ISB 3: Employment Discussions with an Audit Client

The Independence Standards Board (ISB) was established to provide a framework for auditor independence, ensuring auditors remain objective and impartial when reviewing a company’s financial statements. A key output was ISB Standard No. 3, which confronts the threat to independence that emerges when a professional at an audit firm explores job opportunities with an audit client. Though the ISB was later dissolved, its standards were not abandoned. The principles from ISB Standard No. 3 were incorporated into the rules of the Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB), and its core requirements remain in effect and are actively enforced.

Key Definitions and Scope

The regulation applies to an “Audit Client,” which is not just the specific company whose financial statements are being audited. The term also encompasses the client’s affiliates, such as parent companies, subsidiaries, and other related entities. This broad definition ensures that discussions with a closely related company are subject to the same scrutiny.

The rules apply to a “Covered Person” within the audit firm. This term includes members of the audit engagement team and other individuals in a position to influence the audit’s outcome. This can include partners who oversee the engagement, quality control reviewers, and senior managers in the same office who consult on client issues.

The trigger for the standard’s requirements is an “Employment Discussion.” This is a broadly interpreted concept that goes beyond a formal job interview or offer. It includes any exploratory conversation about potential employment, whether initiated by the professional or the client, including a casual inquiry about an open position.

Required Actions for Audit Professionals

Once an employment discussion occurs, the individual audit professional must take immediate action. The rules mandate that the professional must “promptly report” any such conversation to an appropriate person within the audit firm, such as the designated ethics or independence partner. This reporting duty is absolute and does not depend on who initiated the contact or whether a formal job offer was extended.

The term “promptly” is interpreted as within one to two business days of the discussion, and delaying this notification is a violation of the independence rules. This requirement removes any judgment from the professional regarding the seriousness of the discussion; an auditor cannot decide on their own that a conversation was too informal to warrant reporting.

Required Actions for the Audit Firm

Upon receiving a report of an employment discussion, the audit firm must follow a set of procedures. The first step is to remove the professional from the audit engagement without delay. This removal applies to any further work on the audit, including fieldwork, review, or report issuance.

The second required action is for the firm to conduct a thorough review of the work that the affected professional has already performed on the engagement. This review must be carried out by a qualified individual, such as a more senior member of the audit team or a quality control partner, who was not involved in the original work.

This review involves a detailed re-examination of the professional’s working papers and judgments. For instance, if the professional was responsible for auditing a complex area like revenue recognition, the reviewer would reassess the evidence gathered and conclusions reached. If any issues are identified, the firm must take corrective action.

Required Communication with the Audit Committee

The final step involves communication between the audit firm and the client’s audit committee. The firm is obligated to inform the audit committee about any reported employment discussions and the specific actions it has taken in response. This communication is a formal requirement under PCAOB Rule 3526, which mandates that auditors discuss all matters related to independence with the committee.

The firm must detail which professional was involved, the nature of the employment discussion, the date the firm was notified, and confirmation that the individual was removed from the engagement. The firm must also describe the scope and findings of its internal review of the professional’s work.

The audit committee then uses this information to make its own assessment of the situation. It must consider whether the firm’s safeguards were adequate and whether the firm continues to be capable of exercising objective judgment.