and the entity under audit are each
material to the controlling entity. Under the final amendments, if
either the sister entity or the entity under audit is not material to
the controlling entity, then the sister entity will not be deemed an
affiliate of the audit client pursuant to amended 17 CFR 210.2-
01(f)(4)(ii) (``amended Rule 2-01(f)(4)(ii)'').\57\ In the Proposing
Release, the Commission suggested that requiring that the entity under
audit be material to the controlling entity as part of the proposed
definition may exclude sister entities whose relationships with or
services from an auditor would impair the auditor's objectivity and
impartiality.\58\ However, after consideration of the comments received
and further evaluation, we are persuaded that where the entity under
audit is not material to the controlling entity, an auditor's
relationships with or services provided to sister entities would
generally not threaten the auditor's objectivity and impartiality. In

this regard, we agree that when the entity under audit is not material
to the controlling entity, it is less likely that a mutuality of
interest would develop as a result of relationships with or services
provided to sister entities. For example, as one commenter observed,
sister entities with separate governance structures, such as sister
portfolio companies within an ICC, typically lack decision-making
capacity over other sister entities, including an entity under audit.
---------------------------------------------------------------------------

    \57\ We also are making a technical amendment to renumber the
paragraphs within amended Rule 2-01(f)(4).
    \58\ See footnote 20 of the Proposing Release.
---------------------------------------------------------------------------

    We also recognize the benefit to auditors, audit clients, and
investors of reducing compliance-related challenges. The adopted dual
materiality threshold may help address some commenters' concerns about
the inability to obtain all relevant information needed to make a
materiality determination with respect to sister entities under the
proposed single materiality threshold. Under the adopted dual
materiality threshold, the need to assess the materiality relationship
between the entity under audit and each of the controlling entities
should reduce information access concerns because, in the event the
entity under audit is not material to the controlling entity, the
materiality assessment would be made for fewer sister entities as
compared to the proposed single materiality threshold. However, as
discussed in Section II.A.1.b.ii below, the auditor's non-audit
services to and relationships with sister entities that are no longer
deemed affiliates as a result of applying the dual materiality
threshold will continue to be subject to the principles set forth in
Rule 2-01(b), and as such, knowledge of services to and relationships
with such non-affiliate sister entities will be needed to sufficiently
consider the general standard.
    Some commenters also suggested that we incorporate a materiality
qualifier in the evaluation of whether controlling entities would be
considered affiliates, similar to analogous provisions in the AICPA and
IESBA ethics and independence requirements. While commenters cited the
benefits of having a common regime for the consideration of controlling
entities, we were not persuaded that the benefits from such conformity
would justify the potential risk to an auditor's objectivity and
impartiality in these circumstances. In particular, commenters did not
specifically highlight ongoing monitoring or other compliance
challenges associated with the identification of affiliates that
control an entity under audit. It does not appear that the challenges
related to the changing population of potential affiliates and the
ability to obtain appropriate information that occur in the common
control context also exist when evaluating entities that have control
over the entity under audit. In addition, the relationship between
sister entities and an entity under audit is generally different than
the relationship between a controlling entity and the entity under
audit. The controlling entity typically has some decision-making
ability or an ability to influence the entity under audit. As such, we
believe an auditor's independence likely would be impaired if the
auditor provides non-audit services to or engages in relationships with
the controlling entity that are described in Rule 2-01(c), even in
situations in which the entity under audit is not material to the
controlling entity. Accordingly, we are not adopting commenters'
recommendations to incorporate a materiality qualifier in the
evaluation of whether controlling entities should be considered
affiliates.
Entity Under Audit
    We are making modifications to incorporate the term ``entity under
audit'' within amended 17 CFR 210.2-01(f)(4)(i) (``amended Rule 2-
01(f)(4)(i)'') and amended 17 CFR 210.2-01(f)(4)(ii) (``amended Rule 2-
01(f)(4)(ii)''). Given the comments received on this point and in light
of other changes we are making to the final amendments, we believe it
is appropriate to replace the term ``audit client'' with ``entity under
audit'' in amended Rules 2-01(f)(4)(i) and (ii). Specifically, as
illustrated in the example below, we are concerned that if we do not
revise this terminology, it could be applied in a manner that would
negate the adopted dual materiality threshold.
[GRAPHIC] [TIFF OMITTED] TR11DE20.000

    In Figure 1, assume the controlling entities (i.e., Parent 1 and
Hold Co.) have control over all entities downstream from them. If
amended Rules 2-01(f)(4)(i) and (ii) referred to an ``audit client''
instead of an ``entity under audit,'' Sister 1 may be deemed an
affiliate of the audit client regardless of the materiality of Sister 1
or the Entity Under Audit to Parent 1 based on the following
application:
     Parent 1 controls the entity under audit, which makes
Parent 1 an affiliate of the audit client. Parent 1 also is an ``audit
client'' because the definition of such term includes affiliates. A
practitioner might then apply the control provision in amended Rule 2-
01(f)(4)(i) to Parent 1 and deem Sister 1 an affiliate of the audit
client, regardless of the dual materiality threshold. The practitioner
would consider Sister 1 an affiliate because it is controlled by
``audit client'' Parent 1 without applying

the materiality analysis in the common control provision of amended
Rule 2-01(f)(4)(ii).

Similarly, Entities A and B may be deemed affiliates of the audit
client regardless of the materiality of Entity A, Entity B, or the
entity under audit to Hold Co. based on the following application:
     Under the existing and amended rules, Hold Co. is an
affiliate of the audit client (i.e., Hold Co. has control over the
entity under audit) and, as such, also is an audit client. A
practitioner might then apply the control provision in amended Rule 2-
01(f)(4)(i) to Hold Co. and deem both Entities A and B as affiliates of
the audit client, regardless of the dual materiality threshold in
amended Rule 2-01(f)(4)(ii). Again, the practitioner may deem Entities
A and B to be affiliates because ``audit client'' Hold Co. controls
both Entities A and B.\59\
---------------------------------------------------------------------------

    \59\ Relatedly, when assessing whether Entities A and B are
affiliates under amended Rule 2-01(f)(4)(ii), it may otherwise be
unclear to a practitioner assessing materiality of the ``audit
client'' whether such assessment applies to the entity under audit
or an affiliate (such as Parent 1).
---------------------------------------------------------------------------

    Absent clarification, the above-illustrated application (i.e.,
circular reading) of the final amendments could negate the Commission's
objective to focus the common control provision on those relationships
and services that are more likely to threaten the objectivity and
impartiality of an auditor by introducing a dual materiality threshold.
While the proposal did not use the term ``entity under audit'' in the
rule text, we believe this modification is consistent with the proposal
to separate out common control from existing Rule 2-01(f)(4)(i) and
include a materiality provision within the definition. Now that the
amended common control provision includes a dual materiality threshold,
we believe the modification to use the term ``entity under audit'' in
place of the term ``audit client'' in amended Rules 2-01(f)(4)(i) and
(ii) is important to avoid any misunderstandings about how the common
control provision should be applied in the final amendments.
    While some commenters requested that we further amend our rules to
incorporate more precise usage of the term ``entity under audit'' \60\
in other paragraphs that currently refer to the ``audit client,'' those
requests are beyond the scope of this rulemaking. We did not propose or
seek comment on those particular amendments. Moreover, those additional
amendments are not necessary to effectuate any aspect of the proposal.
As such, we are not incorporating the term ``entity under audit'' into
other paragraphs of the rule that currently refer to ``audit client,''
including the significant influence provisions of amended 17 CFR 210.2-
01(f)(4)(iii) (``amended Rule 2-01(f)(4)(iii)'') and 17 CFR 210.2-
01(f)(4)(iv) (``amended Rule 2-01(f)(4)(iv)''). However, the
incorporation of ``entity under audit'' in amended Rules 2-01(f)(4)(i)
and (ii), while leaving the term ``audit client'' within the
significant influence provisions in amended Rules 2-01(f)(4)(iii) and
(iv), does not imply a change from the historical practical application
of these provisions, which has focused and should continue to focus on
the entity under audit.
---------------------------------------------------------------------------

    \60\ See supra note 51.
---------------------------------------------------------------------------

Assessing Materiality and Monitoring
    Several commenters requested clarification and examples of the
application of the proposed amendments, including the proposed
materiality qualifier. In response, we are providing several examples
to illustrate the application of the final amendments to particular
fact patterns.
    Auditors and their audit clients have a shared responsibility to
monitor independence in order to satisfy, as applicable, the
requirements of the federal securities laws, including Rule 2-01 and 17
CFR 210.2-02.\61\ This shared responsibility between auditors and audit
clients applies to all aspects of Rule 2-01, including the final
amendments. This responsibility includes the monitoring of affiliates
and obtaining information necessary to assess materiality. We believe
this process works most effectively when management, audit committees,
and audit firms work together to evaluate the auditor's compliance with
the independence rules. For example, auditors and their audit clients
may need to work together to identify and monitor potential affiliates
based on the affiliate of the audit client definition in the
independence rules. In this regard, it will be important for management
to notify the auditor in a timely manner of changes in circumstances
that may affect the population of potential affiliates, such as by
notifying an auditor of acquisitions before the acquisitions are
effective. Additionally, management should consider communicating to
auditors as early as possible the intent of private companies to file a
registration statement in order for the SEC and PCAOB independence
rules to be considered in advance. Issuers and their audit committees
may want to consider having their own policies and procedures to
identify, consider, and monitor the provision of services by and
relationships with the issuer's independent accountant, which may help
supplement the audit firm's system of quality control.
---------------------------------------------------------------------------

