The Center for Audit Quality, working with Audit Analytics, has just released a new edition of its annual Audit Committee Transparency Barometer, which, over the past five years, has measured the robustness of audit committee disclosures in proxy statements among companies in the S&P Composite 1500. The bottom line, according to the CAQ, is that the level of voluntary transparency has continued to steadily increase in most areas. The report includes several useful examples of the types of disclosure discussed.
Among the key findings:
- An increase in the percentage of S&P 500 companies that disclosed in their proxy statements enhanced discussions of their audit committees’ considerations in recommending the appointment of their audit firms from 13% in 2014 to 40% in 2018; among mid-cap companies, 27% included enhanced discussion of these considerations in 2018 (an increase from 10% in 2014), compared to 19% of small-cap companies in 2018 (an increase from 8% in 2014).
- An increase in the percentage of S&P 500 companies that disclosed audit firm tenure from 47% in 2014 to 70% in 2018; among mid-cap companies, 52% disclosed auditor tenure in 2018 (an increase from 42% in 2014), compared to 51% of small-cap companies in 2018 (an increase from 50% in 2014).
- An increase from 8% in 2014 to 20% in 2018 among S&P 500 companies that stated in their proxy statements audit committee responsibility for fee negotiations; among mid-cap companies, 5% included these statements in 2018, an increase from 1% in 2014, and 4% of small-cap companies included statements to that effect in 2018, also an increase from 1% in 2014.
- The percentage of S&P 500 companies that included in their proxy statements explanations for changes in fees paid to audit firms was flat at 28% relative to 2014 (although a decrease from 31% in 2017); among mid-cap companies, 26% included explanations of the changes in 2018 (declines from 30% in 2014 and 32% in 2017), compared to 30% of small-cap companies in 2018 (an increase from 24% in 2014, but a decline from 35% in 2017).
- An increase from 8% in 2014 to 46% in 2018 in the percentage of proxy statements for S&P 500 companies that discussed the criteria the audit committee considered when evaluating the audit firm; in 2018, 36% of mid-cap companies disclosed these criteria (an increase from 7% in 2014), compared to 32% of small-cap companies in 2018 (an increase from 15% in 2014).
- An increase from 4% in 2014 to 26% in 2018 in the percentage of proxy statements for S&P 500 companies that disclosed that audit firm evaluations were conducted at least annually; among mid-cap companies, 17% included that disclosure in 2018 (an increase from 3% in 2014), compared to 12% of small-cap companies in 2018 (an increase from 4% in 2014).
- An increase from 13% in 2014 to 52% in 2018 in the percentage of proxy statements for S&P 500 companies that explicitly disclosed audit committee involvement in the selection of the audit engagement partner; in 2018, 20% of mid-cap companies disclosed that involvement (an increase from 1% in 2014), compared to 10% of small-cap companies in 2018 (an increase from 1% in 2014).
- An increase from 16% in 2014 to 49% in 2018 in the percentage of proxy statements for S&P 500 companies that disclosed that the audit engagement partner rotated every five years; among mid-cap companies, 20% disclosed the rotation in 2018 (an increase from 3% in 2014), compared to 12% of small-cap companies (an increase from 4% in 2014).
Interestingly, the incidence of one disclosure topic has declined from the prior year across the S&P 1500 indices: an explanation for a change in fees paid to the audit firm. The report indicates that this number has fluctuated from year to year since 2014, with explanations often related to activity such as business combinations or other nonrecurring business activity. In addition, citing Deloitte, the report observes that the “greatest year-over-year percentage increase occurred in disclosures regarding the audit committee’s role in the oversight of cybersecurity, which has increased by 13% since 2017.”
Although, in 2017, Corp Fin staff indicated that the SEC might take up potential amendments arising out of this 2015 concept release regarding possible revisions to audit committee disclosures (see this PubCo post), in the Fall 2018 Unified Agenda of Regulatory and Deregulatory Actions, consideration of those amendments was relegated to the SEC’s long-term agenda. (See this PubCo post.) In the concept release, the SEC had sought comment on the adequacy of existing disclosure requirements 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.”
Ironically, additional company transparency may ultimately result from rules adopted by the PCAOB for disclosures by auditors in audit reports. As discussed in this PubCo post, disclosure of auditor tenure in the audit report has become mandatory for audits of fiscal years ended on or after December 15, 2017. In addition, at later phase-in dates, most audit reports will need to include disclosure of “critical audit matters,” that is, “matters 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 judgment.” Essentially, the concept is intended to capture the matters that kept the auditor up at night, so long as they meet the standard’s criteria. The new CAM disclosure requirement will apply (with some exceptions) to audits conducted under PCAOB standards, including audits of smaller reporting companies and non-accelerated filers (although not to emerging growth companies).
The selection of and disclosure regarding CAMs will certainly present a challenge for both audit committees and auditors. The prospect of the auditors’ providing those disclosures is leading many audit committees to consider the impact of CAM disclosures on companies’ own disclosures. Why? Because, generally, audit committees much prefer that the company get a jump on the disclosure so that the auditors will not need to resort to the creation of original material and the company can best frame the discussion from its own perspective. To be sure, no audit committee would be enthusiastic about the prospect of the auditor’s sharing with the investing public the concerns that arose in performing the audit or the struggles involved in reaching conclusions about the financials. Although the adopting release suggested that the process would be an iterative one between management and the auditors, time will tell whether, once the auditors have crafted a CAM disclosure, they might just be a bit reluctant to allow much input by audit committees or managements. To best position the company, a former Director of Corp Fin cited in this article from Compliance Week advised that audit committee members should be revisiting the company’s own disclosures now, as soon as they have an inkling of which CAMs the auditor plans to identify: the “best CAM disclosure…will be one that cross references a disclosure in the financial statements.” (See this PubCo post.)