1. (a) A certificate or registration holder must be independent in fact and in appearance when performing an engagement in which the certificate or registration holder will issue a report on financial statements of any client, except for a report in which lack of independence may be cured by disclosure under applicable professional standards.

2. (b) Independence will be considered to be impaired if, for example, during the period of the professional engagement or at the time of expressing an opinion, the certificate or registration holder:

   1. (1) had or was committed to acquire any direct or material indirect financial interest in the client;
   2. (2) was a trustee of any trust or executor or administrator of any estate if such trust or estate had or was committed to acquire any direct or material indirect financial interest in the client;
   3. (3) had any joint closely-held business investment with the client or any officer, director, partner, or principal stockholder thereof which was material in relation to the net worth of the certificate or registration holder; or

   4. (4) had any loan to or from the client or any officer, director, partner, or principal stockholder thereof other than certain "grandfathered loans" and "other permitted loans" which will not be considered to impair independence.

      1. (A) Grandfathered loans--Loans from a financial institution made under that institution's normal lending procedures, terms, and requirements, and that meet the other specified conditions stated herein. Grandfathered loans must, at all times, be current as to all terms and such terms shall not be renegotiated after the latest of the dates in clauses (i)-(iv) of this subparagraph. Grandfathered loans include those which:

         1. (i) existed as of January 1, 1997;
         2. (ii) were obtained from a financial institution prior to its becoming a client requiring independence;
         3. (iii) were obtained from a financial institution for which independence was not required and that were later sold to a client for which independence is required; or

         4. (iv) were obtained from a firm's financial institution client requiring independence, by a borrower prior to his or her becoming a member of the firm or registration holder, such as:

            1. (I) loans obtained by the certificate or registration holder which are not material to the net worth of the borrower;
            2. (II) home mortgages; and
            3. (III) other secured loans in which the collateral must equal or exceed the remaining balance of the loan at January 1, 1997, and at all times thereafter.

      2. (B) Other permitted loans--Personal loans obtained from a financial institution client from which independence is required which were made under that institution's normal lending procedures, terms and requirements. Such loans must, at all times, be kept current as to all terms. Other permitted loans include:

         1. (i) automobile loans and leases collateralized by the automobile;
         2. (ii) loans of the surrender value under terms of an insurance policy;
         3. (iii) loans fully collateralized by cash deposits at the same financial institution; and
         4. (iv) credit cards and cash advances on checking accounts with an aggregate balance not paid currently of $5,000 or less.

3. (c) Independence also will be considered to be impaired if, during the period covered by the financial statements, during the period of the professional engagement, or at the time of issuing his report, the certificate or registration holder:

   1. (1) was connected with the client as a promoter, underwriter, or voting trustee, a director or officer, or in any capacity equivalent to that of a member of management or of any employee;
   2. (2) was a trustee for any pension or profit-sharing trust of the client;
   3. (3) receives from a third party, or had a commitment to receive from the client or third party, with respect to services or products procured or to be procured by the client, other compensation which was material in relation to the aggregate normally-recurring fees charged annually to the client for reports on financial statements;
   4. (4) had a commitment from the client for a contingent fee in violation of §501.72 of this title (relating to Contingency Fees); or
   5. (5) had an engagement to provide for the supervision of an individual as provided for in §511.124(a)(1) of this title (relating to Acceptable Supervision).
4. (d) Independence will be presumed to be impaired if the certificate or registration holder performs audit services, other than for charitable organizations, for a fee that is less than the direct labor cost reasonably expected, at the time the engagement was accepted, to be incurred in performing such services. For this purpose direct labor costs means the total compensation of the person or persons expected to perform the service for the time they are expected to serve on the audit plus all payroll expenses related to such compensation.

5. (e) A certificate or registration holder's independence may be impaired by a close relative's association with a client. Close relatives are defined as spouses and dependent persons, whether or not related, and defined as dependent and non-dependent children, grandchildren, stepchildren, brothers, sisters, parents, grandparents, parents-in-law, and their respective spouses.

   1. (1) Certificate and registration holders must consider whether the strength of personal and business relationships between the certificate or registration holder and the close relative would lead a reasonable person who is aware of all the facts to conclude that the situation poses an unacceptable threat to the certificate or registration holder's objectivity and appearance of independence. In reaching this conclusion, the certificate or registration holder should consider the specific association with the client.

   2. (2) A certificate or registration holder's independence will be presumed to be impaired with respect to a client if:

      1. (A) during the period of the professional engagement or at the time of expressing an opinion, the certificate or registration holder participating in the engagement has knowledge of a close relative who has a material financial interest in the client;

      2. (B) during the period covered by the financial statements, during the period of the professional engagement, or at the time of expressing an opinion:

         1. (i) the certificate or registration holder participating in the engagement has a close relative who could exercise significant influence over the operative, financial, or accounting policies of the client or is otherwise employed in a position in which the close relative's activities are normally an element of or subject to significant internal accounting controls;
         2. (ii) a proprietor, shareholder, or individual in a managerial position in a certificate or registration holder's office, has a close relative who could exercise significant influence over the client's operating, financial, or accounting policies, if that proprietor, shareholder or individual participates in a significant portion of the engagement.
6. (f) The examples of impaired independence described in subsections (b)-(e) of this section are not intended to be all-inclusive.

Source Note:The provisions of this §501.70 adopted to be effective June 11, 2000, 25 TexReg 5337.