    \61\ For an overview of the obligations of auditors and audit
clients with respect to auditor independence under the federal
securities laws, please see footnote 101 of the Loan Provision
Adopting Release.
---------------------------------------------------------------------------

    The following are intended as illustrative examples only, and
practitioners and audit clients should be aware that an assessment of
materiality requires consideration of all relevant facts and
circumstances, including quantitative and qualitative factors.
BILLING CODE 8011-01-P

[GRAPHIC] [TIFF OMITTED] TR11DE20.001

BILLING CODE 8011-01-C
    In this example, Company A, the entity under audit, has five
controlling entities, Entities 1 through 5, with Entity 5 as the
ultimate parent. Since each of Entities 1 through 5 controls Company A,
directly or indirectly, each of the entities is an affiliate of Company
A regardless of materiality. For purposes of this example, assume that
Company A is material to Entity 1 and Entity 2 and that Company A is
not material to Entity 3, Entity 4, or Entity 5. Each of Entities 1
through 5 controls other entities (i.e., sister entities) other than
those listed in this example. In this example, the auditor must
evaluate the materiality of the sister entities controlled by each of
Entity 1 and Entity 2 to determine which sister entities are affiliates
of the audit client. For a sister entity controlled by Entity 1, the
auditor must assess the materiality of such sister entity to Entity 1.
For a sister entity controlled by Entity 2, the auditor must assess the
materiality of that sister entity to Entity 2.
Example 2--Controlling and Sister Entities and Monitoring Expectations
    Assume the same facts as in Example 1. Company A and the
controlling entities should provide the auditor with sufficient
information to enable the auditor to appropriately monitor controlling
entities and identify sister entities, even at the levels of Entities 3
through 5. We acknowledge the concerns raised by commenters that
identifying sister entities that are not considered affiliates under
the final amendments and re-assessing the materiality of the entity
under audit and its sister entities may increase existing compliance
burdens. However, identifying sister entities will be important for
complying with the amended rules because there can be qualitative and
quantitative changes that affect the materiality of such relationships,
and audit firms will need to timely address when a sister entity
becomes an affiliate. Such information also will be necessary for an
audit firm to appropriately consider and apply Rule 2-01(b) on an
ongoing basis.
    After the initial materiality assessment is performed to identify
potential affiliates, the auditor, with the assistance of and
information provided by the audit client, should perform updated
assessments based on, among other things, transactions, Commission
filings, or other information that becomes known to the auditor and the
audit client through reasonable inquiry. As a result, obtaining
accurate organizational and financial information will be important to
the auditor's and the audit client's ability to anticipate and plan for
potential changes in materiality status that may lead to the
identification of new affiliates at any point during the audit and
professional engagement period. We understand that this likely will
require additional compliance efforts and believe such efforts and the
resultant costs are appropriate to ensure that an auditor is
independent from its audit client for purposes of investor protection
and investor confidence. To the extent the final amendments mitigate
the compliance challenges associated with

independence violations or prohibitions, or allow an auditor to expand
its audit or non-audit services or relationships, we expect that the
auditor will weigh any related benefits against any additional
monitoring and compliance costs. Also, auditors may already be familiar
with the monitoring efforts related to a dual materiality threshold, as
the AICPA and IESBA have analogous provisions. Where an auditor is
unable to obtain the information needed to make reasonable
determinations of affiliate status for sister entities, the auditor
should treat such sister entities as affiliates of the audit client for
the purpose of the Commission's independence requirements to avoid
potentially impairing the auditor's objectivity and impartiality.
    The final amendments do not include a transition framework, as
requested by a commenter, to address changes in the materiality of the
entity under audit or a sister entity to a controlling entity. As
noted, above, we expect auditors and their clients to be able to
anticipate and plan for changes in materiality and believe this
approach fosters an auditor's objectivity and impartiality. To the
extent that changes in materiality of the entity under audit or sister
entities result in an independence violation, we encourage registrants
and accountants to consult with the Commission's Office of the Chief
Accountant.\62\
---------------------------------------------------------------------------

    \62\ See Section II.E.3 and amended introductory paragraph to
Rule 2-01.
[GRAPHIC] [TIFF OMITTED] TR11DE20.002

    Company B is the entity under audit and a portfolio company
controlled by Fund A. Fund A is an investment company within an ICC.
Company B's auditor will identify affiliates of the audit client by
applying amended Rules 2-01(f)(4)(i) through (iv). While there are
entities described in the ICC definition that are part of Company B's
organizational structure, including Fund A and its investment adviser
or sponsor, Company B's auditor, assuming it does not audit any entity
described in the ICC definition, such as Fund A or the Investment
Adviser, will not apply the ICC definition. Company B's auditor must
apply amended Rules 2-01(f)(4)(i) through (iv) to identify affiliates,
which may result in certain investment companies and investment
advisers or sponsors being deemed an affiliate of the audit client.
    As noted above, we received a few comments related to the term
``controlling entity'' and the term ``control,'' \63\ which is defined
in Rule 1-02(g). We are not amending Rule 1-02(g) to link the
definition of ``control'' to the accounting literature as one commenter
suggested. We believe the suggestion to define ``controlling entity''
solely as the overall private equity firm when assessing materiality of
entities, including a portfolio company, in a private equity structure
\64\ could raise issues beyond the scope of the proposal that warrant
further consideration. We are therefore not adopting this approach.
Under Rule 1-02(g), whether the entity under audit is a subsidiary of
an operating or holding company or a portfolio company within a private
equity structure, all entities that are identified to have control over
an entity under audit are controlling entities.
---------------------------------------------------------------------------

    \63\ See supra note 54.
    \64\ Id.

---------------------------------------------------------------------------

[GRAPHIC] [TIFF OMITTED] TR11DE20.003

    Entity X is the entity under audit and is not an investment
company, an investment adviser, or sponsor. Entity X has a subsidiary
that serves as an investment adviser to several investment companies.
If the auditor is not engaged to audit the investment company or
investment adviser or sponsor on a standalone basis, the auditor will
apply amended Rules 2-01(f)(4)(i) through (iv) to determine the
affiliates of the audit client.
    We note that in determining the affiliates of Entity X, in the
context of amended Rules 2-01(f)(4)(i) through (iv), it will be
important to consider the relationships between the investment adviser
and the investment companies it advises. Even where an investment
company has an independent board that oversees the investment company's
operations and approves the advisory contract, the services provided by
the investment adviser are generally critical to the management of day-
to-day operations and execution of policies for the investment company.
Therefore, the investment adviser generally will have a controlling
relationship over the investment company for purposes of Rule 1-02(g).
    In this example, if the auditor audited Entity X and the investment
adviser subsidiary on a standalone basis, then the auditor would have
to apply both amended Rules 2-01(f)(4)(i) through (iv) as they relate
to the audit of Entity X and amended Rule 2-01(f)(14) as it relates to
the audit of the investment adviser.\65\
---------------------------------------------------------------------------

    \65\ This is consistent with the discussion and example included
in Section II.A.1.b.i of the Proposing Release.
---------------------------------------------------------------------------

b. Proposing Release's Discussion of Rule 2-01(b)
    As noted in the 2000 Adopting Release, ``[c]ircumstances that are
not specifically set forth in our rule are measured by the general
standard set forth in Rule 2-01(b).'' The general standard includes, in
part, that the ``Commission will not recognize an accountant as
independent, with respect to an audit client, if the accountant is not,
or a reasonable investor with knowledge of all relevant facts and
circumstances would conclude that the accountant is not, capable of
exercising objective and impartial judgment on all issues encompassed
within the accountant's engagement.''
    The Commission explained in the Proposing Release that
relationships and services affected by the proposed amendments to the
affiliate of the audit client definition remain subject to the general
independence standard in Rule 2-01(b).\66\ The Commission also noted
that such relationships and services, individually or in the aggregate,
could raise independence concerns pursuant to the general standard in
Rule 2-01(b) due to the nature, extent, relative importance or other
aspects of the service or relationship that may make the service or
relationship a threat to an auditor's objectivity and impartiality. The
Commission indicated that such services or relationships should be
``easily known'' due to the nature, extent, relative importance or
other aspects of the services or relationships. Although the Commission
did not propose amendments to Rule 2-01(b), a number of commenters
provided feedback on the application of the general independence
standard in light of the proposed amendments.
---------------------------------------------------------------------------

