Readers know that I have blogged many times on the SEC's compensation risk assessment requirement for public companies. And on that subject, last spring, I posted a blog entitled "PCAOB Butts in on Executive Compensation?", commenting (unfavorably) on the Public Company Accounting Oversight Board's proposed amendments to auditing standards for identifying and assessing excessive risk in executive compensation programs, which would have significantly expanded the auditors' responsibilities for their clients' executive compensation programs.
If this proposal becomes a reality then it might be possible, . . . that an auditor could tell a company that its compensation programs are, "too risky, we can't sign off on the financials," placing outside auditors in the role of pre-approving executive compensation programs. (Nothing against auditors, but this is not their role. I doubt that they want this role any more than we want to give it to them.
In response to a flood of similar comments, this month the PCAOB re-proposed these new auditing standards, "Identifying and Assessing Risks of Material Misstatement," including "audit procedures related to executive compensation, given the possible incentive compensation can have on to manipulate financial results or engage in fraud." Under the re-proposed auditing standard, PCAOB continues to take the position that:
"A company's financial relationships and transactions with its executive officers might create incentives and pressures that could create risks of material misstatement of the financial statements. Performing procedures to obtain an understanding of a company's financial relationships and transactions with its executive officers can benefit the auditor's identification of fraud risks and other significant risks."
However, the re-proposed standards explicitly "clarify that the auditor's procedures in this area would be performed as part of the auditor's risk assessment process and would not require the auditor to make any determination regarding the reasonableness of the company's compensation arrangement with its executive officers or recommendations regarding such compensation arrangements." Accordingly, the re-proposed amendments, like the proposed amendments, would require the auditor to perform procedures that include, but are not limited to:
- Reading the employment and compensation contracts between the company and its executive officers;
- Reading proxy statements and other relevant company filings with the SEC and other regulatory agencies that relate to the company's financial relationships and transactions with its executive officers, and
- Consider inquiring of the chair of the compensation committee, or the compensation committee's equivalent, and any compensation consultants engaged by either the compensation committee or the company regarding the structuring of the company's compensation for executive officers.
Yikes. If your company has not conducted a thorough compensation risk assessment, this might be your wake-up call. The PCAOB expressly dismissed the concern expressed by many commenters that this type of auditing inquiry could generate documentation that leads to or complicates litigation against the company. Now that we know someone will be looking closely, we ought to try to ferret out and address any issues before someone else does.