The SEC hasn’t issued a concept release since 2011, but that’s changed now with the posting of this concept release regarding possible revisions to audit committee disclosures (foreshadowed in this post).
The concept release seeks public comment on possible new reporting requirements focused on the audit committee’s responsibilities with respect to its oversight of the independent auditor. As the release notes, SOX mandated a number of changes to reporting and corporate governance related to audit committees, but these disclosures do not describe how the audit committee satisfies its responsibilities. Concerns have recently surfaced that the current audit committee report is inadequate and that additional information would be useful for investors in evaluating audit committee performance and auditor ratification, as well as their own investment decisions. According to the release, some investors have requested additional transparency to enable them “to differentiate between companies based on the quality of audit committee oversight, and determine whether such differences in quality of oversight may contribute to differences in performance or quality of financial reporting among companies…. Some investors have sought greater disclosure from audit committees of a number of public companies about matters such as the responsibility of the audit committee for the appointment, compensation, and oversight of the external auditor; audit firm tenure; audit firm fee determinations; and audit committee involvement in the selection of the audit engagement partner. Institutional investor groups have called for additional audit committee disclosures as part of their published ‘good corporate governance policies.’” On the other side are concerns about “disclosure overload,” whether the potential new disclosures would actually be helpful and avoidance of a “one-size-fits-all” approach.
Some companies already voluntarily provide additional disclosures, such as audit firm tenure and the impact of non-audit services. The SEC is seeking comment on the adequacy of current disclosures as well as on potential changes to required disclosures that would “address the audit committee’s responsibilities with respect to the appointment, compensation, retention, and oversight of the work of the registered public accounting firm and better inform investors about how the audit committee executes those responsibilities.” The concept release is full of specific questions about potential disclosures relating to the usefulness, potential impact on audit quality and other negative or positive implications of the potential disclosures. Public comments are due within 60 days after publication of the concept release in the Federal Register. Comments may extend beyond the precise scope of the release to include disclosure of matters such as audit committee qualifications or oversight of financial reporting or internal control.
[Sidebar: Note that, at the same time, the PCAOB has issued its long-expected supplemental request for comment on whether to require firms to file a new PCAOB form to make public the name of the audit engagement partner and information about certain other participants in the audit, a potential alternative to its 2013 proposal to disclose the audit engagement partner in the audit report (which met with substantial resistance). Some have argued that audit committee reports, which are within the jurisdiction of the SEC, are really the correct venue for information about audit firm tenure and identity of engagement partners.The arguments in support of that view are that audit firm tenure and the name of the engagement partner are really disclosure issues, not financial reporting issues, and that they are issues relevant to shareholder ratification of auditors and, therefore, should be disclosed in the proxy statement. Note also that the PCAOB has just issued its own concept release “seeking comment on the content and possible uses of audit quality indicators, measures that may provide new insights into audit quality.” Here are the press release and the related fact sheet for the AQIs.]
Below are some of the areas of possible disclosure suggested in the concept release.
Audit Committee’s Oversight of the Auditor
Audit committee/auditor communications
Potential additional disclosures might address the following:
- the actions the audit committee has taken during the most recently completed fiscal year to oversee the auditor and the audit;
- qualitative disclosures about the nature and timing of the required communications between the audit committee and the auditor, such as whether and when the required communications occurred and the audit committee’s consideration of the matters discussed; and
- communications with the auditor related to “the auditor’s overall audit strategy, timing, significant risks identified, nature and extent of specialized skill used in the audit, planned use of other independent public accounting firms or other persons, planned use of internal audit, basis for determining that the auditor can serve as principal auditor, and results of the audit, among others, and how the audit committee considered these items in its oversight of the independent auditor.”
Frequency of meetings between the audit committee and the auditor
While the number of audit committee meetings is already required to be disclosed, potential additional disclosure might relate to the specific meetings with the auditor to provide additional insight into the audit committee’s oversight of the auditor.