    \66\ See Section II.A.1 of the Proposing Release.
---------------------------------------------------------------------------

i. Comments on the Proposing Release's Discussion of Rule 2-01(b)
    Several commenters agreed that relationships and services with
entities that would no longer be deemed affiliates should still be
evaluated under Rule 2-01(b).\67\ However, one commenter recommended
that the Commission consider whether Rule 2-01(b) is sufficient, or
whether further clarification or rulemaking might be appropriate to
address situations where relationships or non-attest services provided
to a sister entity that is no longer an affiliate under the proposed
definitions are of a magnitude that ``eclipse'' the attest services
provided within a private equity or investment company complex.\68\
---------------------------------------------------------------------------

    \67\ See e.g., letters from Deloitte, EY, KPMG, GT, and Crowe.
Some commenters also indicated that the general standard in Rule 2-
01(b) is sufficient to mitigate the risks when relationships and
services, individually or in the aggregate, with sister entities
that are no longer deemed affiliates under the final amendments
could impact an auditor's objectivity and impartiality. See e.g.,
letters from Deloitte, EY, and KPMG.
    \68\ See letter from BDO.
---------------------------------------------------------------------------

    A few commenters raised concerns with the Proposing Release's
discussion of Rule 2-01(b).\69\ One commenter

asserted that the statements were inconsistent with the 2000 Adopting
Release, which stated that ``[c]ircumstances that are not specifically
set forth in our rule are measured by the general standard set forth in
Rule 2-01(b)'' \70\ and expressed concern that the Proposing Release's
discussion of Rule 2-01(b) could be applied more broadly than just to
the entities captured by the affiliate of the audit client definition.
Another commenter asserted that it ``may be understood in practice as a
change in application and operation of Rule 2-01(b).'' \71\ In voicing
their concerns, these commenters noted that the consideration of Rule
2-01(b) would reduce the benefits expected to result from the proposed
amendments as the auditor would continue to have to track relationships
and services that are being provided to entities that are no longer
affiliates.\72\
---------------------------------------------------------------------------

    \69\ See e.g., letters from RSM and PwC.
    \70\ See letter from RSM (citing to the 2000 Adopting Release at
65 FR 76030). See infra discussion in Section II.A.1.b.ii.
    \71\ See letter from PwC.
    \72\ See e.g., letters from RSM and PwC.
---------------------------------------------------------------------------

    One commenter disagreed with the Proposing Release's reference to
``easily known'' when describing the types of services or relationships
that should be evaluated under Rule 2-01(b) as 17 CFR 210.2-01(c)
(``Rule 2-01(c)'') no longer specifically addresses such items.\73\ A
few commenters asserted that the Proposing Release's use of ``easily
known'' appears to establish an expectation of continued monitoring
that may reduce the benefits, efficiencies, and cost savings expected
to result from the proposed amendments.\74\ Two of these commenters
requested further guidance on on-going monitoring obligations if Rule
2-01(b) continues to apply to non-affiliates and requested the
Commission consider clarifying the reference to ``easily known'' in the
Proposing Release's discussion of the general standard by utilizing the
``knows or has reason to believe'' approach of the AICPA ethics and
independence rules.\75\
---------------------------------------------------------------------------

    \73\ See letter from RSM.
    \74\ See e.g., letters from PwC, RSM, and AIC.
    \75\ See letters from PwC and AIC.
---------------------------------------------------------------------------

ii. Application of Rule 2-01(b) to the Final Amendments
    After considering the public comments and recommendations received,
we affirm our view that Rule 2-01(b) applies to those relationships and
services that previously were, but are no longer, covered by Rule 2-
01(c) as a result of the final amendments. We do not believe that this
position broadens the scope of the ``all relevant facts and
circumstances'' concept in the general standard. Nor are we persuaded
that this scope should be narrowed in light of the amendments we are
adopting. Otherwise, for example, an auditor could have any number or
magnitude of relationships with or provide services to sister entities
that are no longer deemed affiliates under the final amendments--even
where, for example, the importance of such relationships or services to
the auditor and the controlling entity threatens the auditor's
objectivity and impartiality.
    In response to commenters who noted that ``easily known'' is not a
defined term and requested further explanation, we are clarifying that
the types of relationships and services that must be evaluated under
Rule 2-01(b) are those that are known or should be known to the auditor
because of the nature, extent, relative importance or other relevant
aspects of the relationships or services. Consistent with our
discussion in Example 2 above, auditors, with the assistance of their
audit clients, are expected to have sufficient information to be able
to be aware of and prepare for changes in materiality that could lead
to changes in affiliate status of entities in a large corporate or ICC
structure. As such, we do not expect that identifying and monitoring
relationships with and services provided to non-affiliate sister
entities that are known or should be known would require significant
additional effort by audit firms. For example, if audit firms are
performing a high volume of services for or have a number of
relationships with non-affiliate sister entities, the audit firm should
already know that these relationships exist.
    As noted in Section II.A.1.a.iii, the final amendments will more
effectively focus the independence rules and reduce the time and
attention that auditors and audit committees spend avoiding or
addressing compliance challenges that arise under the existing rules
and should permit auditors and audit committees to use their resources
more effectively to the benefit of investors. Nothing in the final
amendments is intended to change the application of the general
independence standard in Rule 2-01(b). As the Commission noted in the
2000 Adopting Release and in the rule text for Rule 2-01(c), paragraph
(c) is a ``non-exclusive'' specification of circumstances. As such,
while Rule 2-01(c) enumerates specific circumstances that are
inconsistent with Rule 2-01(b), the general standard of Rule 2-01(b)
may encompass relationships and services that are not otherwise deemed
independence-impairing by Rule 2-01(c).
c. Amendments to the Investment Company Complex Definition
i. Proposed Amendments
    The Commission proposed to amend Rule 2-01(f)(4) to clarify that,
with respect to an entity under audit that is an investment company or
an investment adviser or sponsor, the auditor and the audit client
should look to proposed Rule 2-01(f)(14) (i.e., the ICC definition) to
identify affiliates of the audit client and not to proposed Rule 2-
01(f)(4).\76\ The Commission also proposed to amend the ICC definition
in Rule 2-01(f)(14) to provide additional clarity by incorporating the
term ``entity under audit'' into Rule 2-01(f)(14) to focus the analysis
from the perspective of the entity under audit and to explicitly define
the term ``investment company'' to include unregistered funds for the
purpose of the ICC definition.\77\ In the Proposing Release, the
Commission indicated that the proposed amendments were designed to more
effectively focus the independence analysis on the entity under audit,
including unregistered funds under audit, and align that analysis with
the independence analysis required for all investment companies.
---------------------------------------------------------------------------

    \76\ The proposed amendment would replace the existing ``and''
that appears at the end of existing Rule 2-01(f)(4)(iii) with an
``or'' in order to direct auditors of an investment company or an
investment adviser or sponsor to the ICC definition. In the final
amendments, the ``or'' now appears at the end of amended Rule 2-
01(f)(4)(iv) and before amended 17 CFR 210.2-01(f)(4)(v).
    \77\ We use the term ``unregistered fund'' in this release to
refer to entities that are not considered investment companies
pursuant to the exclusions in Section 3(c) of the Investment Company
Act of 1940 [15 U.S.C. 80a-3(c)].
---------------------------------------------------------------------------

    In addition to the proposed amendments to clarify certain aspects
of the ICC definition, the Commission proposed to include a materiality
qualifier in the common control provision of the ICC definition to
align with the proposed amendments to the affiliate of the audit client
definition.\78\ To further align with the affiliate of the audit client
definition, the Commission proposed including a significant influence
provision in the ICC definition.\79\ Both of these proposed

amendments were meant to provide consistency between the definitions of
affiliate of the audit client and ICC in light of the proposed
amendment specifying that auditors of an investment company or
investment adviser or sponsor would apply proposed Rule 2-01(f)(14) to
identify affiliates of such entity under audit.
---------------------------------------------------------------------------

    \78\ See Proposed Rule 2-01(f)(14)(i)(D)(1).
    \79\ See Proposed Rule 2-01(f)(14)(i)(E). The existing
definition of ``audit client'' in Rule 2-01(f)(6), for the purpose
of Rule 2-01(c)(1)(i), excludes entities that are affiliates only by
virtue of the significant influence provisions in existing Rules 2-
01(f)(4)(ii) and (iii). To align the treatment of affiliates due to
significant influence under proposed Rule 2-01(f)(14)(i)(E) with
those in the affiliate of the audit client definition, the
Commission proposed an amendment to the ``audit client'' definition
in Rule 2-01(f)(6) to similarly exclude entities identified under
proposed Rule 2-01(f)(14)(i)(E).
---------------------------------------------------------------------------

    The Commission explained in the Proposing Release that while it was
introducing a materiality qualifier in the common control provision, it
was retaining within the scope of the ICC definition any investment
company that has an investment adviser or sponsor that is an affiliate
of the audit client--regardless of whether such sister investment
companies are material to the shared investment adviser or sponsor.\80\
---------------------------------------------------------------------------

