Acquisitions? CEO Overconfidence and the Market's Reaction, 89
Journal of Financial Economics 20 (2008).
    \118\ See Paul Hribar and Holly Yang, CEO Overconfidence and
Management Forecasting, 33 Contemporary Accounting Research 204
(2016).
---------------------------------------------------------------------------

    Given the degree of subjectivity in many financial statement
estimates, these incentive and information issues, coupled with
cognitive biases, present particular problems in the context of
estimates. Managerial biases (conscious or otherwise) may lead managers
to pick a more favorable estimate within the permissible range.\119\
That is, incentive problems and cognitive biases may push management
toward the most favorable estimates, either with respect to specific
accounts or in the overall presentation.
---------------------------------------------------------------------------

    \119\ For purposes of this discussion, a ``favorable'' estimate
can reflect either an upward or a downward bias, for example in
earnings, depending on management incentives.
---------------------------------------------------------------------------

    Audits are one of the mechanisms for mitigating the information and
incentive problems arising in the investor-management
relationship.\120\ Audits are intended to provide a check of
management's financial statements, and thus reduce management's
potential

incentive to prepare and disclose biased or inaccurate financial
statements. Audit reports and auditing standards provide information to
the market that may affect perceptions about the reliability of the
financial statements and therefore mitigate investors' information
problem, potentially lowering the company's cost of capital.\121\
---------------------------------------------------------------------------

    \120\ See Paul M. Healy and Krishna G. Palepu, Information
Asymmetry, Corporate Disclosure, and the Capital Markets: A Review
of the Empirical Disclosure Literature, 31 Journal of Accounting and
Economics 405, 406 (2001). See also Mark DeFond and Jieying Zhang, A
Review of Archival Auditing Research, 58 Journal of Accounting and
Economics 275 (2014).
    \121\ See, e.g., Richard A. Lambert, Christian Leuz, and Robert
E. Verrecchia, Accounting Information, Disclosure, and the Cost of
Capital, 45 Journal of Accounting Research 385 (2007).
---------------------------------------------------------------------------

    The auditor is also an agent of investors, however, and the
information asymmetry between investors and auditors can also give rise
to risks of moral hazard and adverse selection. Auditors have
incentives that align their interests with those of investors, such as
legal considerations, professional responsibilities, and reputational
concerns. However, they may also have incentives to behave sub-
optimally from investors' point of view by, for example, (1) not
sufficiently challenging management's estimates or underlying
assumptions in order not to disturb the client relationship; (2)
shirking, if they are not properly incentivized to exert the effort
considered optimal by shareholders; or (3) seeking to maximize profits
and/or minimize costs--sometimes at the expense of audit quality. As a
result of such misaligned incentives, auditors may engage in practices
that do not align with investors' needs and preferences.
    In addition to the auditor's potential moral hazard problem, the
presence of bounded rationality can inject another layer of challenges
into auditing estimates. In economic theory, bounded rationality refers
to the idea that when individuals make decisions, their rationality may
be limited by certain bounds, such as limits on available information,
limits on analytical ability, limits on the time available to make the
decision, and inherent cognitive biases.\122\ Even if incentives
between principal and agent are aligned, the agent, being boundedly
rational, may be unable to execute appropriately. Hence, some auditors
may find auditing certain estimates challenging because, like all
individuals, they may have limits on their ability to solve complex
problems and to process information,\123\ especially when faced with
time constraints.\124\ Research has shown that even sell-side research
analysts, generally understood to be sophisticated financial experts,
have trouble assessing the impact on earnings of companies' derivative
instruments, where the associated financial reporting involves fair
value measurements.\125\
---------------------------------------------------------------------------

    \122\ For a seminal work in this field, see Herbert A. Simon, A
Behavioral Model of Rational Choice, 69 The Quarterly Journal of
Economics 99 (1955). Simon introduced this theory and argued that
individuals cannot assimilate and process all the information that
would be needed to maximize their benefits. Individuals do not have
access to all the information required to do so, but even if they
did, they would be unable to process it properly, since they are
bound by cognitive limits.
    \123\ Daniel Kahneman refers to the mind as having two systems,
System 1 and System 2. ``System 1 operates automatically and quickly
. . . '' System 2 is the slower one that ``can construct thoughts in
an orderly series of steps.'' System 2 operations ``require
attention and are disrupted when attention is drawn away.'' Daniel
Kahneman, Thinking, Fast and Slow 4, 20-22 (1st ed. 2011). Examples
of System 2 operations include ``[f]ill[ing] out a tax form'' and
``[checking] the validity of a complex logical argument,'' both of
which require time and attention. Without time, one cannot dedicate
attention to a task and fully engage System 2, and hence is left
with the automatic instinctual operation of System 1, which can lead
to use of rules of thumb (heuristics) and ``biases of intuition.''
Id.
    \124\ Time is an essential limitation to problem solving, being
fundamental to the definition of bounded rationality--``[t]he
principle that organisms have limited resources, such as time,
information, and cognitive capacity, with which to find solutions to
the problems they face.'' Andreas Wilke and R. Mata, Cognitive Bias,
as published in The Encyclopedia of Human Behavior 531 (2nd ed.
2012).
    \125\ See Hye Sun Chang, Michael Donohoe, and Theodore
Sougiannis, Do Analysts Understand the Economic and Reporting
Complexities of Derivatives? 61 Journal of Accounting and Economics
584 (2016). For a discussion of the bounded rationality of audit
judgments, see Brian Carpenter and Mark Dirsmith, Early Debt
Extinguishment Transactions and Auditor Materiality Judgments: A
Bounded Rationality Perspective, 17 (8) Accounting, Organizations
and Society 709, 730 (1992) (``[T]he self-reported actions taken by
auditors on actual engagements appear to reveal less complexity in
the sense that they are boundedly rational and tend to emphasize
only a single judgment criterion than do the cognitive judgment
processes of which they are capable.'').
---------------------------------------------------------------------------

    In the context of auditing estimates, one such bound may be the
ability of auditors to analyze and integrate different existing
standards or process the information required to audit estimates that
involve complex processes, which may require sophisticated analytical
and modeling techniques. In the presence of bounded rationality,
individuals may resort to heuristics (i.e., rules of thumb).\126\ In
particular, auditors facing challenges in auditing an accounting
estimate may resort to simplifications that might increase the
potential for biases or errors that have seeped into financial
statements to go undetected.\127\
---------------------------------------------------------------------------

    \126\ ``The essence of bounded rationality is thus to be a
`process of thought' rather than a `product of thought': Individuals
have recourse to reasonable procedures rather than to sophisticated
computations which are beyond their cognitive capacities.'' Bertrand
Munier, Reinhard Selten, D. Bouyssou, P. Bourgine et al., Bounded
Rationality Modeling, 10 Marketing Letters 233, 234 (1999). In
``[s]ituations where evolved task-general procedures are helpful
(heuristics, chunks) . . . agents have difficulty finding even
qualitatively appropriate responses . . . agents are then left with
heuristics . . . '' Id. at 237.
    \127\ For a discussion and examples of heuristics used by
auditors, see, e.g., Stanley Biggs and Theodore Mock, An
Investigation of Auditor Decision Processes in the Evaluation of
Internal Controls and Audit Scope Decisions, 21 (1) Journal of
Accounting Research 234 (1983).
---------------------------------------------------------------------------

    The literature has linked cognitive issues to auditors' actions and
attitudes, specifically to professional skepticism.\128\ For example,
``research in psychology and accounting has identified that auditors'
judgments are vulnerable to various problems, such as difficulty
recognizing patterns of evidence, applying prior knowledge to the
current judgment task, weighting evidence appropriately, and preventing
incentives from affecting judgment in unconscious ways.'' \129\ As a
result, cognitive limitations may pose a threat to professional
skepticism \130\ and ``[b]ias-inducing tendencies can lead even the
brightest, most experienced professionals, including auditors, to make
suboptimal judgments.'' \131\ Accordingly, the existence of bounded
rationality and, in particular, some inherent cognitive biases might
affect auditor judgment when auditing accounting estimates, even
separate from any potential conflict of interest.
---------------------------------------------------------------------------

    \128\ Nelson argues that ``[p]roblem-solving ability, ethical
predisposition, and other traits like self-confidence and tendency
to doubt are all related to [professional skepticism] in judgment
and action,'' and, furthermore ``[c]ognitive limitations affect
[professional skepticism] in predictable ways.'' Mark Nelson, A
Model and Literature Review of Professional Skepticism in Auditing,
28 Auditing: A Journal of Practice & Theory 1, 2 (2009).
    \129\ Id. at 6.
    \130\ ``[A]uditors' judgments can be flawed because, like all
people, sometimes they do not consistently follow a sound judgment
process and they fall prey to systematic, predictable traps and
biases. People, including experienced professionals . . . often
unknowingly use mental ``shortcuts'' . . . to efficiently navigate
complexity . . . [S]ituations can arise where they systematically
and predictably lead to suboptimal judgments and potentially inhibit
the application of appropriate professional skepticism.'' Steven M.
Glover and Douglas F. Prawitt, Enhancing Auditor Professional
Skepticism (Nov. 2013) (a report commissioned by the Standards
Working Group of the Global Public Policy Committee), at 10.
    \131\ Id.
---------------------------------------------------------------------------

    Some of the biases that might affect auditors include, but are not
limited to:
     Anchoring Bias--decision makers anchor or overly rely on
specific information or a specific value and then adjust to that value
to account for other elements of the circumstance, so that there is a
bias toward that value. In the auditing of estimates, the potential
exists for anchoring on management's

estimates.\132\ This can be seen as a manifestation of findings that
auditors may, at times, experience difficulties weighting evidence
appropriately.\133\
---------------------------------------------------------------------------

