The Securities and Exchange Commission has issued a concept release seeking public comment on various potential audit committee disclosure requirements for public companies in the United States. The SEC is considering adding new disclosures regarding, among other topics:
- audit committee communications with the independent auditor;
- the frequency of meetings between the audit committee and the auditor;
- the auditor’s internal quality-control review and most recent inspection report from the Public Company Accounting Oversight Board (PCAOB);
- the process utilized by the audit committee to evaluate the auditor;
- any request for proposal (RFP) utilized in selecting the auditor;
- the name, tenure and experience of the audit engagement partner and key members of the auditor engagement team;
- the length of the auditor’s relationship with the company; and
- the identity of other accounting firms involved in the audit.
The SEC also solicited comment about whether any incremental disclosures adopted should apply to foreign private issuers, emerging growth companies or smaller reporting companies. Comments on the questions raised in the SEC concept release are due on or before September 8, 2015.
Existing audit committee disclosure regime
The existing disclosure requirements relevant to audit committees of US public companies are generally limited to the following topics, which must be disclosed in the issuer’s annual report and/or proxy or information statement related to the election of directors:
- Audit Committee Members and Meetings. Issuers must disclose whether they have an audit committee or a committee performing similar functions and, if so, must identify each committee member, disclose whether they are independent, state the number of committee meetings held in the last fiscal year and describe briefly the functions performed by the committee.
- Audit Committee Report. An audit committee report must disclose whether the audit committee has (i) reviewed and discussed the audited financial statements with management; (ii) discussed with the independent auditor the matters required by PCAOB Auditing Standard No. 16 (Communications with Audit Committees) (previously AU section 380); (iii) received certain required written communications from the auditor regarding its independence, as required by the rules of the PCAOB, and discussed with the auditor its independence; and (iv) recommended to the board of directors that audited financial statements be included in the company’s annual report for filing with the SEC.
- Audit Committee Financial Expert. Issuers must disclose that their board has determined that the issuer either has at least “one audit committee financial expert” serving on its audit committee or that the issuer does not have one.
- Ratification of the Selection of the Auditor. If the issuer solicits the approval or ratification of the auditor from shareholders, the issuer must disclose in the proxy or information statement the name of the audit firm selected or recommended for the current year and whether a representative of the firm will attend the shareholders meeting and be available to answer questions.
- Auditor Compensation. The company must disclose the fees paid to its independent auditor for each of the two most recent fiscal years, separated into audit fees, auditrelated fees, tax fees and all other fees. Companies must disclose the percentage of audit-related fees, tax fees and all other fees that were approved by the audit committee pursuant to its preapproval policies.
- Preapproval Policies. Audit committees are required to preapprove all permissible nonaudit services and all required audit, review or attestation engagements. Companies must provide disclosure regarding the audit committee’s preapproval policies and procedures.
Charter. The company must disclose whether or not the audit committee has a charter. If it has a charter, the company must disclose whether a current copy is available on the company’s web site and, if so, must provide the web site address. If it is not available on the web site, a copy must be included in an appendix to the proxy or information statement at least once every three years.
Possible changes to the audit committee disclosure requirements
The SEC’s concept release observes that a significant number of companies voluntarily provide more information about their audit committee than the disclosures required by existing rules, and that the SEC understands that some investors and other stakeholders have requested greater transparency about audit committee activities. In addition, the PCAOB is separately exploring additional disclosure requirements for the audit report, and foreign regulators have also been requiring incremental disclosures regarding audit committee activities. Accordingly, the SEC’s concept release solicits comment with respect to new disclosure requirements in the following areas:
- Frequency of Meetings with the Independent Auditor. The concept release considers whether, in addition to the existing requirement to disclose the number of audit committee meetings generally, companies should also disclose the frequency of meetings between the audit committee and the auditor, and the topics discussed.
- The Auditor’s Internal Quality Review and PCAOB Inspection Report. The New York Stock Exchange requires the audit committee of listed companies to obtain and review a report by the independent auditor describing the audit firm’s internal quality-control procedures and any material issues raised by the most recent internal quality-control review, or peer review, of the audit firm, or by any inquiry or investigation by governmental or professional authorities, within the preceding five years, with respect to one or more audits carried out by the audit firm. The SEC is considering whether companies should add disclosures about the audit committee’s consideration and discussion of the auditor’s internal quality-control review and most recent PCAOB inspection report, including disclosures about the nature and extent of such discussions, and about how the audit committee considered the results described in the PCAOB inspection reports in its oversight of the auditor.
- The Substance of Communications Between the Audit Committee and the Auditor. The audit committee report in its current form must indicate whether certain required communications with the auditor occurred but not the substance of such communications. The SEC concept release considers the following incremental disclosures:
- whether, in addition to disclosing that the required communications with the auditor have occurred, companies should disclose the nature or substance of any or all such communications, including disclosure of such matters as (i) any significant risks identified by the independent auditor, (ii) the nature and extent of specialized skill used in the audit, (iii) the planned use of the company’s internal auditors, (iv) the involvement of other accounting firms and (v) how the audit committee dealt with disagreements between company management and the independent auditor;
- for audits involving multiple locations, whether the audit committee report should disclose information regarding how the audit committee considered the scope of the audit, locations visited by the auditor, and the relative amount of account balances related to such locations compared to the consolidated financial statements;
- whether the company should be required to disclose all auditor communications to the audit committee required by all SEC and PCAOB rules, rather than only those required by PCAOB Auditing Standing No. 16, or whether the company should disclose all communications to the audit committee generally whether or not required by a specific standard or rule; and
- whether there should be a requirement to disclose the audit committee’s consideration of the auditor’s required communication about independence, beyond a mere statement that the audit committee has received and discussed the matters required.