    \80\ See Proposed Rule 2-01(f)(14)(i)(F).
---------------------------------------------------------------------------

    The Commission also noted that while the proposed amendments to the
ICC definition would alter the composition of entities that would be
deemed affiliates of the audit client principally due to a materiality
qualifier being added for sister entities, the general independence
standard in Rule 2-01(b) would continue to apply.\81\ The Commission
stated its belief that the proposed amendments to the ICC definition
would provide clarity and address certain compliance challenges,
including challenges related to the number of related entities or the
volume of acquisitions and dispositions in ICCs, and more effectively
focus the ICC definition on those relationships and services that are
more likely to threaten auditor objectivity and impartiality.\82\
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    \81\ See Section II.A.1.b of the Proposing Release.
    \82\ See Section II.A.1 of the Proposing Release.
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ii. Comments Received
Comments on Overall Approach to ICC Definition
    Commenters generally supported the Commission's proposal to clarify
that with respect to an entity under audit that is an investment
company or an investment adviser or sponsor, the auditor and the audit
client should look solely to the ICC definition to identify affiliates
of the audit client,\83\ and no commenters specifically opposed the
proposed approach.
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    \83\ See e.g., letters from NYSSCPA, CAQ, Deloitte, BDO, EY,
KPMG, RSM, GT, Crowe, and ICI/IDC. One commenter recommended that
the final amendments specify that the ICC definition applies when
the entity obtains an audit ``for SEC reporting or compliance
purposes.'' See letter from KPMG. We believe this concept is implied
by the requirements to apply Rule 2-01 in certain applicable
provisions of the Federal securities laws.
---------------------------------------------------------------------------

    Several commenters expressly agreed with the proposed references to
``entity under audit'' in Rule 2-01(f)(14),\84\ and no commenters
specifically opposed the proposed references.
---------------------------------------------------------------------------

    \84\ See e.g., letters from NYSSCPA, Deloitte, BDO, EY, KPMG,
and GT.
---------------------------------------------------------------------------

    Some commenters supported the Commission's proposal to include
within the meaning of the term investment company, for the purposes of
the ICC definition, entities ``that would be an investment company but
for the exclusions provided by Section 3(c) of the Investment Company
Act.'' \85\ For example, one commenter stated that under the current
rules, ``it was not clear if unregistered funds would be part of the
[ICC] definition, which created uncertainty and inconsistency in
practice.'' \86\ Another commenter stated that, if adopted, the
inclusion of unregistered funds within the ICC definition would enable
``the asset management industry holistically [to] serve the interests
of investors and provide for more consistent treatment across fund
businesses.'' \87\ No commenters expressly opposed this proposed
amendment.
---------------------------------------------------------------------------

    \85\ See e.g., letters from Deloitte, EY, KPMG, Crowe, and RSM.
    \86\ See letter from Crowe.
    \87\ See letter from EY.
---------------------------------------------------------------------------

    Many commenters who were supportive of the proposed amendments also
requested clarification on the application of the proposed definitions
to specific fact patterns, including the following circumstances:
     An investment adviser is the entity under audit and is
both an issuer and parent entity; \88\
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    \88\ See e.g., letters from CAQ and ICI/IDC. Consistent with the
discussion in Section II.A.1 of the Proposing Release, where an
auditor is auditing only an investment company or investment adviser
or sponsor, such auditor would look to the amended ICC definition to
identify affiliates of the audit client. Even where the investment
adviser under audit is an issuer and a parent entity, the final
amendments dictate that the adviser's auditor look solely to the
amended ICC definition to identify affiliates of the audit client.
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     An operating company is the entity under audit and has
sister entities that include an investment company or an investment
adviser or sponsor,\89\ or the operating company under audit has a
subsidiary that is an investment adviser that manages investment
companies; \90\ and
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    \89\ See e.g., letters from CAQ and Deloitte. The discussion in
Section II.A.1.a.iii, above, including Example 3, illustrates how to
apply the amended definitions where an auditor audits only a
portfolio company.
    \90\ See letter from EY. The discussion in Section II.A.1.a.iii,
above, including Example 4, illustrates how to apply the amended
definitions in response to this circumstance.
---------------------------------------------------------------------------

     The entity under audit is an investment company with
sister funds advised by the same investment adviser, and such sister
funds control portfolio companies.\91\
---------------------------------------------------------------------------

    \91\ See e.g., letters from CAQ, BDO, EY, KPMG, Crowe, and AIC.
The discussion in Section II.A.1.c.iii, including Example 5, below,
illustrates how to apply the amended definitions in response to this
circumstance. One commenter raised a related fact pattern and
suggested aligning the proposed amendments with the recent
amendments to the Loan Provision. See letter from PwC.
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    Regarding other general aspects of the proposed ICC definition, one
commenter sought clarification about whether the reference to
investment adviser or sponsor in the proposed ICC definition also would
include custodians.\92\ A different commenter requested that we revise
the ICC definition to separately address affiliates of an investment
company and affiliates of an investment adviser or sponsor.\93\
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    \92\ See letter from EY; see also infra note 118.
    \93\ See letter from RSM. We do not see a compelling reason to
adopt this approach and create separate provisions for these related
entities within an ICC. Additionally, such an approach may be
duplicative and add unnecessary complexity to the amended ICC
definition.
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Comments on Proposed Rule 2-01(f)(14)(i)(D)(1)--Common Control and
Materiality
    Many commenters supported the inclusion of a materiality qualifier
within proposed Rule 2-01(f)(14)(i)(D)(1), the common control provision
of the proposed ICC definition.\94\ Consistent with feedback received
in response to the proposed materiality qualifier for operating
companies under common control,\95\ some commenters expressed the view
that the materiality qualifier would not increase the risk to auditor
objectivity and impartiality.\96\ A few commenters, consistent with
their feedback on the affiliate of the audit client definition, also
recommended that proposed Rule 2-01(f)(14)(i)(D)(1) include a dual
materiality threshold that would include consideration of whether the
entity under audit is material to the controlling entity.\97\
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    \94\ See e.g., letters from CAQ, BDO, EY, KPMG, RSM, PwC, GT,
Crowe, AIC, ICI/IDC, IBC, CCMC, and Charles E. Andrews, Audit
Committee Chair, Washington Mutual Investors Fund, et al (Mar. 10,
2020) (``Fund AC Chairs'').
    \95\ See Section II.A.1.a.iii.
    \96\ See e.g., letters from EY, RSM, and KPMG.
    \97\ See e.g., letters from EY, AIC, and CCMC.
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    However, the two commenters that opposed the proposed materiality
qualifier in the affiliate of the audit client definition also opposed,
for similar reasons, the inclusion of such a qualifier in the proposed
ICC amendments.\98\
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    \98\ See letters from CII and CFA.
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    While some commenters indicated that auditors would not experience
significant challenges or burdens with

assessing materiality in the ICC context,\99\ other commenters voiced
concerns or noted that additional guidance about the application of
materiality would be helpful.\100\ Some commenters noted the importance
of access to current financial information of controlling entities and
sister entities for auditors and their clients if the proposed
amendments were adopted.\101\ In this regard, some commenters requested
that the Commission address the shared responsibility of auditors,
their audit clients, and audit committees.\102\
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    \99\ See e.g., letters from Fund AC Chairs, EY, and RSM.
    \100\ See e.g., letters from NYSSCPA, GT, RSM, KPMG, PwC and
ICI/IDC.
    \101\ See e.g., letters from RSM, GT, KPMG, PwC, ICI/IDC, and
Fund AC Chairs.
    \102\ See e.g., letters from PwC and EY.
---------------------------------------------------------------------------

    In response to a request for comment regarding potential
application challenges in the Proposing Release, one commenter
indicated there may be challenges in applying the materiality qualifier
because the current definition does not require an assessment of
materiality of sister entities in the context of the ICC.\103\ The
commenter suggested that such challenges could be addressed by
auditors, the Commission, and companies working together to develop
consistent practices and protocols for providing the information needed
by auditors to maintain compliance with the independence rules.
Similarly, another commenter requested guidance on the timing and
frequency of monitoring materiality in the ICC context. The commenter
suggested the Commission clarify that, if the sister investment adviser
or a fund advised by such sister investment adviser were not deemed
material to the controlling entity after an initial assessment, then
the auditor could satisfy its obligation to monitor materiality on an
ongoing basis in response to significant transactions, SEC filings, or
other information that becomes known to the auditor, or the audit
client, through reasonable inquiry.\104\
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    \103\ See letter from KPMG.
    \104\ See letter from ICI/IDC. See also letters from Deloitte
(expressing a similar view as it relates to both Rule 2-01(f)(4) and
Rule 2-01(f)(14)) and PwC (suggesting a transition framework to
address inadvertent independence violations that arise out of an
unexpected change in the population of affiliates for reasons other
than a merger or acquisition).
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    Under the proposal, auditors and audit clients would have to assess
the materiality of sister entities to their controlling entity even if
the sister entities' investment advisers are not material to the entity
that controls both the sister entities and the entity under audit. In
response to a request for comment regarding whether auditors should
have to assess the materiality of sister investment companies to a
controlling entity even where the investment advisers for such sister
investment companies are not material to a controlling entity,
commenters generally thought requiring such assessment would be
appropriate to account for instances when a controlling entity may have
an investment in an investment company that would make the investment
company material to the controlling entity even though the investment
company's adviser is not material to the same controlling entity.\105\
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    \105\ See e.g., letters from EY, KPMG, and RSM. One commenter
noted that this situation is ``not likely to be common.'' See letter
from EY. Another commenter requested additional guidance to foster
consistent application. See letter from KPMG.
---------------------------------------------------------------------------