    \132\ For a discussion on anchoring biases and some evidence,
see, e.g., Robert Sugden, Jiwei Zheng, and Daniel John Zizzo, Not
All Anchors Are Created Equal, 39 Journal of Economic Psychology 21
(2013).
    \133\ Nelson, A Model and Literature Review of Professional
Skepticism in Auditing 6.
---------------------------------------------------------------------------

     Confirmation Bias--a phenomenon wherein decision makers
have been shown to actively seek out and assign more weight to evidence
that confirms their hypothesis, and ignore or underweight evidence that
could disconfirm their hypothesis. As such, confirmation bias can be
thought of as a form of selection bias in collecting evidence. It
becomes even more problematic in the presence of anchoring bias, since
auditors may anchor on management's estimate and may only seek out
information to corroborate that value (or focus primarily on
confirming, rather than challenging, management's model).\134\ For
example, in the accounting estimates standard, as one of the available
three approaches in evaluating the reasonableness of an estimate, the
auditor is instructed to ``develop an independent expectation of the
estimate to corroborate the reasonableness of management's estimate''
(emphasis added).\135\
---------------------------------------------------------------------------

    \134\ For a discussion of confirmation bias, see, e.g., Raymond
S. Nickerson, Confirmation Bias: A Ubiquitous Phenomenon in Many
Guises, 2 Review of General Psychology 175 (1998). For a discussion
of the manifestation of this bias in auditing, see, e.g., Griffith
et al., Audits of Complex Estimates as Verification of Management
Numbers: How Institutional Pressures Shape Practice.
    \135\ AS 2501.10b.
---------------------------------------------------------------------------

     Familiarity Bias--``Familiarity is associated with a
general sense of comfort with the known and discomfort with--even
distaste for and fear of--the alien and distant.'' \136\ In the context
of auditing accounting estimates, auditors may be biased toward
procedures, methods, models, and assumptions that seem more familiar to
them, and auditors' familiarity with management may lead them to tend
to accept management's assertions without sufficient challenge or
consideration of other options.\137\
---------------------------------------------------------------------------

    \136\ Gur Huberman, Familiarity Breeds Investment, 14 Review of
Financial Studies 659, 678 (2001).
    \137\ Academic research also argues and provides evidence that
some level of auditor familiarity with the client can help the
auditing process. See Wuchun Chi and Huichi Huang, Discretionary
Accruals, Audit-Firm Tenure and Audit-Partner Tenure: Empirical
Evidence from Taiwan, 1 (1) Journal of Contemporary Accounting and
Economics 65, 67 (2005). Although the study does not address
familiarity bias, the results indicate that auditor familiarity with
the client produces higher earnings quality as it has an effect on
learning experience and increases client-specific knowledge, while
excessive familiarity impairs audit quality, resulting in lower
earnings quality.
---------------------------------------------------------------------------

    All of these cognitive biases would pose a threat to the proper
application of professional skepticism and an appropriate focus on the
potential for management bias in accounting estimates. Academic
research illustrates how cognitive biases may affect auditing. Griffith
et al. find that auditors focus primarily on confirming, rather than
challenging, management's model, and appear to accept management's
model as a starting point and then verify aspects of that model.\138\
None of the auditors in the study indicated that he or she considered
whether additional factors beyond the assumptions made by management
should be included in management's model. This type of behavior is
suggestive of anchoring bias.\139\
---------------------------------------------------------------------------

    \138\ See Griffith et al., Audits of Complex Estimates as
Verification of Management Numbers: How Institutional Pressures
Shape Practice.
    \139\ The problem resulting from this bias can be ameliorated,
but not completely eliminated. The audit, by its nature, uses the
company's financial statements as a starting point. For that reason,
starting with management's number is often unavoidable since the
auditor is opining on whether the company's financial statements are
fairly presented, in all material respects, in conformity with the
applicable financial reporting framework. When reference is made to
anchoring bias in this release, it is therefore not intended to
refer to the auditor's responsibility to start with management's
financial statements, but instead to the auditor's potential failure
to effectively challenge management.
---------------------------------------------------------------------------

    Importantly, bounded rationality and the associated biases exist in
addition to any incentive problems (moral hazard). Cognitive biases and
moral hazard could work in the same direction to increase the
likelihood of auditors agreeing with management, not considering
contradictory evidence, or discounting the potential importance or
validity of alternative methods, data, and assumptions. It is important
for auditors to be wary of their own biases as well as management's
biases when auditing accounting estimates (e.g., in order to avoid
merely searching for evidence that corroborates management's
assertions).\140\
---------------------------------------------------------------------------

    \140\ See, e.g., Martin et al., Auditing Fair Value
Measurements: A Synthesis of Relevant Research.
---------------------------------------------------------------------------

    It is also logical to conclude that the potential for bias
increases in the presence of measurement uncertainty, since there is
more latitude in recording an estimate in such circumstances. Academic
studies find that the measurement uncertainty associated with
accounting estimates can be substantial.\141\ Martin, Rich, and Wilks
point out that fair value measurements frequently incorporate forward-
looking information as well as judgments, and that, since future events
cannot be predicted with certainty, an element of judgment is always
involved.\142\ The measurement uncertainty inherent in estimates allows
room for both management bias and error to affect preparers' valuation
judgments, and estimates become less useful to capital market
participants as they become less reliable.\143\
---------------------------------------------------------------------------

    \141\ See, e.g., Brant E. Christensen, Steven M. Glover, and
David A. Wood, Extreme Estimation Uncertainty in Fair Value
Estimates: Implications for Audit Assurance, 31 Auditing: A Journal
of Practice & Theory 127 (2012); Cannon and Bedard, Auditing
Challenging Fair Value Measurements: Evidence from the Field.
    \142\ See Martin et al., Auditing Fair Value Measurements: A
Synthesis of Relevant Research.
    \143\ See, e.g., Russell Lundholm, Reporting on the Past: A New
Approach to Improving Accounting Today, 13 Accounting Horizons 315
(1999); and Griffith et al., Audits of Complex Estimates as
Verification of Management Numbers: How Institutional Pressures
Shape Practice.
---------------------------------------------------------------------------

    To help auditors overcome, or compensate for, potential biases and
identify situations where management is consistently optimistic, and to
discourage shirking, the new standard emphasizes the auditor's existing
responsibility to apply professional skepticism, including addressing
potential management bias. It does so by emphasizing these professional
obligations in the specific context of auditing accounting estimates.
It also includes revised terminology to describe the nature of the
auditor's responsibility and the new requirements described in Section
C to guide the auditor in the appropriate application of professional
skepticism, including addressing potential management bias, when
auditing estimates.
    Some commenters on the proposal were supportive of a new standard
taking into consideration management bias and emphasizing the
application of professional skepticism while some others highlighted
the difficulties in evaluating and identifying management bias in
accounting estimates due to the uncertainty and subjectivity involved.
Some commenters were critical of ``negative'' tone or overemphasis on
management bias and the application of professional skepticism. Some
commenters, on the other hand, recommended that the new standard
further expand the discussion and emphasis of management bias and the
need to challenge management's assertions. As discussed above, the
Board believes that reinforcing the importance of professional
skepticism when auditing estimates, in light of the potential for
management bias, will remind auditors of their responsibilities to
evaluate contradictory evidence and