- Assessment of the Auditor’s Objectivity and Professional Skepticism. The SEC is considering whether the audit committee should be required to disclose how it evaluated the auditor’s objectivity and professional skepticism and the results of such evaluation.
- Assessment and Selection of the Independent Auditor. The SEC is considering disclosures about the process the audit committee undertook and the criteria used to evaluate the external auditor and the audit committee’s rationale for selecting or retaining the auditor. The SEC is also considering whether disclosures should be added regarding the nature, timing and extent of “audit quality indicators” (published metrics or criteria for measuring audit quality being developed by the PCAOB and other organizations), if any, considered by the audit committee.
- Auditor Compensation. The SEC is considering additional disclosures about the nature of the audit committee’s involvement in the determination, evaluation and approval of the auditor’s compensation, as well as additional disclosures about the nature and extent of non-audit services provided by the independent auditor and the audit committee evaluation of how such services related to its assessment of the independence and objectivity of the independent auditor.
- Requests for Proposal (RFP) for the Independent Auditor. The SEC is considering adding disclosure about whether the audit committee sought proposals for the independent auditor or whether it has a policy in this regard, and disclosures about the process undertaken by the audit committee and the factors considered in selecting the independent auditor.
- Board Policy Regarding Shareholder Ratification Vote on the Selection of the Auditor. The SEC is considering whether to require disclosure of the company’s policy, if any, on seeking shareholder ratification of the auditor and the factors the board considered in establishing the policy. In addition, in situations where the audit firm fails to achieve shareholder support, and the board of directors determines to go forward with the auditor despite a significant number of votes against its ratification, the SEC is considering whether the audit committee should be required to provide reasons for its decision.
- Information About the Engagement Partner and Members of the Engagement Team. The SEC is considering whether to require disclosure of the name of the engagement partner and key members of the engagement team or disclosure of certain other qualifications (such as the length of time the person served in the respective role, professional licenses and relevant experience, such as the number of prior audit engagements performed and whether they were in the same industry). The PCAOB has been separately exploring a requirement that the auditor disclose the name of the engagement partner in the auditor’s report or elsewhere. The SEC is also considering disclosures about the audit committee’s participation in the selection of the engagement partner and what the audit committee considered in providing input to the assignment of the engagement partner.
- The Number of Years the Auditor Has Audited the Company. The SEC is considering whether to require disclosure (in the audit committee report or another filing such as a form filed with the PCAOB) of the length of the audit relationship with the independent auditor, as well as disclosure about the audit committee’s consideration of the auditor’s tenure in determining to retain the auditor and evaluating the auditor’s independence and objectivity. The PCAOB has been separately exploring a requirement that the auditor’s tenure be disclosed in the auditor’s report. Other Accounting Firms Involved in the Audit. The SEC is considering, if other accounting firms performed audit procedures along with the independent auditor, whether the names of such firms and the extent of their involvement should be disclosed. The PCAOB has been separately exploring a requirement that the auditor disclose, in the auditor’s report or elsewhere, the names, locations and extent of participation of other independent public accounting firms that took part in the audit and the locations and extent of participation of other persons not employed by the auditor that took part in the audit.
- Location of Audit Committee Disclosures. Audit committee disclosures currently can appear in different places. The SEC is considering the appropriate location of existing and potential new audit committee disclosures, and whether any or all audit committee disclosures, including the audit committee report, should be included in registration statements filed pursuant to the Securities Act of 1933 or in the annual report on Form 10-K.
- Other Entities. The SEC concept release asks whether any or all of the incremental disclosures should be required for foreign private issuers, emerging growth companies and smaller reporting entities, and whether the requirements should be mandatory only for issuers subject to the proxy rules (which would omit foreign private issuers).
In addition to the suggestions raised in the SEC’s concept release, the PCAOB has in the past several years also proposed a number of enhancements to the audit report. The PCAOB has proposed requiring the auditor to disclose in each auditor’s report “critical audit matters” that would be specific to each audit, focusing on those matters the auditor addressed during the audit that involved the most difficult, subjective, or complex auditor judgments, posed the most difficulty to the auditor in obtaining sufficient appropriate evidence, or posed the most difficulty to the auditor in forming the opinion on the financial statements. In addition, the PCAOB has proposed requiring the audit report to include (i) a statement regarding the auditor's existing requirements to be independent of the company, (ii) the year the auditor began serving as the company's auditor, and (iii) the auditor's responsibilities for, and the results of, the auditor's evaluation of other information (such as MD&A and selected financial data) in annual reports filed with the SEC containing the financial statements and the related auditor's report.