Comments on Proposed Rule 2-01(f)(14)(i)(F)--Inclusion of Investment
Companies Advised or Sponsored by an Affiliate Investment Adviser or
Sponsor
    In the Proposing Release, the Commission requested comment
regarding whether proposed Rule 2-01(f)(14)(i)(F), which would include
within an ICC any investment company that has any investment adviser or
sponsor that is an affiliate of the audit client pursuant to proposed
Rules 2-01(f)(14)(i)(A) through (D), should be adopted. Several
commenters supported the continued inclusion of sister investment
companies under proposed Rule 2-01(f)(14)(i)(F), regardless of the
materiality of the sister investment companies once an investment
adviser is deemed to be an affiliate under Rules 2-01(f)(14)(i)(A)
through (f)(14)(i)(D).\106\ However, one commenter stated that not
including a materiality qualifier in proposed Rule 2-01(f)(14)(i)(F)
renders the relief intended by the common control provision in the
proposed ICC definition ``inconsequential.'' \107\ Another commenter,
while supportive of proposed Rule 2-01(f)(14)(i)(F), recommended that
the reference to proposed Rule 2-01(f)(14)(i)(D) be removed from
proposed Rule 2-01(f)(14)(i)(F) with respect to investment companies
advised by sister investment advisers, because the proposed provision
appeared to be inconsistent with other proposed provisions that would
include a materiality qualifier for sister entity affiliates.\108\
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    \106\ See e.g., letters from BDO, EY, KPMG, and ICI/IDC.
    \107\ See letter from RSM. Specifically, the commenter stated
that all entities with a common investment adviser or sponsor should
not automatically be deemed affiliates when other common control
entities that are not material to the controlling entity are not
deemed affiliates.
    \108\ See letter from KPMG.
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Comments on Proposed Rule 2-01(f)(14)(i)(E)--the Significant Influence
Provision
    Some commenters expressly supported the proposed amendment to
introduce a significant influence provision in proposed Rule 2-
01(f)(14)(i)(E),\109\ and no commenters specifically opposed the
proposed amendment. One commenter, while not explicitly supporting or
objecting, recommended that the Commission reiterate the statement from
the Loan Provision Adopting Release that provides guidance on how to
apply significant influence in an investment company context.\110\
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    \109\ See e.g., letters from CAQ, BDO, EY, KPMG, and RSM.
    \110\ See letter from ICI/IDC.
---------------------------------------------------------------------------

    Commenters that addressed this aspect of the proposal also
supported the proposed conforming amendment to Rule 2-01(f)(6) to
reference the proposed significant influence provision in the ICC
definition.\111\
---------------------------------------------------------------------------

    \111\ See e.g., letters from EY, KPMG, and RSM.
---------------------------------------------------------------------------

iii. Final Amendments
Overall Approach to ICC Definition
    After considering the public comments and recommendations received,
we are adopting, substantially as proposed, amendments to the ICC
definition in amended 17 CFR 210.2-01(f)(14) (``amended Rule 2-
01(f)(14)''), with modifications to address the concerns and
suggestions raised by commenters and to align the ICC definition with
the final amendment related to the dual materiality threshold in
amended Rule 2-01(f)(4)(ii) discussed above.\112\
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    \112\ See Section II.A.1.a.iii.
---------------------------------------------------------------------------

    Consistent with the proposal, the final amendments to Rule 2-
01(f)(4), the affiliate of the audit client definition, direct an
auditor of an investment company or investment adviser or sponsor to
apply the ICC definition in amended Rule 2-01(f)(14) to identify
affiliates. As proposed, the amended ICC definition uses the term
``entity under audit'' as the starting point for the analysis of
entities included within the ICC definition.\113\ We also are adopting

as proposed a definition of ``investment company'' for the purpose of
amended Rule 2-01(f)(14) that includes unregistered funds.\114\
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    \113\ In addition, the final amendments make conforming
technical amendments to amended 17 CFR 210.2-01(f)(14)(i) to
incorporate the term ``entity under audit.'' Using the term ``entity
under audit'' in those subparagraphs alleviates the need to refer to
each subparagraph separately, which makes the subparagraphs more
concise. The conforming amendments to the subparagraphs of amended
17 CFR 210.2-01(f)(14)(i) retain the application of the ICC
definition as described in the Proposing Release.
    \114\ One commenter suggested that the Commission clarify
whether commodity pools are included within the meaning of the term
investment company for the purpose of applying amended Rule 2-
01(f)(14). See letter from PwC. The term investment company, for the
purpose of amended Rule 2-01(f)(14), does not include a commodity
pool unless that commodity pool is an investment company or would be
an investment company but for the exclusions provided by Section
3(c) of the Investment Company Act of 1940.
---------------------------------------------------------------------------

    Similarly, the final amendments to the ICC definition include the
significant influence provision of new 17 CFR 210.2-01(f)(14)(i)(E)
(``Rule 2-01(f)(14)(i)(E)'') substantially as proposed but modified to
incorporate the term ``entity under audit.''
New 17 CFR 210.2-01(f)(14)(i)(D)--Common Control and Materiality
    After considering the public comments and recommendations received,
we are adopting, with modification, new 17 CFR 210.2-01(f)(14)(i)(D)
(``Rule 2-01(f)(14)(i)(D)'') to incorporate the dual materiality
threshold in the common control provision, consistent with the
modification to the common control provision we are adopting for the
affiliate of the audit client definition.\115\
---------------------------------------------------------------------------

    \115\ See Section II.A.1.a.iii.
---------------------------------------------------------------------------

    We were persuaded by commenters that the dual materiality threshold
for identifying common control affiliates will be equally helpful in
reducing compliance challenges in the ICC context as in the operating
company context.\116\ Such alignment also provides internal consistency
within Rule 2-01, which should facilitate compliance efforts by
reducing the potential for confusion and inconsistency when assessing
common control affiliates.
---------------------------------------------------------------------------

    \116\ See e.g., letters from EY, AIC, and CCMC. For example,
CCMC expressed the view that Rule 2-01(f)(14)(i)(D) should be
amended to include sister investment advisers and investment
companies only when both the sister entity and the investment
adviser under audit, or the investment adviser or sponsor of an
investment company under audit, are material to the controlling
entity.
---------------------------------------------------------------------------

    Although some commenters objected to including a materiality
threshold in the ICC amendments, we do not believe the adopted approach
increases the risk to auditor independence. When an entity under audit
is under common control with an investment company, or an investment
adviser or sponsor, and the adopted dual materiality threshold is not
met, we believe there is less risk to an auditor's objectivity and
impartiality from the auditor's services to or relationships with such
sister entity, for the reasons discussed regarding the dual materiality
threshold for the common control provision in the affiliate of the
audit client definition.\117\ Further, we believe any threats to
independence that may exist when the entity under audit is not material
to the controlling entity will be sufficiently mitigated by the general
independence standard in Rule 2-01(b).\118\
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    \117\ Rule 2-01(f)(14)(i)(D) retains the existing provision that
includes sister entities engaged in the business of providing
administrative, custodian, underwriting, or transfer agent services
to any entity identified by amended 17 CFR 210.2-01(f)(14)(i)(A)
(``amended Rule 2-01(f)(14)(i)(A)'') and amended 17 CFR 210.2-
01(f)(14)(i)(B), regardless of materiality.
    \118\ One commenter sought clarification about whether Rule 2-
01(f)(14) would apply to engagements required by Rule 206(4)-2(a)(6)
under the Investment Advisers Act of 1940 (the ``Advisers Act
Custody Rule''). See letter from EY; 17 CFR 275.206(4)-2(a)(6). The
Advisers Act Custody Rule requires that when an investment adviser
or a related person acts as a qualified custodian for client funds
and securities, the investment adviser, in addition to the
independent verification requirement, must annually obtain, or
receive from the related person, an internal control report prepared
by an independent public accountant. The Advisers Act Custody Rule
defines a ``related person'' as ``any person, directly or
indirectly, controlling or controlled by [the investment adviser],
and any person that is under common control with [the investment
adviser].'' 17 CFR 275.206(4)-2(d)(7). For purposes of this
engagement, the related person qualified custodian would be the
``entity under audit'' under the final rule. Accordingly, the
auditor engaged would apply amended Rule 2-01(f)(4)--not amended
Rule 2-01(f)(14)--to determine the affiliates of the audit client,
which would require the auditor to assess the investment adviser's
materiality if under common control. In these circumstances,
however, the accountant would be required to be independent of the
adviser under Rule 2-01(b) regardless of the results of this
materiality determination.
---------------------------------------------------------------------------

