With the SEC now considering whether to approve AS 3101, the PCAOB’s new enhanced disclosure requirement for the auditor’s report (see this PubCo post), and SEC concept releases and other disclosure projects still hovering in the ether, there seems to be a steady march by companies toward inclusion of more supplemental audit committee disclosures on a voluntary basis, according to a new study by the EY Center for Board Matters. The study, which reviewed audit committee reporting in proxy statements by companies in the Fortune 100 for 2017, showed that companies in that elite group have demonstrated “[y]ear-over-year growth in voluntary audit-related disclosures in 2017 filings … similar to that seen in 2015 and 2016, indicating that companies and audit committees continue to reflect upon and make changes to the information that they communicate to shareholders.”
Currently, audit committee members are required to confirm in their reports only that they have reviewed and discussed the financial statements with management, that they have received certain disclosures from the outside auditors and discussed with them independence matters as required under Auditing Standard No. 1301 and that they have recommended inclusion of the financials in the Form 10-K. However, the SEC’s 2015 concept release floated a number of possible additional disclosure mandates related to how the audit committee satisfies its oversight and other responsibilities, including the factors used by the audit committee in assessing independence and quality of the outside auditor, auditor tenure, the audit committee’s rationale for auditor selection and the nature of the audit committee’s involvement in evaluating and approving the auditor’s compensation. (See this PubCo post.) In addition, the SEC’s much vaunted Disclosure Effectiveness Project, which could affect financial disclosures, is still ongoing. (See this PubCo post and this PubCo post.) As EY notes, as part of that Project, “the SEC staff has encouraged issuers to voluntarily review their disclosures to consider whether and how they can better provide investors with better information.”
As EY observes, in the last few years, investors and other stakeholders “have sought greater transparency around the audit and oversight of financial reporting. This interest in transparency may be due in part to the fact that, even as the obligations of audit committees have expanded over the years, required audit committee disclosures have not….” In response to these pressures, as EY’s study demonstrates, many companies have enhanced their audit committee reporting voluntarily.
Notably, the PCAOB has recently imposed new mandates on auditors, including the requirement to file Form AP to disclose the name of the lead audit engagement partner and to identify other accounting firms that participated in the audit, if their work constituted 5% or more of the total audit hours (see this PubCo post and this PubCo post), as well as the requirement, subject to SEC approval, to enhance disclosure in the auditor’s report (see this PubCo post).)
In its analysis, EY examined the proxy materials of 75 companies in the 2017 Fortune 100 that filed proxy statements each year from 2012 to 2017 for annual meetings through August 15, 2017. EY found that since 2012, Fortune 100 companies have, on a voluntary basis, significantly increased the information available about audit firm selection, retention and oversight. Many companies are now enhancing their disclosures with low-hanging fruit: explicitly disclosing that the audit committee is responsible for the appointment, compensation and oversight of the auditor (87% in 2017, up from 81% in 2016); that the audit committee considers non-audit services and fees when assessing the independence of the external auditor (84%, up from 81% in 2016); and that the audit committee was involved in the selection of the lead audit partner (75%, up from 69% in 2016 and only 1% in 2012).
Not surprisingly, however, most companies have steadfastly remained opaque about the juicier information: for example, only a paltry percentage (3% to 4%) of companies identified the topics discussed by their audit committees with their external auditors. One company identified by EY that did disclose presentations by the auditors identified the following as topics: “the company’s: (i) enterprise risk assessment process; (ii) information technology systems and controls; (iii) income tax strategy and risks; (iv) derivatives policy and usage; (v) benefit plan fund management; (vi) 20XX integrated audit plan; (vii) updates on completion of the audit plan; (viii) critical accounting policies; (ix) assessment of the impact of new accounting guidance; (x) compliance with the internal controls required under Section 404 of SOX; (xi) ethics and compliance program; (xii) risk management initiatives and controls for various acquisitions and business units; (xiii) strategy and management of the implementation of new systems; and (xiv) cyber security.”
However, that low statistic could change dramatically if the SEC approves the PCAOB’s new auditing standard for the auditor’s report, which will require auditors to include a discussion 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.” The prospect of the auditors pouring out their hearts about their struggles in making judgments about the company’s financials may be enough to drive more than a few audit committees to present their sides of the story. (See this PubCo post.)
With regard to auditor retention decisions, 56% of the companies studied disclosed the factors used by the committee in assessing the auditor’s qualifications and work quality, representing a significant increase from 48% in 2016 and only 17% in 2012. For example, one company disclosed that the factors considered included the “historical and recent performance of the current independent audit firm, an analysis of known significant legal or regulatory proceedings related to the firm, external data on audit quality and performance, including PCAOB reports, industry experience, audit fee revenues, firm capabilities and audit approach, and the independence and tenure of the audit firm.” Another company disclosed that the audit committee evaluated the firm’s “qualifications, assessing the firm’s quality of service, the firm’s sufficiency of resources, the quality of the communication and interaction with the firm, and the firm’s independence, objectivity, and professional skepticism. The Committee also considers the advisability and potential impact of selecting a different independent public accounting firm.” With respect to the last sentence above, 60% of companies in 2017 disclosed that, when assessing whether to retain the current auditor, the audit committee considered the impact of changing auditors, up from 55% in 2016 and 3% in 2012.
While SEC rules require disclosure of amounts and categories of fees—and most companies do explain the types of services included within each fee category—there is no requirement to disclose the underlying reasons for changes. EY found that 43% of companies provided information in 2017 about the reasons for changes in fees, compared with in 31% of 2016 and only 11% in 2012. Among the reasons given for changes were one-time events such as mergers or acquisitions. EY found that companies are more likely to provide explanations for rising audit fees than for declining fees. In 2017, of the companies with audit fees > 5% higher than in 2016, 29% provided an explanation, while those with audit fees >5% lower, only 9% provided an explanation. In 2012, none of the companies stated that the audit committee was responsible for fee negotiations, but in 2017, 32% included that disclosure and 27% did so in 2016.
The incidence of disclosure of outside auditor tenure has also jumped over the long haul: in 2012, only 27% of companies included that disclosure, while in 2017, 67% disclosed audit firm tenure and 65% did so in 2016.
With regard to audit committee composition, 48% of companies disclosed that they have three or more financial experts on their audit committees, a decline from 51% in 2016, but a significant increase over the 33% reported in 2012. In 2017, 26% of audit committee members were women, compared with 19% in 2012. Between 2012 and 2017, there was a 41% turnover in audit committee chairs, and 85% of audit committees gained new members.
Finally, EY suggests that, in deciding whether to include or increase the level of voluntary disclosures, audit committees consider the following questions:
- “To what extent does the audit committee already provide voluntary audit or audit-related disclosures?
- Have investors expressed interest in greater transparency in the audit committee’s work in connection with broader company-investor engagement conversations?
- How has the role of the audit committee evolved in recent years (e.g., oversight of the ERM process, cybersecurity risk) — and to what extent are these changes being communicated to stakeholders via the proxy statement?
- What additional voluntary disclosures might be useful to shareholders related the audit committee’s time spent on certain activities such as company restructuring or financial statement reporting developments?”