to address the effects of bias on the financial statements.
Fostering a More Efficient Audit
Tailoring Requirements for Different Types of Pricing Information
    The new standard requires different audit procedures for the
different types of third-party pricing information used for fair value
measurements of financial instruments, and is intended to drive a level
of work effort commensurate with both the risks of material
misstatement in the valuation of financial instruments and the
relevance and reliability of the evidence obtained. Existing
requirements do not provide specific direction about how to evaluate
the relevance and reliability of pricing information from third parties
and might have led to additional work and cost for some audits and
insufficient work and effort for some audits. Under the new standard,
auditors will be prompted to direct more effort toward pricing
information that may be more subject to bias or error based on the type
of instrument being valued and how or by whom the pricing information
is generated. For certain types of third parties--specifically, pricing
services and brokers or dealers--the new standard provides more
specific direction.
    The Board understands that pricing information generated by pricing
services generally tends to have three main characteristics not shared
by other estimates (1) uniformity of product (with little to no
differentiation across users, so there is less risk of inherent bias);
(2) work of the pricing service that, in most cases, is not prepared at
the direction of a particular client; and (3) buyers of the product
with little, if any, market power. These characteristics reduce the
risk of bias, unless the pricing service has a relationship with the
company by which company management has the ability to directly or
indirectly control or significantly influence the pricing service. The
potential for bias is further attenuated for pricing services since
there is monitoring by the market as a whole, and most of the prices
provided by these services are for traded securities or for securities
for which quotes are available or for which similar securities are
traded. Overall, the Board believes that these characteristics
contribute to a lower risk of bias in information provided by pricing
services relative to other estimates and warrant tailored audit
requirements.
    The Board believes that there also are differences between the
information provided by pricing services on the one hand, and brokers
or dealers on the other, that warrant differential treatment. Based on
outreach and observations from the Board's oversight activities, the
Board understands that pricing services tend to accumulate overall
market information, rather than engage directly in market transactions,
and typically have well-defined methodologies that are used
consistently over time. Therefore, they tend to provide customers with
more uniform pricing information. Brokers or dealers, on the other
hand, are in the business of providing liquidity to the market (by
acting as a buyer or seller) and connecting buyers and sellers. As
such, it is likely their pricing is more idiosyncratic (i.e., dependent
on the party asking for a quote, timing, and other factors related to
the business operations of the broker or dealer) and brokers or dealers
may occasionally be less transparent in pricing the instruments. In
addition, not all brokers or dealers necessarily have a firm-wide
methodology, as they typically provide prices on an as-requested basis.
Therefore, the Board believes that auditors' consideration of pricing
information obtained from a broker or dealer should differ from their
consideration of pricing information from a pricing service.
    The issue of different types of pricing information provided by
third-party sources is addressed in the special topics appendix of the
new standard. This appendix more broadly addresses auditing financial
instruments and includes procedures specific to an auditor's use of
evidence from third-party pricing sources. These procedures allow the
auditor to use pricing information from pricing sources used by the
company in some circumstances (e.g., generally in cases where the
company uses a pricing service based on trades of similar instruments
to value securities with a lower risk of material misstatement). This
would be an appropriate risk-based audit response, since there is a
lower chance of management bias when the company uses a pricing
service.
    One commenter who provided views on the third-party pricing
information agreed that the reliability of the pricing information from
the third-party pricing sources may differ and that factors covered in
the proposal captured that variability. A few commenters also asserted
that third-party pricing services generally provide pricing that is
free from influence of any one user of the services, and one of these
commenters opined that this absence of management bias increased the
relevance and reliability of the evidence. In addition, one commenter
suggested inclusion of differences in valuation approaches of pricing
services as an additional factor in evaluating reliability. Although
the differences in valuation approaches could create biased valuations,
auditors are required to evaluate the relevance and reliability of
pricing information provided by pricing services.
Multiple Standards With Overlapping Requirements
    Having multiple standards with similar approaches but varying
levels of detail in procedures may create unnecessary problems.
Perceived inconsistencies among existing standards may result in (1)
different auditor responsibilities for accounts for which a similar
audit approach would seem appropriate; (2) inconsistent application of
standards; and (3) inappropriate audit responses.
    Academic research speaks to the undesirable nature of overlapping
standards addressing the same issue, which adds to task difficulty
\144\ and may, therefore, create unnecessary additional costs, as it is
costly to sift through the standards and reconcile potential conflicts.
These costs may exacerbate the principal-agent and cognitive challenges
discussed above. For example, auditors might, consciously or otherwise,
apply the standards in a manner that satisfies their objectives but not
those of investors (e.g., auditors may choose an approach with fewer
procedures and requirements to minimize audit cost, or for expediency,
hence maximizing their profits). The existence of overlapping
requirements might also lead to uncertainty about compliance, if
auditors do not understand what is required. Finally, overlapping
requirements may increase perceived uncertainty about audit quality,
since market participants may not fully understand what standard is
being, or even should be, applied.
---------------------------------------------------------------------------

    \144\ See Brian Bratten, Lisa Milici Gaynor, Linda McDaniel,
Norma R. Montague, and Gregory E. Sierra, The Audit of Fair Values
and Other Estimates: The Effects of Underlying Environmental, Task,
and Auditor-Specific Factors, 32 Auditing: A Journal of Practice &
Theory 7, 15-16 (2013).
---------------------------------------------------------------------------

    To address the issues stemming from having multiple, overlapping
estimates standards, the new standard replaces the existing three
standards related to auditing accounting estimates. Moreover, it aligns
the requirements with the risk assessment standards through targeted
amendments to promote the development of appropriate responses to the
risks of material

misstatement related to accounting estimates.
    A number of commenters supported the development of a single
standard to replace the three existing standards. For example, some
noted that a single, consistent set of requirements aligned with the
risk assessment standards would provide greater uniformity and clarity
and eliminate the need to navigate among three related standards in
order to ensure that all requirements were met. On the other hand, one
commenter cautioned that a single standard would lead to a one-size-
fits-all audit approach and not allow the tailoring of audit procedures
based on the issuer-specific risks of material misstatement. By
aligning with the risk assessment standards and describing the basic
requirements for testing and evaluating estimates, the Board believes
the new standard is designed to allow auditors to tailor their
procedures in order to respond to specific risks of material
misstatement.

Lack of Market Solutions

    The issues discussed above are not, and cannot efficiently be,
addressed through market forces alone because the auditor may not be
fully incentivized to address them and market forces may not be
effective in making the auditor more responsive to investors' concerns
regarding the auditing of estimates. The auditor may not be fully
incentivized because auditors may incur additional costs to produce
higher audit quality but would earn lower profits on the audit, since
audit quality may not be observable \145\ and auditors may be unable to
charge more for better audits.\146\ Furthermore, because investors are
diverse and geographically distributed, they face a potential
collective action problem that creates additional barriers to jointly
negotiating with auditors over requirements for auditing accounting
estimates.
---------------------------------------------------------------------------

    \145\ An ``audit is a credence service in that its quality may
never be discovered by the company, the shareholders or other users
of the financial statements. It may only come into question if a
`clean' audit report is followed by the collapse of the company.''
See Alice Belcher, Audit Quality and the Market for Audits: An
Analysis of Recent UK Regulatory Policies, 18 Bond Law Review 1, 5
(2006). Credence services are difficult for users of the service
(such as investors in the context of company audit services) to
value because their benefits are difficult to observe and measure.
See also Monika Causholli and W. Robert Knechel, An Examination of
the Credence Attributes of an Audit, 26 Accounting Horizons 631
(2012).
    \146\ The general effect of cost pressures on audit quality has
been studied in the academic literature with varying empirical
findings. See, e.g., James L. Bierstaker and Arnold Wright, The
Effects of Fee Pressure and Partner Pressure on Audit Planning
Decisions, 18 Advances in Accounting 25 (2001); B. Pierce and B.
Sweeney, Cost-Quality Conflict in Audit Firms: An Empirical
Investigation, 13 European Accounting Review 415 (2004); and Scott
D. Vandervelde, The Importance of Account Relations When Responding
to Interim Audit Testing Results, 23 Contemporary Accounting
Research 789 (2006).
---------------------------------------------------------------------------

    For the mitigation of this collective action problem and other
potential sources of market failure,\147\ investors generally rely on
auditing standards that are based on investor and public interests.
PCAOB auditing standards establish performance requirements that, if
not implemented, can result in costly penalties to the auditor in the
form of litigation and reputational risk.
---------------------------------------------------------------------------

    \147\ For a discussion of the concept of market failure, see,
e.g., Francis M. Bator, The Anatomy of Market Failure, 72 The
Quarterly Journal of Economics 351 (1958); and Steven G. Medema, The
Hesitant Hand: Mill, Sidgwick, and the Evolution of the Theory of
Market Failure, 39 History of Political Economy 331 (2007).
---------------------------------------------------------------------------

Economic Impacts
Benefits
    The new standard should lead to two broad categories of benefits.
The first relates directly to audit quality and the second relates to
fostering an efficient risk-based approach to auditing accounting
estimates, including fair value measurements. The new standard
strengthens auditor responsibilities for auditing accounting estimates,
including fair value measurements, which should increase the likelihood
that auditors detect material misstatements, and more explicitly
integrates the risk assessment standards, which should encourage a
uniform approach to achieve a more efficient and risk-based audit
response. These improvements should enhance audit quality and, in
conjunction with the clarification of the procedures the auditor should
perform, should provide greater confidence in the accuracy of
companies' financial statements.\148\ From a capital market
perspective, an increase in the information quality of companies'
financial statements resulting from improved audit quality can reduce
the non-diversifiable risk to investors and generally should result in
investment decisions by investors that more accurately reflect the
financial position and operating results of each company, increasing
the efficiency of capital allocation decisions.\149\
---------------------------------------------------------------------------

    \148\ For a discussion on the relationship between audit quality
and financial reporting quality, see DeFond and Zhang, A Review of
Archival Auditing Research 275, 281 (``. . . [A]udit quality is a
component of financial reporting quality, because high audit quality
increases the credibility of the financial reports. This increased
credibility arises through greater assurance that the financial
statements faithfully reflect the [company's] underlying
economics.'').
    \149\ See, e.g., Lambert et al., Accounting Information,
Disclosure, and the Cost of Capital, 388 (finding that information
quality directly influences a company's cost of capital and that
improvements in information quality by individual companies
unambiguously affect their non-diversifiable risks.); and Ahsan
Habib, Information Risk and the Cost of Capital: Review of the
Empirical Literature, 25 Journal of Accounting Literature 127, 128
(2006) (``[H]igh quality auditing could provide credible information
in the market regarding the future prospect of the [company] and
hence could reduce the cost of capital in general, and cost of
equity capital in particular.''). See also Jukka Karjalainen, Audit
Quality and Cost of Debt Capital for Private Firms: Evidence from
Finland, 15 International Journal of Auditing 88 (2011).
---------------------------------------------------------------------------