    In response to commenters' request for guidance, consistent with
the discussion in Section II.A.1.a.iii above, we remind auditors and
their audit clients of their shared responsibility to monitor
independence, including monitoring affiliates and obtaining information
necessary to assess materiality. We are not providing any specific
guidance on materiality at this time because we understand that
auditors and their audit clients have developed approaches to determine
materiality in compliance with current rules, and we expect those
approaches would continue to be applicable under the final amendments.
Auditors, working together with their audit clients, should assess
materiality for the purpose of complying with Rule 2-01, as amended,
including consideration of relevant qualitative and quantitative
factors. Depending on the circumstances, it may be reasonable to use
certain measures, such as assets under management, when evaluating a
potential affiliate in one instance, but not when evaluating a
different potential affiliate. The assessment also should be attentive
to the nature of the relationship, the governance structure of the
entity, certain business and financial relationships, and other
relevant qualitative considerations.
    As noted in Section II.A.1.a.iii, understanding the organizational
structure of an audit client is important when considering the general
standard under Rule 2-01(b). We believe that after the initial
materiality assessment to identify potential affiliates, the auditor
and the audit client should conduct updated assessments based on any
transactions, Commission filings, or other information that become
known to the auditor or the audit client through reasonable inquiry.
New 17 CFR 210.2-01(f)(14)(i)(F)--The Provision To Include Investment
Companies Advised or Sponsored by an Affiliate Investment Adviser or
Sponsor
    After considering the public comments and recommendations received,
we are adopting, as proposed, new 17 CFR 210.2-01(f)(14)(i)(F) (``Rule
2-01(f)(14)(i)(F)''), which includes certain sister investment
companies within the ICC definition regardless of materiality. We
believe that this paragraph, together with the amendments to the common
control provision in Rule 2-01(f)(14)(i)(D), as discussed above, will
focus the scope of our independence rules on entities where
relationships and services are more likely to threaten an auditor's
objectivity and impartiality.
    Specifically, under the existing ICC definition, sister investment
advisers or sponsors and, as a result, their funds, regardless of
whether the sister investment advisers or sponsors are material to the
applicable controlling entities, would be included in the ICC of an
investment company under audit.\119\ Rule 2-01(f)(14)(i)(F) includes
within the ICC definition investment advisers or sponsors identified by
amended Rules 2-01(f)(14)(i)(A) through (D), which will include sister
investment advisers or sponsors where a dual material relationship
exists pursuant to Rule 2-01(f)(14)(i)(D) and exclude sister investment
advisers or sponsors where a dual material relationship does not exist.
While some commenters indicated that Rule 2-01(f)(14)(i)(F) should
include a materiality qualifier, we believe that such an approach risks
excluding entities where an auditor's services to or

relationships with a sister investment company could impair an
auditor's objectivity and impartiality because the sister investment
company is advised or sponsored by an affiliate investment adviser or
sponsor.
---------------------------------------------------------------------------

    \119\ See Rule 2-01(f)(14).
---------------------------------------------------------------------------

    Where a sister investment company shares the same adviser or
sponsor as an investment company under audit, we continue to believe
that these entities should be included as part of the ICC in evaluating
the auditor's independence, regardless of whether such sister
investment company is material to the shared investment adviser or
sponsor. In our view, the nature of the relationship between the
investment adviser and the entity under audit that it advises presents
risks to an auditor's objectivity and impartiality when the auditor has
relationships with or provides services to investment companies advised
by such investment adviser.
    Similarly, when a sister investment adviser or sponsor is included
under the dual materiality threshold, we believe that the investment
companies advised or sponsored by the sister investment adviser or
sponsor should be included as part of the ICC in evaluating the
auditor's independence, regardless of whether such sister investment
companies are material to the applicable controlling entities. Once the
sister investment adviser or sponsor is included in the ICC due to the
dual materiality threshold, relationships with and services to
investment companies advised or sponsored by the sister investment
adviser or sponsor also are more likely to pose a threat to an
auditor's objectivity and impartiality.
Amended 17 CFR 210.2-01(f)(14)(i)(C)--Application to Portfolio
Companies Controlled by Sister Investment Companies
    As noted above, we received several comments regarding how the
control provision in proposed Rule 2-01(f)(14)(i)(C) applies to
portfolio companies of an affiliate sister investment company when an
investment company is under audit.\120\ We are mindful of the concerns
raised by commenters and are adopting the control provision in amended
17 CFR 210.2-01(f)(14)(i)(C) (``amended Rule 2-01(f)(14)(i)(C)'') with
modifications to apply a dual materiality threshold for portfolio
companies of sister investment companies that are controlled by the
investment adviser or sponsor unless the portfolio companies are
engaged in the business of providing administrative, custodial,
underwriting, or transfer agent services to any entity identified by
amended Rules 2-01(f)(14)(i)(A) or (B). As illustrated by Example 5
below, this modification will affect only the application of the rule
for portfolio companies because Rule 2-01(f)(14)(i)(F), as discussed
above, will dictate when sister investment companies are included
within the ICC definition.
---------------------------------------------------------------------------

    \120\ See e.g., letters from CAQ, BDO, EY, KPMG, Crowe, and AIC.
---------------------------------------------------------------------------

    Under a scenario where neither the investment company under audit
nor the portfolio company is material to the shared investment adviser
or sponsor, there is less risk to the auditor's objectivity and
impartiality. The modification in amended Rule 2-01(f)(14)(i)(C) does
not alter the application of the ICC definition to portfolio companies
controlled by an investment company under audit, as such portfolio
companies will always be included in the ICC pursuant to amended 17 CFR
210.2-01(f)(14)(i)(C)(1) (``amended Rule 2-01(f)(14)(i)(C)(1)''). The
following is intended as an illustrative example only, and
practitioners and audit clients should be aware that an assessment of
materiality requires consideration of all relevant facts and
circumstances, including quantitative and qualitative factors.
[GRAPHIC] [TIFF OMITTED] TR11DE20.004

    Investment Company A, the entity under audit, is advised by Adviser
1, which also advises Investment Company B. Investment Company B
controls Portfolio Company X and, as a result, Adviser 1 is deemed to
control Portfolio Company X. Pursuant to amended Rule 2-
01(f)(14)(i)(C)(1), Investment Company A's auditor would include in the
ICC any portfolio company controlled by Investment Company A even if
the portfolio company is not material to Adviser 1. Pursuant to Rule 2-
01(f)(14)(i)(F), the auditor also would include in the ICC Investment
Company B even if Investment Company B is not material to Adviser 1.
However, the auditor would apply the dual materiality threshold in new
17 CFR 210. 2-01(f)(14)(i)(C)(2) (``Rule 2-01(f)(14)(i)(C)(2)'') to
determine if Portfolio Company X is included in the ICC in connection
with Investment Company A's audit. If neither Portfolio Company X nor
Investment Company A is material to Adviser 1 and Portfolio

Company X is not engaged in the business of providing administrative,
custodial, underwriting, or transfer agent services to any entity
identified by amended Rules 2-01(f)(14)(i)(A) and (B), Portfolio
Company X would not be included in the ICC in connection with the audit
of Investment Company A.
2. Amendment to the Definition of Audit and Professional Engagement
Period
    Rules 2-01(c)(1) through (5) prescribe certain circumstances the
occurrence of which during the ``audit and professional engagement
period'' are inconsistent with the general standard under Rule 2-
01(b).\121\ Under the current rule, the term ``audit and professional
engagement period'' is defined differently for domestic issuers and
foreign private issuers (``FPIs'') \122\ that are filing, or required
to file, a registration statement or report with the Commission for the
first time (``first-time filers''). Specifically, 17 CFR 210.2-
01(f)(5)(i) and (ii) define the audit and professional engagement
period as including both the ``period covered by any financial
statements being audited or reviewed'' and the ``period of the
engagement to audit or review the . . . financial statements or to
prepare a report filed with the Commission . . .'' (the ``look-back
period''). However, 17 CFR 210.2-01(f)(5)(iii) (``Rule 2-
01(f)(5)(iii)'') of the definition narrows the audit and professional
engagement period for audits of the financial statements of foreign
private issuers to the ``first day of the last fiscal year before the
foreign private issuer first filed, or was required to file, a
registration statement or report with the Commission, provided there
has been full compliance with home country independence standards in
all prior periods covered by any registration statement or report filed
with the Commission.''
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    \121\ See Preliminary Note 2 and Rules 2-01(c)(1) through (5).
    \122\ 17 CFR 240.3b-4(c). A foreign private issuer is any
foreign issuer other than a foreign government, except for an issuer
that (1) has more than 50% of its outstanding voting securities held
of record by U.S. residents; and (2) any of the following: (i) A
majority of its executive officers or directors are citizens or
residents of the United States; (ii) more than 50% of its assets are
located in the United States; or (iii) its business is principally
administered in the United States. See 17 CFR 240.3b-4(c).
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a. Proposed Amendments
    The Commission proposed to amend Rule 2-01(f)(5)(iii) so that the
one year look-back period for first-time filers will apply to all such
filers, which would result in treating all first-time filers (i.e.,
domestic issuers and FPIs) similarly for purposes of the independence
requirements under Rule 2-01.\123\
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    \123\ The proposed amendment would not impact the compliance
analysis related to the partner rotation provisions in 17 CFR 210.2-
01(c)(6).
---------------------------------------------------------------------------

