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Financial Reporting and the Law

Last week, the SEC and the PCAOB issued releases that evidence a coordinated approach to addressing investor requests for additional information about how audit committees oversee independent auditors and evaluate their performance and about the quality of audits. Taken together, these three releases suggest an effort by the SEC and the PCAOB to enhance audit committee performance and investor understanding of the performance of both audit committees and independent auditors, and thereby impact investor decision-making with respect to how to vote on directors who are audit committee members, whether to ratify the selection of the independent auditors, and whether to invest in a company. Given the breadth of these releases, we urge companies and their audit committees to consider submitting comments—at least to the SEC—to impact the nature and scope of the SEC’s next steps in this area.

The SEC’s July 1 concept release seeks comment on whether revisions to its audit committee reporting requirements—and particularly the committee’s disclosure about how it oversees the independent auditors—would be useful to investors. The PCAOB’s July 1 concept release relates to audit quality indicators, which are quantitative measures that the PCAOB believes should “inform” discussions between the audit committee and the independent auditors about audit quality, strengthen audit quality, and enhance investors’ understanding of audit quality. The PCAOB identified 28 potential audit quality indicators and is seeking comment on their content and their potential value to audit committees, accounting firms, investors, and regulators.

The PCAOB’s June 30 supplemental request for comment seeks comment on whether it should require independent auditors to disclose in a new PCAOB form (rather than in the auditors’ report as the PCAOB had proposed in 2013) the name of the audit engagement partner and (a) the name(s) of any other public accounting firm that performed 5% or more of the audit work and information about the percentage of total audit hours performed by such other public accounting firm and (b) the number of other public accounting firms that individually performed less than 5% of the total audit hours and information about the aggregate percentage of the audit work performed by such group of public accounting firms. The new form would be filed on the PCAOB’s website and would be searchable by the name of the engagement partner and the name of the company. Disclosure in the new form would address concerns expressed by commenters that adoption of the PCAOB’s 2013 proposal would subject the persons named in the auditors’ report to liability under Section 11 of the Securities Act. The supplemental request notes that investors have consistently sought this information since the PCAOB’s first proposal in this area in 2009 and that some commenters on the PCAOB’s 2013 proposal had stated that such disclosures should be in the audit committee’s report included in proxy statements because of the audit committee’s responsibility to engage the auditors.

The SEC requests comment in 74 numbered sets of questions on the adequacy of the existing audit committee reporting requirements, additional possible disclosures, the location of the additional disclosures (such as in one place in the proxy statement and in the Form 10-K or in a prospectus), and the applicability of the additional disclosures to smaller reporting companies and emerging growth companies. The additional possible disclosures relate to the following three areas:

  • Disclosures related to audit committee oversight.For example:
    • Qualitative disclosure about the nature or substance and the timing of all of the communications between the audit committee and the independent auditors, including communications required by the PCAOB, and about matters such as significant risks identified by the auditors, the results of the audit, how the audit committee dealt with disagreements, and how the audit committee evaluated the adequacy of the audit of multiple locations.
    • Disclosure about (a) the frequency and substance of the meetings between the audit committee and the independent auditors, including the number of private meetings, (b) discussions about the results of the accounting firm’s internal quality review and most recent PCAOB inspection, and (c) whether, and, if so, how, the audit committee assesses, promotes, or reinforces the auditors’ subjectivity and professional skepticism.
  • Disclosures related to the audit committee’s process for appointing or retaining the auditors.For example:
    • Disclosure about the process the audit committee undertook and the criteria used to assess the auditors’ independence, objectivity, and audit quality, such as any audit quality indicators identified by the PCAOB as a result of its concept release, and to determine the auditors’ compensation.
    • Disclosure about the process the audit committee undertook, if any, to seek proposals for the independent audit, including factors considered in selecting the accounting firm.
    • Disclosure of any policy to seek annual shareholder approval of the selection of the independent auditors, how the audit committee evaluates the results of such a vote, and whether such a vote should continue to be a “routine matter” with respect to which brokers have discretionary voting authority.
  • Disclosures related to the qualifications of the independent auditors and certain members of the engagement team.For example:
    • Disclosure of the factors considered by the audit committee in selecting or retaining the auditors.
    • Disclosure (perhaps in the audit committee’s report, the auditors’ report, or the PCAOB’s proposed new form) of the name of the engagement partner, the engagement quality reviewer, and any other key members of the audit engagement team, their tenure in those positions and experience in the industry, and disclosure about any known change in those audit participants for the upcoming year’s audit— perhaps even sooner than in the next proxy statement.
    • Disclosure about the audit committee’s involvement in the selection of the audit engagement partner and the factors considered by the audit committee.
    • Disclosure, perhaps in the audit committee’s report or in the auditors’ report, about the number of years the independent auditors have audited the company, the audit committee’s evaluation of such tenure, and other persons involved in the audit.