    The extent of these benefits, which are discussed further below,
will largely depend on the extent to which firms have to change their
practices and methodologies. Benefits will be less in the case of firms
that have already adopted practices and methodologies similar to the
requirements being proposed.
    First, the new standard should reduce the problems generated by
moral hazard and potential cognitive biases by strengthening the
performance requirements for auditing accounting estimates and by
emphasizing the importance of addressing potential management bias and
the need to maintain a skeptical mindset while auditing accounting
estimates. Reinforcing the need for professional skepticism should
encourage auditors, for example, to ``refram[e] hypotheses so that
confirmation biases favor [professional skepticism],'' and thereby
mitigate the effect of such biases on auditor judgment.\150\ It should
encourage auditors to be more conscious when weighing audit evidence
and should reduce instances where auditors fail to consider
contradictory evidence. For example, the use of terms such as
``evaluate'' and ``compare'' instead of ``corroborate,'' and greater
emphasis on auditors identifying the significant assumptions in
accounting estimates should promote a more deliberative approach to
auditing estimates, rather than a mechanical process of looking for
evidence to support management's assertions. Academic research also
provides evidence on the effect of framing in the context of auditors'
fair value judgments.\151\ In an experimental

study, Cohen et al. found that when one group of auditors were
instructed to ``support and oppose'' management's assertions, they
recommended significantly different fair value estimates than another
group of auditors who were instructed to ``support'' management's
assertions.
---------------------------------------------------------------------------

    \150\ Nelson, A Model and Literature Review of Professional
Skepticism in Auditing 2. In addition, another experimental study
found other factors, such as improved cognitive tools, might be
necessary to enhance the use of professional judgment and critical
thinking skills. See Anthony Bucaro, Enhancing Auditors' Critical
Thinking in Audits of Complex Estimates, Accounting, Organizations
and Society 1, 11 (2018).
    \151\ See Jeffrey Cohen, Lisa Gaynor, Norma Montague, and Julie
Wayne, The Effect of Framing on Information Search and Information
Evaluation in Auditors' Fair Value Judgments (Feb. 2016) (working
paper, available in Social Science Research Network).
---------------------------------------------------------------------------

    Several commenters on the proposal supported the emphasis on
professional skepticism and one commenter agreed that the new
requirements would prompt auditors to devote greater attention to
identifying and addressing management bias. Moreover, some commenters
confirmed that raising awareness of cognitive biases and including
reminders of professional skepticism could help mitigate the effects of
auditors' own biases. In addition, a few commenters supported the
change in terminology and agreed that it would further reinforce the
application of professional skepticism by moving from a corroborative
mindset to an evaluation mindset, while one commenter expressed
skepticism about the impact of terminology on auditor behavior. Some
commenters noted the difficulties and limitations in evaluating and
identifying management bias in accounting estimates due to the
uncertainty and subjectivity involved. Given the subjective assumptions
and inherent measurement uncertainty in many estimates, bias may not be
eliminated entirely. However, the Board believes that a standard that
reinforces the application of professional skepticism and reminds
auditors of risk of management bias and their responsibilities to
evaluate contradictory evidence and to address the effects of bias can
help ameliorate the problems resulting from this bias.
    Second, requirements specific to the use of pricing information
from third parties as audit evidence should lead to a more efficient
audit as these new requirements will prompt more tailored audit
procedures (including by performing procedures over groups of similar
instruments, where appropriate) and direct more audit effort toward
pricing information that may be more subject to bias or error.
    Third, in addition to achieving these efficiencies, the new
standard should lead to a better allocation of auditing resources more
generally by aligning more closely with the risk assessment standards,
with more hours, effort, and work being dedicated to higher-risk areas.
Essentially, the new standard should lead to increased audit quality
for harder-to-measure estimates (e.g., estimates with high inherent
subjectivity) due to enhanced procedures and should lead to an increase
in efficiency for easier-to-measure and lower-risk estimates.
    Fourth, uniformity of the standards should lead to benefits to
auditors and users of financial statements. A single, consistent set of
requirements should lead to more consistent and efficient audits with
greater comparability since there should be no doubt as to what
requirements to apply, and no need to navigate among multiple standards
to make sure that all relevant requirements are met. In turn, assuming
that firms comply with the new requirements, this should increase and
make more uniform the quality of the information presented in the
financial statements. Having a uniform set of requirements might also
enhance the audit committee's understanding of the auditor's
responsibilities and, therefore, potentially facilitate communications
between the audit committee and the auditor. Moreover, a single
standard will facilitate the development of timely guidance for
specific issues when needed.
    Finally, establishing more clarity and specificity in requirements
for estimates should lead to efficiency gains by providing auditors
with a better understanding both of their duties and of the Board's
expectations, reducing the risk that auditors would perform unnecessary
or ineffective procedures. Hence, holding audit quality constant,
auditors should gain efficiencies.
    Overall, these changes should lead to greater confidence in
financial statements, reducing investors' information asymmetry.
Reinforcing and clarifying auditors' responsibilities should enhance
investors' trust that auditors are obtaining sufficient appropriate
evidence regarding management's accounting estimates, thereby
increasing investors' confidence in companies' financial statements and
the corresponding audit work performed. Also, the new standard may lead
to fewer restatements as a result of increased audit quality for
higher-risk estimates and, hence, increase investor confidence in
financial statements. Increased confidence in companies' financial
statements should ameliorate investors' information asymmetry problem
(adverse selection) and allow for more efficient capital allocation
decisions.
    Some commenters on the proposal cautioned against raising investor
expectations about the impact of auditing procedures on the reliability
and accuracy of accounting estimates and expressed skepticism about
potential benefits related to investor confidence and audit quality.
For example, citing the inherent uncertainty and judgment involved in
estimates, some argued that unreasonable bias would be difficult to
detect and a level of bias and uncertainty would remain irrespective of
the level of audit effort. While auditing cannot eliminate the
uncertainty and judgment involved in estimates, it can help identify
material omissions and errors. Furthermore, even if more robust
auditing procedures do not yield more accuracy and precision for each
individual estimate, to the extent that any pattern of bias or error
can be eliminated, this should result in more reliable financial
reporting. The financial statements as a whole may not be fairly
presented if the most optimistic estimates are consistently selected by
the preparer even when each individual estimate is within a reasonable
range. Emphasizing the risk of management bias in accounting estimates
and the auditor's responsibility to apply professional skepticism can
help focus auditors on the effects of management bias on financial
statements.
Costs
    The Board recognizes that imposing new requirements may result in
additional costs to auditors and the companies they audit. In addition,
to the extent that auditors pass on any increased costs through an
increase in audit fees, companies and investors could incur an indirect
cost.
    Auditors may incur certain fixed costs (costs that are generally
independent of the number of audits performed) related to implementing
the new standard and related amendments. These include costs to update
audit methodologies and tools, prepare training materials, and conduct
training. Larger firms are likely to update methodologies using
internal resources, whereas smaller firms are more likely to purchase
updated methodologies from external vendors.
    In addition, auditors may incur certain variable costs (costs that
are generally dependent on the number of audits performed) related to
implementing the new standard. These include costs of implementing the
standard at the audit engagement level (e.g., in the form of additional
time and effort spent on the audit). For example, the new standard
requires, in some instances, performing more procedures related to
assessing risk and testing the company's process, such as evaluating
which of the assumptions used by the company are significant. This
could impose additional costs on auditors and require additional
management time.
    Recurring costs (fixed or variable) may also increase if firms
decide to increase their use of specialists in response to the final
auditing