    In the Proposing Release, the Commission explained that the
proposed amendment would provide parity between domestic issuers and
FPIs and noted feedback that such parity may also benefit capital
formation.\124\ The Commission stated its belief that the proposed
requirement to comply with applicable independence standards in all
prior periods included in the first-time filing sufficiently mitigates
the risk associated with shortening the look-back provision for
domestic first-time filers. In addition, as it relates to relationships
and services in prior years that would not be included in the look-back
period as a result of the proposed amendment, the Commission noted that
such relationships and services still would be considered under the
general independence standard of Rule 2-01(b), either individually or
in the aggregate.
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    \124\ See Section II.A.2 of the Proposing Release.
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b. Comments Received
    Many commenters supported the proposed amendment to shorten the
domestic company look-back period for evaluating independence
compliance to the most recent year to be included in the first filing
with the Commission.\125\ Several commenters stated that the current
requirement can result in challenges, cost, or delays to an initial
public offering (``IPO'').\126\ One commenter indicated that these
challenges are especially relevant in the private equity environment
where strategies change within a one- or two-year time frame.\127\ Some
commenters also noted that the current provision puts domestic issuers
at a disadvantage relative to FPIs.\128\
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    \125\ See e.g., letters from NASBA, CAQ, AICPA, Deloitte, BDO,
EY, KPMG, RSM, PwC, Crowe, AIC, EQT, FEI, GT, CCMC, and Parrett.
    \126\ See e.g., letters from CAQ, Deloitte, EY, EQT, GT, PwC,
and AIC.
    \127\ See letter from BDO.
    \128\ See e.g., letters from EQT and FEI.
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    Some commenters opposed the proposed amendment and, instead,
suggested the Commission lengthen the look-back period for FPIs.\129\
One of these commenters posited that entities contemplate going public
for years before an IPO and, as such, the current domestic look-back
period is not an ``egregious'' burden.\130\ Another commenter cited the
increased risk associated with ``unicorn'' IPOs and asserted that this
proposed amendment would weaken the applicable independence rules when
serious questions ``have arisen around accounting practices at some of
the largest private companies.'' \131\
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    \129\ See e.g., letters from NYSSCPA, CII, and CFA.
    \130\ See letter from NYSSCPA.
    \131\ See letter from CFA.
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    A few commenters supported the Commission's view that all
relationships and services in prior periods should still be evaluated
under Rule 2-01(b) and that these relationships and services should be
easily known.\132\
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    \132\ See e.g., letters from Deloitte and KPMG. But see letters
from RSM and PwC. The view expressed by RSM and PwC regarding the
application of Rule 2-01(b) also applies to the discussion of its
applicability in this context.
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    Several commenters also requested that the Commission clarify how
the proposed amendment would apply to specific situations such as:
     Reverse mergers or special purpose acquisition companies,
if such a transaction is being considered by an audit client that is
currently an issuer; \133\
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    \133\ See letter from GT.
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     An existing and a new audit relationship; \134\ and
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    \134\ See letter from KPMG.
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     When a registration statement is withdrawn and a new
registration statement subsequently is filed.\135\
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    \135\ See letters from GT and Crowe.
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c. Final Amendments
    After considering the public comments and recommendations received,
we are adopting amended 17 CFR 210.2-01(f)(5)(iii) (``amended Rule 2-
01(f)(5)(iii)'') as proposed. As noted in the Proposing Release, the
staff has observed, from its independence consultation experience
related to potential filings of initial registration statements, that
often one factor, among many, in the auditor's objectivity and
impartiality analysis is how long ago the service or relationship
ended. If the service or relationship ended in the early years of the
financial statements included in the initial registration statement,
that fact may support a conclusion that the auditor is objective and
impartial under Rule 2-01 at the time the IPO is consummated. As
discussed above, a number of commenters supported the Commission's
reasoning for the proposal.
    We were not persuaded by the commenters who opposed the proposal
and who recommended lengthening the look-back period for FPIs instead.
As a general matter, we believe that lengthening the look-back period
would unnecessarily increase the burden on

capital formation and impose new regulatory costs on FPIs without
significantly enhancing investor protection. With respect to the
comment regarding the impact of shortening the look-back period for
``unicorn'' IPOs,\136\ it is not clear that financial reporting quality
would be undermined or concerns, such as ``inadequate corporate
governance and lax accounting practices,'' would be exacerbated by the
shorter look-back period for domestic issuers. Moreover, the final
amendments do not affect the auditing standards to which a company
undergoing an IPO is subject. Additionally, we continue to believe that
applying Rule 2-01 to the most recent fiscal year, together with the
application of the general independence standard in Rule 2-01(b) and
the requirement to comply with applicable independence standards for
the earlier years, mitigate the risk to an auditor's objectivity and
impartiality associated with the shorter look-back period.\137\
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    \136\ See letter from CFA.
    \137\ For additional guidance regarding the application of Rule
2-01(b) to the final amendments, see Section II.A.1.a.iii, above.
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    In response to some commenters' request for clarification or
guidance, we note that the final amendment applies to both existing and
new audit relationships. We see no proportionate investor protection
benefit to introducing complexity to a first-time filer's decision
whether to retain or select a new auditor by applying different
standards. Where a registrant is undergoing a reverse merger that is in
substance similar to an IPO, the audit client and auditor should not
apply the transition framework discussed in Section II.D, but may apply
the shorter look-back period under the final amendments.\138\ Finally,
consistent with the position taken by the staff in consultations, we
are clarifying that where an issuer withdraws an initial registration
statement, the re-filing of a new registration statement would be
considered the issuer's first-time filing.
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    \138\ See Section II.D.3.
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B. Amendments to Loans or Debtor-Creditor Relationships

1. Amendment To Except Student Loans
a. Proposed Amendment
    The Loan Provision in Rule 2-01(c)(1)(ii)(A) provides that an
accountant is not independent if it has any loan to or from an audit
client and certain other persons related to the audit client. The Loan
Provision also excepts four types of loans from its scope.\139\ The
Commission proposed to add an exception to 17 CFR 210. 2-
01(c)(1)(ii)(A)(1) (``Rule 2-01(c)(1)(ii)(A)(1)'') for student loans
obtained from a financial institution under its normal lending
procedures, terms, and requirements for a covered person's educational
expenses, provided the loan was obtained by the individual prior to
becoming a covered person in the firm as defined in 17 CFR 210.2-
01(f)(11).\140\
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    \139\ See Rule 2-01(c)(1)(ii)(A)(1)(i) through (iv), which lists
as excepted loans those that are collateralized by automobiles,
insurance policies, cash deposits, and primary residences.
    \140\ See 17 CFR 210.2-01(f)(11), defining which partners,
principals, shareholders, and employees of an accounting firm are
considered covered persons.
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    In the Proposing Release, the Commission indicated that limiting
the exception to student loans ``not obtained while the covered person
in the firm was a covered person'' would provide a familiar compliance
principle as it is consistent with the limitation to the primary
mortgage loan exception in current 17 CFR 210.2-01(c)(1)(ii)(A)(1)(iv)
(``Rule 2-01(c)(1)(ii)(A)(1)(iv)''). The Commission also expressed the
belief that obtaining a student loan as a covered person poses a higher
risk to the auditor's objectivity and impartiality and creates, at a
minimum, an independence appearance issue that is not present when a
non-covered person obtained a similar student loan from such audit
client.
    The proposed amendment also limited the exclusion to student loans
obtained for the covered person's educational expenses. The Commission
did not propose to extend the exception to a covered person's immediate
family members due to concerns, at that time, that the amount of
student loan borrowings could be significant when considering student
loans obtained for multiple immediate family members and thus could
impact an auditor's objectivity and impartiality.
b. Comments Received
    Commenters generally supported adding student loans to the list of
excepted loans.\141\ Many commenters recommended that the Commission
expand the exception to include student loans of the covered person's
immediate family members under the same terms as the proposed
amendment.\142\ For example, one commenter questioned the Commission's
argument that ``the amount of student loan borrowings could be
significant when considering student loans obtained for multiple
immediate family members and thus could impact an auditor's objectivity
and impartiality'' when considering that there is no similar
proscription with respect to a mortgage loan, which could be
substantially more significant than student loan debt in terms of
absolute dollars.\143\ However, another commenter agreed with the
proposal not to include student loans of immediate family members in
the proposed amendment.\144\
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    \141\ See e.g., letters from NASBA, NYSSCPA, CAQ, Deloitte, BDO,
EY, KPMG, RSM, PwC, GT, Crowe, CII, ICI/IDC, IBC, FEI, Fund AC
Chairs, and CCMC.
    \142\ See e.g., letters from NASBA, NYSSCPA, CAQ, Deloitte, BDO,
EY, KPMG, RSM, PwC, GT, Crowe and ICI/IDC.
    \143\ See letter from NYSSCPA.
    \144\ See letter from CII.
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    In the Proposing Release, the Commission requested comment on
whether student loans of a covered person's immediate family members
also should be excluded. Some commenters indicated that even if the
proposed amendment were expanded to include student loans of immediate
family members, there should be no limit on the amount
outstanding.\145\ One commenter suggested that the materiality of the
loan to the covered person's net worth should be considered.\146\ A few
commenters indicated that Rule 2-01(b) should mitigate the risks of the
amount of student loans impairing an auditor's objectivity and
impartiality.\147\ Without addressing immediate family members' loans,
some commenters asserted that there should be no limit on the amount
outstanding, similar to the existing primary residence mortgage
exception.\148\ We also note that certain commenters requested that the
Commission clarify the scope of the term ``educational expenses'' and
whether it includes expenses for room and board, tuition, books, and
other educational supplies.\149\
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    \145\ See e.g., letters from RSM, Deloitte, and EY.
    \146\ See letter from NASBA.
    \147\ See e.g., letters from Deloitte and EY.
    \148\ See e.g., letters from NYSSCPA, BDO, and KPMG.
    \149\ See e.g., letters from CAQ, BDO, PwC, Crowe, and GT.
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c. Final Amendment
    After considering the public comments and recommendations received,
we are adopting amendments to except certain student loans from the
Loan Provision with two modifications from the proposed amendments.
Consistent with the recommendation of many commenters, the final
amendment also will except student loans obtained by a covered person's
immediate family members, as that term is defined in 17 CFR 210.2-
01(f)(13). We are persuaded that there is no need to include such a
limitation, especially in light of the fact that similar exclusions,
such as the one