The auditor’s internal quality review and PCAOB inspection report
Certain listing requirements mandate that the audit committee review a “report by the independent auditor describing the firm’s internal quality-control procedures, any material issues raised by the most recent internal quality-control review, or peer review, of the firm, or by any inquiry or investigation by governmental or professional authorities, within the preceding five years, with respect to one or more independent audits carried out by the firm.” Some aspects of the inspection reports are confidential, but the PCAOB has suggested a number of questions that audit committees could ask about these inspections and reports without undermining their confidentiality. The SEC could require disclosure regarding:
- whether this type of discussion has occurred; and
- the nature of any discussions with the auditor about the results of the firm’s internal quality review and most recent PCAOB inspection.
Auditor’s objectivity and professional skepticism
Through heightened oversight, the audit committee can assess, promote and reinforce the auditor’s objectivity and professional skepticism, which should promote greater audit quality. The audit committee could disclose:
- whether, and if so how, as part of its oversight of the auditor, it assesses, promotes, or reinforces the auditor’s objectivity and professional skepticism; and
- the results of its evaluation of the auditor’s objectivity and professional skepticism.
Audit Committee’s Process for Appointing or Retaining the Auditor
Assessment of auditor independence, objectivity and audit quality; audit committee’s rationale for auditor selection
Understanding this assessment process could provide transparency into the rigor of audit committee oversight. Disclosures could include:
- steps involved in the process to assess the auditor;
- the specific elements or criteria the audit committee considered (e.g.,whether non-audit services were taken into account);
- the nature of the audit committee’s involvement in evaluating and approving the auditor’s compensation; and
- the extent of the use and consideration by the audit committee of published audit quality indicators or metrics (such as those from the PCAOB, noted in the Sidebar above) in assessing the quality of the auditor and the audit.
Process the committee undertook to seek requests for proposals, if any, and factors in selecting auditor
Disclosures about the process undertaken could include:
- the number of auditors asked to make a proposal;
- how they were selected; and
- the information the audit committee used in reaching a decision about which auditor to select for the upcoming fiscal year’s audit.
Policy regarding an annual shareholder vote on the auditor and the audit committee’s consideration of the voting results
The concept release also asks if auditor ratification should continue to be considered a “routine” proxy proposal for purposes of NYSE Rule 452. Disclosures could include:
- the board of directors’ policy, if any, for soliciting annual shareholder ratification of the selection of the auditor; and
- the audit committee’s consideration of the voting results in its selection process, especially where the audit firm fails to achieve majority support.
Qualifications of the Audit Firm and Certain Members of the Engagement Team Selected By the Audit Committee
Certain Individuals on the Engagement Team
As noted above, the PCAOB has been struggling for several years to find a way to disclose the name of the engagement partner that would be acceptable to all interested parties. The concept release asks whether identification would be more appropriate in the audit report or in a separate PCAOB filing (the PCAOB’s most current proposal). Disclosures might include:
- the name of the engagement partner;
- the names of other key members of the audit engagement team (such as the engagement quality reviewer);
- the length of time they have each served in that role and any relevant experience (e.g., the number of prior audit engagements performed, whether they were in the same industry); and
- if the individuals disclosed will be changing for the upcoming year’s audit.
This topic has attracted some public interest, and academic research on the beneficial or detrimental impact on audit quality of shorter or longer auditor tenure has been mixed. Disclosure of auditor tenure could provide insight into the audit committee’s overall decision to engage or retain the auditor.
Audit committee input in selecting the engagement partner
Disclosures might include a discussion of any input the audit committee had in the assignment of the engagement partner.
Other firms Involved in the audit
The auditor is required to communicate to the audit committee certain information regarding other accounting firms or other persons, who are not employed by the auditor, that performed audit procedures in the audit. However, this information is not required to be publicly disclosed. The question is whether the names of the other firms and related information about those firms should be made public.
- Should the audit committee report and other audit committee-related disclosures (that are not otherwise incorporated by reference) be included in IPO or other registration statements?
- Should the current and potential audit committee disclosure requirements be applicable to smaller reporting companies or emerging growth companies?