A lead audit partner finishes year five on an issuer engagement. The client offers her firm a $400,000 internal audit outsourcing contract. The audit committee chair signs off the next morning. Two SEC rules just got broken and one PCAOB rule is about to be, and she has not yet billed an hour.
After Enron and WorldCom collapsed, Congress concluded that audit firms selling consulting to clients they audited had compromised the audit. Sarbanes-Oxley's fix: ban certain services outright, force partner rotation, and create the PCAOB. The SEC implemented Sarbanes-Oxley through Rule 2-01 of Regulation S-X; the PCAOB layered Rules 3520-3526 on top. The regime applies whenever the client is an issuer, a company with publicly traded securities or in registration with the SEC.
KEY: Issuer = SEC registrant. The exam hides this in the stem: "publicly traded," "files Form 10-K," "registered under the 1934 Act" all signal issuer rules apply.
Rule 2-01(b) says an accountant is not independent when a reasonable investor would conclude they cannot exercise objective judgment. Four situations always violate this standard:
Common mistakes
- Treating audit-committee pre-approval as a cure for prohibited services. Firm proposes internal audit outsourcing to an issuer; candidate marks "permitted because pre-approved." The audit committee cannot pre-approve a service banned by §201. Trap: "permitted with pre-approval."
- Confusing 5-year and 7-year rotation. Stem asks how long the lead partner can serve; candidate answers 7 years. Lead and concurring rotate at 5 years with 5-year cooling-off; other partners rotate at 7 years with 2-year cooling-off. Trap: "7 years."
- Allowing tax services to the CFO personally. Candidates extend issuer-level tax permission to the CFO's individual return. Rule 3523 separately bans tax services to FROR executives. Trap: "permitted because the audit committee pre-approved."
Bottom line
- SEC Rule 2-01 of Regulation S-X sets issuer independence: four guiding principles (no mutual interest, no self-review, no management role, no advocacy) plus nine prohibited non-audit services.
- Sarbanes-Oxley §201 lists the nine bans: bookkeeping, IT systems, valuation, actuarial, internal audit, management/HR, investment services, legal services, plus a PCAOB catch-all.
- §203 rotates lead and concurring partners after 5 years with a 5-year cooling-off; other audit partners rotate at 7 years with a 2-year cooling-off.
- §206 imposes a 1-year cooling-off before audit staff can take a financial reporting oversight role at the client, with the clock starting at audit-team departure.
Exam shortcut
When the stem mentions an SEC registrant, publicly traded company, or 10-K filer, drop the AICPA framework. Walk three checks: (1) is the service on the §201 list, (2) was pre-approval obtained, (3) does rotation or §206 cooling-off apply. Any failure impairs independence.
The full lesson (about 2,296 words, 15 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- I.A2
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