requirements. If this were to occur, it may in particular affect firms
that do not currently employ or engage specialists and instead rely on
the work of company specialists for some of their audit engagements,
potentially affecting the competitiveness of such firms for such audit
engagements.\152\
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    \152\ The PCAOB staff analyzed inspection data to assess the
baseline for auditors' use of the work of specialists and existing
practice in the application of those requirements. The PCAOB
observed that the firms that do not currently employ or engage
auditor's specialists and use the work of company specialists tend
to be smaller audit firms. The PCAOB staff also found that smaller
audit firms generally have comparatively few audit engagements in
which they use the work of company specialists. See the Specialists
Release, supra note 2, for additional discussion.
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    To the extent the new standard and related amendments require new
or additional procedures, they may increase costs. For example, the
amendment to AS 2110.52 requires the auditor to include, as part of the
key engagement team members' discussion of the potential for material
misstatement due to fraud, how the financial statements could be
manipulated through management bias in accounting estimates in
significant accounts and disclosures. The new requirement focuses the
auditor's attention on a risk that is particularly relevant to
accounting estimates and further underscores the importance of applying
professional skepticism in this area. The additional requirement could
increase costs.
    The new standard's impact on the auditor's fixed and variable costs
will likely vary depending on, among other things, the extent to which
the requirements have already been incorporated in accounting firms'
audit methodologies or applied in practice by individual engagement
teams. For example, the new standard sets minimum requirements when
using pricing information obtained from third-party pricing sources, so
audit firms that are doing less than the minimum requirements will
likely experience higher cost increases. In addition, the standard's
impact could vary based on the size and complexity of an audit. All
else equal, any incremental costs generally are expected to be
scalable: Higher for larger, more complex audits than for smaller, less
complex audits.
    The economic impact of the new standard on larger accounting firms
and smaller accounting firms may differ. For example, larger accounting
firms will likely take advantage of economies of scale by distributing
fixed costs (e.g., updating audit methodologies) over a larger number
of audit engagements. Smaller accounting firms will likely distribute
their fixed costs over fewer audit engagements. However, larger
accounting firms will likely incur greater variable costs than smaller
firms, because larger firms more often perform larger audits and it
seems likely that these larger audits will more frequently involve
accounting estimates with complex processes. It is not clear whether
these costs (fixed and variable), as a percentage of total audit costs,
will be greater for larger or for smaller accounting firms. One
commenter on the proposal cautioned that the costs associated with
implementing the new standard might be significant for some smaller
firms; however, this commenter also noted that many of the smaller
firms applying analogous requirements of other standard setters (e.g.,
ISA 540) would already have methodologies in place that addressed many
of the requirements in the new standard. Another commenter asserted
that any new standard would have a disproportionate impact on medium-
sized accounting firms and their clients, as compared with larger firms
and their clients. Additionally, one commenter noted that passing any
incremental costs on to clients might be especially difficult for
smaller firms. The Board believes that the new standard and related
amendments are risk-based and scalable for firms of all sizes, and that
any related cost increases are justified by expected improvements in
audit quality.
    In addition to the auditors, companies being audited may incur
costs related to the new standard and related amendments, both directly
and indirectly. Companies could incur direct costs from engaging with
or otherwise supporting the auditor performing the audit. Some
companies could face costs of providing documents and responding to
additional auditor requests for audit evidence, due to a more rigorous
evaluation of the company's assumptions and methods. Companies may also
incur costs if, as a result of the new standard, auditors need to
discuss additional information with audit committees relating to
accounting estimates. In addition, to the extent that auditors are able
to pass on at least part of the increased costs they incur by
increasing audit fees, companies and investors could incur an indirect
cost. Some commenters on the proposal raised concerns that some of the
increased costs, including the costs associated with requests for
additional data and pricing information from third parties, might be
passed through to companies in the form of increased audit fees. One
commenter asserted that the proposal would in effect require some
companies to increase their use of quantitative models that employ
mathematical and statistical techniques producing precise calculations.
The Board acknowledges the possibility of increased costs to companies
related to the new requirements, but believes that it is reasonable to
expect corresponding increases in audit quality, which will benefit
companies and investors as well as auditors, as discussed in the
previous section.
    Some commenters argued that the new requirements would likely lead
to significant expansion of audit procedures, documentation, and/or use
of specialists, with limited incremental benefit. In addition, a few
commenters raised concerns that the requirements could result in
increased or duplicative work for issuers with no perceived benefit.
The Board believes that the scalable, risk-based approach of the new
standard allows auditors to tailor their procedures to respond to the
risks. By aligning with the risk assessment standards and setting forth
a framework for testing and evaluating procedures, the new standard is
designed to require more audit effort for accounting estimates with
higher risk of material misstatement, where greater benefits are
expected, and less audit effort for estimates with lower risk of
material misstatement, where lower potential benefits are expected. In
some areas, such as evaluating the relevance and reliability of pricing
information provided by third-party pricing sources, the new standard
may result in decreased audit effort and decreased costs, where
justified by lower risk of material misstatement.
Unintended Consequences
    One potential unintended consequence of replacing three existing
standards with one standard might be a perceived loss of some
explanatory language, since the new standard is intended to eliminate
redundancies in the current standards. The Board believes that the new
standard and related amendments, interpreted as described in this
release, should provide adequate direction. However, the PCAOB will
monitor implementation to determine whether additional interpretive
guidance is necessary.
    Another possible unintended consequence may result if an auditor
exploits the latitude allowed under the new standard for using
information from the company's third-party pricing source, but does so
inappropriately. The new standard does, however, set forth specific
direction for evaluating the relevance and reliability of such

information from the third-party pricing source.
    One commenter also cautioned that perceived information sharing by
third-party pricing sources beyond contractual agreements could induce
market data originators to stop sharing their confidential market data
with pricing services. The Board does not seek to impose obligations on
auditors to obtain pricing information beyond what is available under
prevailing subscriber arrangements. Clarifications reflected in the
requirements with respect to grouping of financial instruments also
should help alleviate concerns in this area.
    Finally, a few commenters on the proposal presented other potential
unintended consequences. For example, one commenter cautioned that
auditors may expand procedures performed unnecessarily, not as a
response to increased risk, but due to fear of inspections. The Board
believes that a single, uniform set of requirements with more clarity
and specificity should provide auditors with a better understanding
both of their duties and of the Board's expectations and reduce the
risk that auditors would perform unnecessary procedures due to fear of
inspections.
    Another commenter pointed to the risk of cost spillover to private
company audits, where PCAOB standards are not legally required but may
nevertheless be applied. Pursuant to its statutory mandate under the
Sarbanes-Oxley Act, the Board sets standards for audits of issuers and
SEC-registered brokers and dealers based on considerations of investor
protection and the public interest in the preparation of informative,
accurate, and independent audit reports. The Board does not have
authority either to require or to prohibit application of its standards
in other contexts, and cannot predict or control the extent to which
private companies and their auditors may elect to apply PCAOB
standards.
    The Board expects that the overall benefits of the proposed
standard will justify any potential unintended negative effects.
Alternatives Considered, Including Policy Choices
    The development of the new standard involved considering a number
of alternative approaches to address the problems described above. This
section explains (1) why standard setting is preferable to other
policy-making alternatives, such as providing interpretive guidance or
enhancing inspection or enforcement efforts; (2) other standard-setting
approaches that were considered; and (3) key policy choices made by the
Board in determining the details of the new standard.
Alternatives to Standard Setting--Why Standard Setting is Preferable to
Other Policy-Making Alternatives
    Among the Board's policy tools, an increased focus on inspections,
enforcement of existing standards, or providing additional guidance are
alternatives to revising the standards. The Board considered whether
increasing inspections or enforcement efforts would be effective
corrective mechanisms to address concerns with the audit of estimates,
including fair value measurements, and concluded that inspections or
enforcement actions alone would be less effective in achieving the
Board's objectives than in combination with amending auditing
standards.
    Inspection and enforcement actions take place after audits have
occurred (and potential investor harm in the case of insufficient audit
performance). They reinforce future adherence to current auditing
standards. Given the differences in the estimates standards discussed
previously, devoting additional resources to inspections and
enforcement activities without improving the relevant performance
requirements for auditors would increase auditors' compliance with what
the Board and many stakeholders view as standards that could be
improved.
    The PCAOB has issued seven Staff Audit Practice Alerts between 2007
and 2014 that address, to varying degrees, auditing accounting
estimates.\153\ The PCAOB has considered issuing additional practice
alerts or other staff guidance specific to the use of third parties
such as pricing services.\154\ The Board believes guidance specific to
the use of third parties would be limited to discussing the auditor's
application of the existing standards and, given the differences in
these standards discussed herein, guidance would be an ineffective tool
and not a long-term solution.
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    \153\ See, e.g., Matters Related to Auditing Fair Value
Measurements of Financial Instruments and the Use of Specialists,
Staff Audit Practice Alert No. 2 (Dec. 10, 2007); Auditor
Considerations Regarding Fair Value Measurements, Disclosures, and
Other-Than-Temporary Impairments, Staff Audit Practice Alert No. 4
(Apr. 21, 2009); Assessing and Responding to Risk in the Current
Economic Environment, Staff Audit Practice Alert No. 9 (Dec. 6,
2011); Maintaining and Applying Professional Skepticism in Audits,
Staff Audit Practice Alert No. 10 (Dec. 4, 2012); and Matters
Related to Auditing Revenue in an Audit of Financial Statements,
Staff Audit Practice Alert No. 12 (Sept. 9, 2014).
    \154\ Other standard setters have issued guidance relating to
their existing standards. For example, the IAASB issued
International Auditing Practice Note 1000, Special Considerations in
Auditing Financial Instruments (Dec. 16, 2011), to provide guidance
to auditors when auditing fair value measurements of financial
instruments.
---------------------------------------------------------------------------

    The Board's approach reflects its conclusion that, in these
circumstances, standard setting is needed to fully achieve the benefits
that could result from improvements in the auditing of estimates.
Other Standard-Setting Alternatives Considered
    The Board considered certain standard-setting alternatives,
including (1) developing a separate standard on auditing the fair value
of financial instruments or (2) enhancing the estimates standards
through targeted amendments.
Developing a Separate Standard on Auditing the Fair Value of Financial
Instruments
    The Board considered developing a separate standard that would
specifically address auditing the fair value of financial instruments.
The Board chose not to pursue this alternative because the addition of
a separate standard could result in confusion and potential
inconsistencies in the application of other standards. Additionally,
the auditing issues pertinent to accounting estimates, including
financial instruments, inherently overlap. Instead, the new standard
includes a special topics appendix, which separately discusses certain
matters relevant to financial instruments without repeating
requirements that relate more broadly to all estimates, such as
evaluating audit evidence.
Enhancing the Estimates Standards Through Targeted Amendments
    The Board considered, but determined not to pursue, amending rather
than replacing the three estimates standards. Retaining multiple
standards with similar requirements would not eliminate redundancy and
could result in confusion and potential inconsistencies in the
application of the standards. The approach presented in the new
standard is designed to be clearer and to result in more consistent
application and more effective audits.
    Commenters on the proposal were generally supportive of a single,
uniform standard with a consistent set of requirements. One commenter
said that they believed that audit quality would be promoted with a
single framework. On the other hand, one commenter, citing the
differences between fair value measurements and derivatives and hedging
accounting, expressed concerns

about combining multiple standards into one, but did not specify how
the auditing approach could or should differ. Another commenter
cautioned that a single standard would lead to a one-size-fits-all
audit approach and not allow the tailoring of audit procedures.
However, by aligning with the risk assessment standards and describing
the basic requirements for testing and evaluating estimates, the new
standard is designed to allow the auditors to tailor their procedures
in order to respond to specific risks of material misstatement.
Key Policy Choices
    Given a preference for a single, comprehensive standard applicable
to all accounting estimates, including fair value measurements, in
significant accounts and disclosures, the Board considered different
approaches to addressing key policy issues.
Include a Reporting Requirement in the New Standard
    Measurement uncertainty cannot be eliminated entirely through audit
procedures. This raises a question of whether reporting of additional
information about such procedures in the auditor's report is necessary.
    However, the Board also considered whether requiring communication
in the auditor's report relating to estimates would be duplicative of
the new requirement to communicate critical audit matters (``CAMs'');
any matters arising from the audit of the financial statements that
were communicated or required to be communicated to the audit committee
and that (1) relate to accounts or disclosures that are material to the
financial statements and (2) involved especially challenging,
subjective, or complex auditor judgments.\155\ Under the new auditor's
reporting standard, auditors will identify each CAM, describe the
principal considerations that led them to determine it was a CAM,
briefly describe how the CAM was addressed in the audit, and refer to
the relevant accounts or disclosures in the financial statements.
Because these reporting requirements will apply to financial statement
estimates, including fair value measurements, if they meet the
definition of CAM, AS 2501 (Revised) does not include any additional
reporting requirements.
---------------------------------------------------------------------------