for mortgage loans, are not similarly proscribed. Also, in response to
comments seeking guidance on the term ``educational expenses,'' we
believe the entire balance for loans that qualify as a student loan
under the applicable terms, conditions, and requirements should be
within the scope of the final amendments.
    The proposed amendment's reference to student loans ``obtained for
a covered person's or his or her immediate family members' educational
expenses'' was intended to make explicit that it is only student loans
for the covered persons' and their immediate family members'
educational expenses that should be covered and not loans that they
undertake to pay for another person's educational expenses. That
limitation continues to apply. However, we are modifying the rule text
to delete this phrase to avoid potential confusion about whether
``educational expenses'' is meant as a limitation on the amount of
student loans excepted.\150\ The remaining terms of the exclusion are
consistent with the proposal.
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    \150\ With ``educational expenses'' deleted, the reference to
covered persons and their immediate family members would be
duplicative of the same references in 17 CFR 210.2-01(c)(1)(ii).
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    We are not specifying a numerical limit to the amount of
outstanding student loans held by a covered person or a covered
person's immediate family members that would be excepted. In light of
comments received, we are persuaded that the purpose for which student
loans are incurred and the standard terms associated with such loans
set them apart from other debtor/creditor relationships not excepted
from the Loan Rule and are less likely to threaten an auditor's
objectivity and impartiality. We believe the nature of student loans
and the requirement that the loans are obtained from a financial
institution under its normal lending procedures, terms, and
requirements mitigate the risk such loans would pose to an auditor's
objectivity and impartiality. Not including a numerical limit also is
consistent with the exception for mortgage loans in Rule 2-
01(c)(1)(ii)(A)(1)(iv).
2. Amendment To Clarify the Reference to ``A Mortgage Loan''
a. Proposed Amendment
    The Commission proposed a clarifying amendment to the reference to
``a mortgage loan'' in Rule 2-01(c)(1)(ii)(A)(1)(iv) to refer to
``mortgage loans'' in the plural. As noted in the Proposing Release,
Rule 2-01(c)(1)(ii)(A)(1)(iv) was not intended to exclude just one
outstanding mortgage loan on a borrower's primary residence, and the
Commission staff has previously provided guidance consistent with the
proposed amendment.\151\
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    \151\ See Section B. Question 1 Office of the Chief Accountant:
Application of the Commission's Rules on Auditor Independence
Frequently Asked Questions (June 27, 2019) (originally issued August
6, 2007) (``Auditor Independence FAQs'') (indicating the staff's
view that the rationale for a mortgage on a primary residence also
applies to second mortgages, home improvement loans, equity lines of
credit and similar mortgage obligations collateralized by a primary
residence obtained from a financial institution under its normal
lending procedures, terms and requirements and while not a covered
person in the firm).
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b. Comments Received
    Commenters supported the proposed amendment.\152\ We received no
comments specifically opposing this proposed amendment. One commenter
requested examples of how the proposed amendment applies to different
types of mortgage loans, such as home equity or home improvement
loans.\153\ Another commenter suggested that the Commission consider
extending the exemption to include mortgages collateralized by property
other than primary residences.\154\ One commenter requested that the
Commission include in the adopting release the guidance discussed in
Section II.B.2 of the Proposing Release regarding the situation where a
borrower becomes a covered person only because of a change in the
ownership in the loan.\155\
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    \152\ See e.g., letters from NASBA, NYSSCPA, CAQ, BDO, EY, KPMG,
RSM, PwC, GT, FEI, and Crowe.
    \153\ See letter from FEI.
    \154\ See letter from Crowe.
    \155\ See letter from EY.
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c. Final Amendment
    After considering the public comments and recommendations received,
we are adopting as proposed the amendment to Rule 2-
01(c)(1)(ii)(A)(1)(iv) to refer to ``mortgage loans'' instead of ``a
mortgage loan.'' In response to the commenter who requested examples or
guidance on the application of the mortgage loan exception when a
borrower has obtained different types of loans collateralized by a
primary residence, we note that the Commission has previously clarified
that the rationale for the mortgage loan exception focuses on the
status of the covered person at the time of the loan origination.\156\
The same focus applies to second mortgages, home improvement loans,
equity lines of credit, and similar mortgage obligations collateralized
by a primary residence obtained from a financial institution under its
normal lending procedures, terms and requirements and while the
borrower is not a covered person in the firm.
---------------------------------------------------------------------------

    \156\ See 2000 Adopting Release.
---------------------------------------------------------------------------

    Also, as noted in the Proposing Release,\157\ where the borrower
becomes a covered person only because of a change in the ownership in
the loan, and provided there is no modification in the original terms
or conditions of the loan or obligation after the borrower becomes, or
in contemplation of the borrower becoming, a covered person, the loan
would be included within this exception.
---------------------------------------------------------------------------

    \157\ Section II.B.2 of the Proposing Release.
---------------------------------------------------------------------------

    Regarding a commenter's suggestion to extend the mortgage loan
exception to loans collateralized by a non-primary residence (e.g., a
secondary or vacation home), we believe excepting loans on non-primary
residences, which may be held for investment, would introduce increased
risk to an auditor's objectivity and impartiality. As such, we do not
see a compelling reason to expand the exception as suggested.
3. Amendment To Revise the Credit Card Rule To Refer to ``Consumer
Loans''
a. Proposed Amendment
    The Commission proposed revising 17 CFR 210.2-01(c)(1)(ii)(E)
(``Rule 2-01(c)(1)(ii)(E)'') (the ``Credit Card Rule'') to replace the
reference to ``credit cards'' with ``consumer loans'' and revise the
provision to reference any consumer loan balance owed to a lender that
is an audit client that is not reduced to $10,000 or less on a current
basis taking into consideration the payment due date and available
grace period. The Proposing Release set forth the Commission's view
that a limited amount of debt that is routinely incurred by a covered
person or any of his or her immediate family members for personal
consumption, even if the audit client is the lending entity, would
typically not impair an auditor's objectivity and impartiality. The
proposed amendment would expand the current Credit Card Rule to
encompass the types of consumer financing borrowers routinely obtain
for personal consumption, such as, for example, retail installment
loans, cell phone installment plans, and home improvement loans that
are not secured by a mortgage on a primary residence. The Proposing
Release explained that the types of consumer loans contemplated, like
credit cards, would typically have a payment due date (e.g.,
monthly).\158\
---------------------------------------------------------------------------

    \158\ Section II.B.3 of the Proposing Release.

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b. Comments Received
    All commenters that addressed this proposed amendment expressed
their support.\159\ We received no comments that specifically opposed
this proposed amendment. Some commenters supported the proposed $10,000
limit,\160\ while other commenters recommended raising the limit to
$20,000 to account for inflation.\161\ One commenter suggested an
increase to $20,000 or $25,000 while citing to recent studies about
consumer finances.\162\ Some commenters encouraged the Commission to
consider adjustments of the dollar threshold to account for