    \155\ See The Auditor's Report on an Audit of Financial
Statements When the Auditor Expresses an Unqualified Opinion and
Related Amendments to PCAOB Standards, PCAOB Release No. 2017-001
(June 1, 2017).
---------------------------------------------------------------------------

Require the Auditor To Develop an Independent Expectation
    Given the variety of types of accounting estimates and the ways in
which they are developed, the Board is retaining the three common
approaches from the existing standards for auditing accounting
estimates, including fair value measurements. In addition, the new
standard continues to require the auditor to determine what substantive
procedures are responsive to the assessed risks of material
misstatement.
    The Board considered, but determined not to pursue, requiring the
auditor to develop an independent expectation for certain estimates, or
when an estimate gives rise to a significant risk. Some members of the
Board's advisory groups advocated for a requirement for the auditor to
develop an independent expectation in addition to testing management's
process. In addition, some SAG members suggested a requirement for the
auditor to develop an independent expectation rather than test
management's process. Finally, a few commenters on the proposal stated
that auditors should develop independent estimates in addition to
testing management's process. Although requiring an independent
expectation could help reduce the risk of anchoring bias, it may not
always be feasible. For some accounting estimates, the data and
significant assumptions underlying the estimate often depend on
internal company information. Also, developing a customized method or
model for a particular company's estimate may not be practical, and a
more general method or model could be less precise than the company's
own model. In those situations, the auditor may not have a reasonable
alternative to testing the company's process.
Require Additional Audit Procedures When an Accounting Estimate Gives
Rise to Significant Risk
    The Board considered including additional requirements when an
accounting estimate gives rise to a significant risk, either more
broadly or specifically when a wide range of measurement uncertainty
exists. Alternatives considered included:
     Establishing that certain estimates are presumed to give
rise to a significant risk (e.g., the allowance for loan losses).
     Establishing specific procedures that would depend on the
risk determined to be significant (e.g., the use of a complex model
determined to give rise to a significant risk would result in the
auditor being required to perform specific procedures on that model).
     Including a requirement, similar to those in AU-C Section
540, Auditing Accounting Estimates, Including Fair Value Accounting
Estimates, And Related Disclosures (``AU-C 540''),\156\ for the auditor
to evaluate how management has considered alternative assumptions or
outcomes and why it has rejected them when significant measurement
uncertainty exists.
---------------------------------------------------------------------------

    \156\ See paragraph 15a of AU-C 540.
---------------------------------------------------------------------------

    Including additional requirements when an estimate gives rise to a
significant risk would mandate the auditor to direct additional
attention to that risk. AS 2301, however, already requires an auditor
to perform substantive procedures, including tests of details that are
specifically responsive to the assessed risks of material misstatement.
This includes circumstances when the degree of complexity or judgment
in the recognition or measurement of financial information related to
the risk, especially those measurements involving a wide range of
measurement uncertainty, give rise to a significant risk.\157\ Further,
with respect to critical accounting estimates,\158\ the new standard
and related amendments require the auditor to obtain an understanding
of how management analyzed the sensitivity of its significant
assumptions to change, based on other reasonably likely outcomes that
would have a material effect on its financial condition or operating
performance,\159\ and to take that understanding into account when
evaluating the reasonableness of the significant assumptions and
potential for management bias.
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    \157\ See AS 2301.11 and AS 2110.71f.
    \158\ See paragraph .A3 of AS 1301, Communications with Audit
Committees.
    \159\ See Commission Guidance Regarding Management's Discussion
and Analysis of Financial Condition and Results of Operations,
Release No. 33-8350.
---------------------------------------------------------------------------

    Thus, requiring specific procedures for accounting estimates that
give rise to significant risks would be duplicative in some ways of the
existing requirement in AS 2301 as well as those set forth by the new
standard, and could result in additional audit effort without
significantly improving audit quality. Additionally, including
prescriptive requirements for significant risks could result in the
auditor performing only the required procedures when more effective
procedures exist, or could provide disincentives for the auditor to
deem a risk significant in order to avoid performing the additional
procedures.
    Accordingly, the Board did not adopt these alternatives in favor of
retaining the existing requirement in AS 2301.

Special Considerations for Audits of Emerging Growth Companies
    Pursuant to Section 104 of the Jumpstart Our Business Startups
(``JOBS'') Act, rules adopted by the Board subsequent to April 5, 2012,
generally do not apply to the audits of EGCs unless the SEC
``determines that the application of such additional requirements is
necessary or appropriate in the public interest, after considering the
protection of investors, and whether the action will promote
efficiency, competition, and capital formation.'' \160\ As a result of
the JOBS Act, the rules and related amendments to PCAOB standards the
Board adopts are generally subject to a separate determination by the
SEC regarding their applicability to audits of EGCs.
---------------------------------------------------------------------------

    \160\ See Public Law 112-106 (Apr. 5, 2012). See Section
103(a)(3)(C) of the Sarbanes-Oxley Act, as added by Section 104 of
the JOBS Act. Section 104 of the JOBS Act also provides that any
rules of the Board requiring (1) mandatory audit firm rotation or
(2) a supplement to the auditor's report in which the auditor would
be required to provide additional information about the audit and
the financial statements of the issuer (auditor discussion and
analysis) shall not apply to an audit of an EGC. The new standard
and related amendments do not fall within either of these two
categories.
---------------------------------------------------------------------------

    The proposal sought comments on the applicability of the proposed
requirements to the audits of EGCs. Commenters on the issue supported
applying the proposed requirements to audits of EGCs, citing benefits
to the users of EGC financial statements and the risk of confusion and
inconsistency if different methodologies were required for EGC and non-
EGC audits. One commenter suggested ``phasing'' the implementation of
the requirements for audits of EGCs to reduce the compliance burden.
    To inform consideration of the application of auditing standards to
audits of EGCs, the staff has also published a white paper that
provides general information about characteristics of EGCs.\161\ As of
the November 15, 2017 measurement date, the PCAOB staff identified
1,946 companies that had identified themselves as EGCs in at least one
SEC filing since 2012 and had filed audited financial statements with
the SEC in the 18 months preceding the measurement date.
---------------------------------------------------------------------------

    \161\ See PCAOB white paper, Characteristics of Emerging Growth
Companies as of November 15, 2017 (Oct. 11, 2018) (``EGC White
Paper''), available on the Board's website.
---------------------------------------------------------------------------

    The Board believes that accounting estimates are common in the
financial statements of many EGCs.\162\ The Board also notes that any
new PCAOB standards and amendments to existing standards determined not
to apply to the audits of EGCs would require auditors to address the
differing requirements within their methodologies, which would create
the potential for confusion.\163\ This would run counter to the
objective of improving audit practice by setting forth a more uniform,
risk-based approach to auditing accounting estimates, including fair
value measurements.
---------------------------------------------------------------------------

    \162\ The five SIC codes with the highest total assets as a
percentage of the total assets for the EGC population are (i) real
estate investment trusts; (ii) state commercial banks; (iii)
national commercial banks; (iv) crude petroleum and natural gas; and
(v) pharmaceutical preparations. Id. at 14-15. The financial
statements of companies operating in these industries would likely
have accounting estimates that include, for example, asset
impairments and allowances for loan losses.
    \163\ Approximately 99% of EGCs were audited by accounting firms
that also audit issuers that are not EGCs and 40% of EGC filers were
audited by firms that are required to be inspected on an annual
basis by the PCAOB because they issued audit reports for more than
100 issuers in the year preceding the measurement date. See EGC
White Paper at 3.
---------------------------------------------------------------------------

    Overall, the above discussion of benefits, costs, and unintended
consequences is generally applicable to audits of EGCs. Since EGCs tend
to be smaller public companies, their accounting estimates may be less
likely to involve complex processes,\164\ although those estimates may
constitute some of the largest accounts in EGCs' financial statements.
Furthermore, EGCs may generally be more subject to information
asymmetry problems associated with accounting estimates than other
issuers. EGCs generally tend to have shorter financial reporting
histories than other exchange-listed companies and as a result, there
is less information available to investors regarding such companies
relative to the broader population of public companies. Although the
degree of information asymmetry between investors and company
management for a particular issuer is unobservable, researchers have
developed a number of proxies that are thought to be correlated with
information asymmetry, including small issuer size, lower analyst
coverage, larger insider holdings, and higher research and development
costs.\165\ To the extent that EGCs exhibit one or more of these
properties, there may be a greater degree of information asymmetry for
EGCs than for the broader population of companies, increasing the
importance of the external audit to investors in enhancing the
credibility of management disclosure.\166\ The new standard and related
amendments, which are intended to enhance audit quality, could increase
the credibility of financial statement disclosures by EGCs.
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    \164\ See, e.g., the note to AS 2201.09, which provides that
many smaller companies have less complex operations and that less
complex business processes and financial reporting systems are a
factor indicating less complex operations.
    \165\ See, e.g., David Aboody and Baruch Lev, Information
Asymmetry, R&D, and Insider Gains, 55 Journal of Finance 2747
(2000); Michael J. Brennan and Avanidhar Subrahmanyam, Investment
Analysis and Price Formation in Securities Markets, 38 Journal of
Financial Economics 361 (1995); Varadarajan V. Chari, Ravi
Jagannathan, and Aharon R. Ofer, Seasonalities in Security Returns:
The Case of Earnings Announcements, 21 Journal of Financial
Economics 101 (1988); and Raymond Chiang, and P.C. Venkatesh,
Insider Holdings and Perceptions of Information Asymmetry: A Note,
43 Journal of Finance 1041 (1988).
    \166\ See, e.g., Molly Mercer, How Do Investors Assess the
Credibility of Management Disclosures?, 18 Accounting Horizons 185,
189 (2004) (``[Academic studies] provide archival evidence that
external assurance from auditors increases disclosure credibility .
. . These archival studies suggest that bankers believe audits
enhance the credibility of financial statements . . .'').
---------------------------------------------------------------------------

    When confronted with information asymmetry, investors may require a
larger risk premium, and thus increase the cost of capital to
companies.\167\ Reducing information asymmetry, therefore, can lower
the cost of capital to companies, including EGCs, by decreasing the
risk premium required by investors.\168\ Therefore, investors in EGCs
may benefit as much as, if not more than, investors in other types of
issuers as a result of the new standard and related amendments.
---------------------------------------------------------------------------

    \167\ See, e.g., Lambert et al., Information Asymmetry,
Information Precision, and the Cost of Capital 21.
    \168\ For a discussion of how increasing reliable public
information about a company can reduce risk premium, see Easley and
O'Hara, Information and the Cost of Capital 1553.
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    PCAOB staff gathered data from 2012-2016 reported inspection
findings for issuer audits that were identified to be EGCs in the
relevant inspection year.\169\ The chart below shows the number of EGC
audits with deficiencies related to the accounting estimates standard
and fair value standard \170\ based on the 2012-2016 reported
inspection findings.\171\ The data help demonstrate

the high frequency of deficiencies related to the existing estimates
and fair value standards in the audits of EGCs, raising questions about
whether professional skepticism is being appropriately applied and
about overall audit quality in this area. The EGC audits that had
deficiencies related to the existing estimates and fair value standards
as a proportion of total EGC audits that had deficiencies (including
deficiencies in internal control over financial reporting) have
remained relatively high (45%-60%) for the 2012-2016 period.
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    \169\ See EGC White Paper for the methodology used to identify
EGCs.
    \170\ Deficiencies related to the derivatives standard were
infrequent over the inspection period reviewed, and therefore
considered insignificant for purposes of this analysis.
    \171\ The chart identifies the audits of EGCs with deficiencies
reported in the public portion of inspection reports. It shows the
relative frequency of EGC audits with deficiencies citing the
existing accounting estimates standard or the existing fair value
standard compared to the total EGC audits with deficiencies for that
year. It also shows the frequency of inspected EGCs audits that had
a deficiency. For example, in inspection year 2013, 50% of the EGC
audits that were inspected had a deficiency and 60% of the audits
with deficiencies included at least one deficiency citing the
accounting estimates standard or the fair value standard (total 2016
reported inspection findings are based on preliminary results).
[GRAPHIC] [TIFF OMITTED] TN04AP3.001

    The Board has provided this analysis to assist the SEC in its
consideration of whether it is ``necessary or appropriate in the public
interest, after considering the protection of investors and whether the
action will promote efficiency, competition, and capital formation,''
to apply the new standard and related amendments to audits of EGCs.
    For the reasons explained above, the Board believes that the new
standard and related amendments are in the public interest and, after
considering the protection of investors and the promotion of
efficiency, competition, and capital formation, recommends that the new
standard and related amendments apply to audits of EGCs. Accordingly,
the Board recommends that the Commission determine that it is necessary
or appropriate in the public interest, after considering the protection
of investors and whether the action will promote efficiency,
competition, and capital formation, to apply the new standard and
related amendments to audits of EGCs. The Board stands ready to assist
the Commission in considering any comments the Commission receives on
these matters during the Commission's public comment process.
Applicability to Audits of Brokers and Dealers
    The proposal indicated that the proposed standard and amendments
would apply to audits of brokers and dealers, as defined in Sections
110(3)-(4) of the Sarbanes-Oxley Act. The Board solicited comment on
any factors specifically related to audits of brokers and dealers that
may affect the application of the proposed amendments to those audits.
Commenters that addressed the issue agreed that the proposal should
apply to these audits, citing benefits to users of financial statements
of broker and dealers and the risk of confusion and inconsistency if
different methodologies were required under PCAOB standards for audits
of different types of entities.
    After considering comments, the Board determined that the new
standard and related amendments, if approved by the SEC, will be
applicable to all audits performed pursuant to PCAOB standards,
including audits of brokers and dealers.
    The information asymmetry between the management and the customers
of brokers and dealers about the brokers' and dealers' financial
condition may be significant and of particular interest to customers,
as the brokers or dealers may have custody of customers assets, which
could become inaccessible to the customers in the event of an
insolvency. In addition, unlike the owners of brokers and dealers, who
themselves may be managers and thus may be subject to minimal or no
information asymmetry, customers of brokers and dealers may, in some
instances, be large in number and may not be expert in the management
or operation of brokers and dealers. Such information asymmetry between
the management and the customers of brokers and dealers increases the
role of auditing in enhancing the reliability of financial information,
especially given that the use of estimates, including fair value
measurements, is prevalent among brokers and dealers. The provision to
regulatory agencies of reliable and accurate accounting estimates on
brokers' and dealers' financial statements may enable these agencies to

more effectively monitor these important market participants. Improved
audits may help prevent accounting fraud that affects brokers' and
dealers' customers and that may be perpetrated, for example, through
manipulated valuations of securities. Therefore, the new standard
should benefit customers and regulatory authorities of brokers and
dealers by increasing confidence that brokers and dealers are able to
meet their obligations to their customers and are in compliance with
regulatory requirements.
    Accordingly, the discussion above of the need for the new standard
and related amendments, as well as the costs, benefits, alternatives
considered, and potential unintended consequences to auditors and the
companies they audit, also applies to audits of brokers and dealers. In
addition, with respect to the impact of the new standard on customers
of brokers and dealers, the expected improvements in audit quality
described above would benefit such customers, along with investors,
capital markets and auditors, while the final requirements are not
expected to result in any direct costs or unintended consequences to
customers of brokers and dealers.

III. Date of Effectiveness of the Proposed Rules and Timing for
Commission Action

    Pursuant to Section 19(b)(2)(A)(ii) of the Exchange Act, and based
on its determination that an extension of the period set forth in
Section 19(b)(2)(A)(i) of the Exchange Act is appropriate in light of
the PCAOB's request that the Commission, pursuant to Section
103(a)(3)(C) of the Sarbanes-Oxley Act, determine that the proposed
rules apply to the audits of EGCs, the Commission has determined to
extend to July 3, 2019 the date by which the Commission should take
action on the proposed rules.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed
rules are consistent with the requirements of Title I of the Act.
Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/pcaob.shtml); or
     Send an email to [email protected]. Please include
File Number PCAOB-2019-02 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number PCAOB-2019-02. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (http://www.sec.gov/rules/pcaob.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rules that are filed
with the Commission, and all written communications relating to the
proposed rules between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for website viewing and printing in
the Commission's Public Reference Room, on official business days
between the hours of 10:00 a.m. and 3:00 p.m. Copies of such filing
will also be available for inspection and copying at the principal
office of the PCAOB. All comments received will be posted without
charge. Persons submitting comments are cautioned that we do not redact
or edit personal identifying information from comment submissions. You
should submit only information that you wish to make available
publicly. All submissions should refer to File Number PCAOB-2019-02 and
should be submitted on or before April 25, 2019.

    For the Commission, by the Office of the Chief Accountant, by
delegated authority.\172\
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    \172\ 17 CFR 200.30-11(b)(1) and (3).
---------------------------------------------------------------------------

Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-06426 Filed 4-3-19; 8:45 am]
 BILLING CODE 8011-01-P


[Federal Register Volume 82, Number 177 (Thursday, September 14, 2017)]
[Notices]
[Pages 43262-43264]
[FR Doc No: 2017-19537]

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SECURITIES AND EXCHANGE COMMISSION

[Investment Company Act Release No. 32812; 812-14781]

Innovator ETFs Trust, et al.

September 11, 2017.
AGENCY: Securities and Exchange Commission (``Commission'').

ACTION: Notice.

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    Notice of an application for an order under section 6(c) of the
Investment Company Act of 1940 (the ``Act'') for an exemption from
sections 2(a)(32),

5(a)(1), 22(d), and 22(e) of the Act and rule 22c-1 under the Act,
under sections 6(c) and 17(b) of the Act for an exemption from sections
17(a)(1) and 17(a)(2) of the Act, and under section 12(d)(1)(J) for an
exemption from sections 12(d)(1)(A) and 12(d)(1)(B) of the Act. The
requested order would permit (a) actively-managed series of certain
open-end management investment companies (``Funds'') to issue shares
redeemable in large aggregations only (``Creation Units''); (b)
secondary market transactions in Fund shares to occur at negotiated
market prices rather than at net asset value (``NAV''); (c) certain
Funds to pay redemption proceeds, under certain circumstances, more
than seven days after the tender of shares for redemption; (d) certain
affiliated persons of a Fund to deposit securities into, and receive
securities from, the Fund in connection with the purchase and
redemption of Creation Units; and (e) certain registered management
investment companies and unit investment trusts outside of the same
group of investment companies as the Funds (``Funds of Funds'') to
acquire shares of the Funds.

Applicants: Innovator Capital Management, LLC (``Innovator''), a
Delaware limited liability company registered as an investment adviser
under the Investment Advisers Act of 1940, Innovator ETFs Trust
(formerly, Academy Funds Trust) (the ``Trust''), a Delaware statutory
trust registered under the Act as an open-end management investment
company with multiple series, and Quasar Distributors, LLC (the
``Distributor''), a Delaware limited liability company and broker-
dealer registered under the Securities Exchange Act of 1934 (``Exchange
Act'').

Filing Dates:  The application was filed on June 7, 2017, and amended
on September 8, 2017.

Hearing or Notification of Hearing: An order granting the requested
relief will be issued unless the Commission orders a hearing.
Interested persons may request a hearing by writing to the Commission's
Secretary and serving applicants with a copy of the request, personally
or by mail. Hearing requests should be received by the Commission by
5:30 p.m. on October 5, 2017, and should be accompanied by proof of
service on applicants, in the form of an affidavit, or for lawyers, a
certificate of service. Pursuant to rule 0-5 under the Act, hearing
requests should state the nature of the writer's interest, any facts
bearing upon the desirability of a hearing on the matter, the reason
for the request, and the issues contested. Persons who wish to be
notified of a hearing may request notification by writing to the
Commission's Secretary.

ADDRESSES: Secretary, Securities and Exchange Commission, 100 F Street
NE., Washington, DC 20549-1090; Applicants: The Trust and Innovator,
120 N. Hale Street, Suite 200, Wheaton, Illinois 60187; the
Distributor, 615 East Michigan Street, Milwaukee, Wisconsin 53202.

FOR FURTHER INFORMATION CONTACT: Hae-Sung Lee, Attorney-Adviser, at
(202) 551-7345, or Andrea Ottomanelli Magovern, Acting Branch Chief, at
(202) 551-6821 (Division of Investment Management, Chief Counsel's
Office).

SUPPLEMENTARY INFORMATION: The following is a summary of the
application. The complete application may be obtained via the
Commission's Web site by searching for the file number, or for an
applicant using the Company name box, at http://www.sec.gov/search/search.htm or by calling<PHONE_NUMBER>.

Summary of the Application

    1. Applicants request an order that would allow Funds to operate as
actively-managed exchange traded funds (``ETFs'').\1\ Fund shares will
be purchased and redeemed at their NAV in Creation Units only. All
orders to purchase Creation Units and all redemption requests will be
placed by or through an ``Authorized Participant,'' which will have
signed a participant agreement with the Distributor. Shares will be
listed and traded individually on a national securities exchange, where
share prices will be based on the current bid/offer market. Any order
granting the requested relief would be subject to the terms and
conditions stated in the application.\2\
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    \1\ Applicants request that the order apply to the initial Fund
and any additional series of the Trust, and any other open-end
management investment company or series thereof (each, included in
the term ``Fund''), each of which will operate as an actively-
managed ETF. Any Fund will (a) be advised by Innovator or an entity
controlling, controlled by, or under common control with Innovator
(each, an ``Advisor'') and (b) comply with the terms and conditions
of the application.
    \2\ Prior to May 9, 2017, Innovator Management LLC (``Innovator
Management'') served as the Trust's investment adviser. (Innovator
and Innovator Management are not affiliated persons of each other.)
Innovator Management entered into an agreement with Innovator
pursuant to which Innovator Management transferred the assets of its
investment advisory business and related intellectual property to
Innovator (the ``Transaction''). The closing of the Transaction (the
``Closing'') occurred on May 9, 2017. The Commission previously
granted relief to Innovator Management and the Trust that, other
than the identity of the investment adviser, was identical in all
material respects to that requested in the application. Innovator
Management LLC, et al., Investment Company Act Release Nos. 31209
(Aug. 13, 2014) (notice) and 31248 (Sep. 9, 2014) (order)
(``Existing Order''). On May 5, 2017, the Commission staff provided
oral no-action relief to Innovator, the Trust, and the Distributor
to rely on the Existing Order until the earlier of the receipt of
any order granted by the Commission on the application or 150 days
from the date of the Closing.
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    2. Each Fund will consist of a portfolio of securities and other
assets and investment positions (``Portfolio Instruments''). Each Fund
will disclose on its Web site the identities and quantities of the
Portfolio Instruments that will form the basis for the Fund's
calculation of NAV at the end of the day.
    3. Shares will be purchased and redeemed in Creation Units and
generally on an in-kind basis. Except where the purchase or redemption
will include cash under the limited circumstances specified in the
application, purchasers will be required to purchase Creation Units by
depositing specified instruments (``Deposit Instruments''), and
shareholders redeeming their shares will receive specified instruments
(``Redemption Instruments''). The Deposit Instruments and the
Redemption Instruments will each correspond pro rata to the positions
in the Fund's portfolio (including cash positions) except as specified
in the application.
    4. Because shares will not be individually redeemable, applicants
request an exemption from section 5(a)(1) and section 2(a)(32) of the
Act that would permit the Funds to register as open-end management
investment companies and issue shares that are redeemable in Creation
Units only.
    5. Applicants also request an exemption from section 22(d) of the
Act and rule 22c-1 under the Act as secondary market trading in shares
will take place at negotiated prices, not at a current offering price
described in a Fund's prospectus, and not at a price based on NAV.
Applicants state that (a) secondary market trading in shares does not
involve a Fund as a party and will not result in dilution of an
investment in shares, and (b) to the extent different prices exist
during a given trading day, or from day to day, such variances occur as
a result of third-party market forces, such as supply and demand.
Therefore, applicants assert that secondary market transactions in
shares will not lead to discrimination or preferential treatment among
purchasers. Finally, applicants represent that share market prices will
be disciplined by arbitrage opportunities, which should prevent

shares from trading at a material discount or premium from NAV.
    6. With respect to Funds that hold non-U.S. Portfolio Instruments
and that effect creations and redemptions of Creation Units in kind,
applicants request relief from the requirement imposed by section 22(e)
in order to allow such Funds to pay redemption proceeds within fourteen
calendar days following the tender of Creation Units for redemption.
Applicants assert that the requested relief would not be inconsistent
with the spirit and intent of section 22(e) to prevent unreasonable,
undisclosed or unforeseen delays in the actual payment of redemption
proceeds.
    7. Applicants request an exemption to permit Funds of Funds to
acquire Fund shares beyond the limits of section 12(d)(1)(A) of the
Act; and the Funds, and any principal underwriter for the Funds, and/or
any broker or dealer registered under the Exchange Act, to sell shares
to Funds of Funds beyond the limits of section 12(d)(1)(B) of the Act.
The application's terms and conditions are designed to, among other
things, help prevent any potential (i) undue influence over a Fund
through control or voting power, or in connection with certain
services, transactions, and underwritings, (ii) excessive layering of
fees, and (iii) overly complex fund structures, which are the concerns
underlying the limits in sections 12(d)(1)(A) and (B) of the Act.
    8. Applicants request an exemption from sections 17(a)(1) and
17(a)(2) of the Act to permit persons that are affiliated persons, or
second-tier affiliates, of the Funds, solely by virtue of certain
ownership interests, to effectuate purchases and redemptions in-kind.
The deposit procedures for in-kind purchases of Creation Units and the
redemption procedures for in-kind redemptions of Creation Units will be
the same for all purchases and redemptions and Deposit Instruments and
Redemption Instruments will be valued in the same manner as those
Portfolio Instruments currently held by the Funds. Applicants also seek
relief from the prohibitions on affiliated transactions in section
17(a) to permit a Fund to sell its shares to and redeem its shares from
a Fund of Funds, and to engage in the accompanying in-kind transactions
with the Fund of Funds.\3\ The purchase of Creation Units by a Fund of
Funds directly from a Fund will be accomplished in accordance with the
policies of the Fund of Funds and will be based on the NAVs of the
Funds.
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    \3\ The requested relief would apply to direct sales of shares
in Creation Units by a Fund to a Fund of Funds and redemptions of
those shares. Applicants, moreover, are not seeking relief from
section 17(a) for, and the requested relief will not apply to,
transactions where a Fund could be deemed an affiliated person, or a
second-tier affiliate, of a Fund of Funds because an Advisor or an
entity controlling, controlled by or under common control with an
Advisor provides investment advisory services to that Fund of Funds.
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    9. Section 6(c) of the Act permits the Commission to exempt any
persons or transactions from any provision of the Act if such exemption
is necessary or appropriate in the public interest and consistent with
the protection of investors and the purposes fairly intended by the
policy and provisions of the Act. Section 12(d)(1)(J) of the Act
provides that the Commission may exempt any person, security, or
transaction, or any class or classes of persons, securities, or
transactions, from any provision of section 12(d)(1) if the exemption
is consistent with the public interest and the protection of investors.
Section 17(b) of the Act authorizes the Commission to grant an order
permitting a transaction otherwise prohibited by section 17(a) if it
finds that (a) the terms of the proposed transaction are fair and
reasonable and do not involve overreaching on the part of any person
concerned; (b) the proposed transaction is consistent with the policies
of each registered investment company involved; and (c) the proposed
transaction is consistent with the general purposes of the Act.

    For the Commission, by the Division of Investment Management,
under delegated authority.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-19537 Filed 9-13-17; 8:45 am]
 BILLING CODE 8011-01-P