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SEC Mulls Changes in Audit Committee Disclosures

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September 9, 2015

The Securities and Exchange Commission will be poring over the comments it received on its recent proposal to toughen audit committee disclosures after the comment deadline expired Tuesday.

Back in July, the SEC issued a 55-page concept release proposing a set of revisions in audit committee disclosure requirements with the goal of improving the information provided to investors about the audit committee’s responsibilities and activities (see SEC Considers Tougher Audit Committee Disclosures).

The deadline for comments was September 8. Some of the proposals reflected ideas that also have been floated by the Public Company Accounting Oversight Board and met with some resistance among auditing firms.

Jim DeLoach

“I think it’s a very interesting development with the SEC and the PCAOB both introducing respective releases and proposals,” said Jim DeLoach, managing director at the consulting firm Protiviti. “It will be very interesting to see how the market will react. This is a dialogue that has been going on for a long time. There is some historical context.”

Protiviti recently released a report assessing the SEC’s proposals and how some of the proposals mesh with the PCAOB’s Auditing Standard No. 16, addressing the auditor’s communication with the audit committee, as well as some PCAOB proposals that have not yet been approved as standards.

“It dates back to the PCAOB’s effort to engage in auditor reform, talking about auditor rotation, and the advancement and expansion of the auditor report,” said DeLoach. “The PCAOB has had difficulty gaining traction with this idea. The PCAOB has focused on issuing AS 16 and has reached out to audit committees to ask more probing, tougher questions of the auditor. The PCAOB has done a lot to enhance the quality of the audit process. There is one thing that the SEC and the PCAOB share: that the audit committee is essential to overseeing the audit process. If the audit committee believes its primary function is to drive down audit fees, it doesn’t get it. It doesn’t understand its primary role.”

The SEC and the PCAOB believe audit committees need to get more involved in overseeing the work of the audit firms because, as DeLoach noted, recent PCAOB inspections still indicate a high percentage of audits are failing.

“I think the SEC is now stepping into the arena and saying maybe we now need to expand disclosures over how the audit committee exercises its oversight functions,” he said. “That expansion is why this concept release has been issued. There is some indication that there is a will to act. They want to enhance the quality of the audit process, and they both believe that the audit committee is essential.”

The SEC concept release emphasizes the importance of the audit committee’s oversight of the auditor and engagement with the auditor in terms of understanding the risks, significant audit areas and the issues surrounding internal controls.

“All of these things really pose a significant dialogue that the committee needs to be having with the auditor,” said DeLoach. “The concept release really stresses the importance of the committee taking a proactive role in this dialogue. The PCAOB is providing examples of probing questions that audit committees should be addressing to their auditors through Auditing Standard 16. The regulators are trying to say, ‘Look, these parties—the audit committee and the auditor—should be having a dialogue about what they should be addressing and talking about.”

Besides the matter of audit committee oversight, the SEC concept release also deals with the process of employing and retaining the auditor, as well as evaluating the qualifications of the audit firm.

“This is dealing with disclosures around the audit committee’s input and selecting the audit partners and the audit firm tenure with the company,” said DeLoach. “How long did it audit the company? And in addition, what other audit firms are involved with the process, to the extent that the external auditor refers work to another audit firm, in a global company environment? I think the expectation is that the audit committee is engaged and involved in making sure all the right skills are brought to bear. The concept release says there should be disclosure around the audit committee’s assessment in that regard.”

DeLoach pointed out, however, that this is a concept release and not an exposure draft.

“It’s a way for the SEC to ‘test the waters,’ just to gauge the market’s reaction to these ideas,” he said. “It doesn’t mean it’s going to find its way into an exposure draft. In some cases, concept releases don’t find their way into an official pronouncement at all. This shows there’s a will to act here. While not all of it may find its way into an exposure draft, the market can safely bet that the SEC is going to take action. Some of it will find its way into an exposure draft and then into a final rule.”

DeLoach doubts that any final rule would be passed early enough to affect the disclosures in next year’s proxy season, though. He believes any rule is more likely to take effect in the 2017 proxy season.

A new report from Ernst & Young found that audit committees are already providing much more disclosure than is currently required. The EY Center for Board Matters report, Audit Committee Reporting to Shareholders, found that during the 2015 proxy season, the majority of Fortune 100 companies continue to disclose more information about their audit committees and external auditors than the SEC mandates. The report examined 76 Fortune 100 companies in 2014 that filed proxy statements for three consecutive years as of August 15.

Seventy-one percent of the companies specified that the audit committee is responsible for the appointment, compensation and oversight of the auditor, compared to 41 percent in 2012 and 65 percent in 2014. In addition, 61 percent of the companies disclosed that the audit committee was involved in the selection of the audit firm’s lead engagement partner. No companies did this in 2012. 

The report also found that disclosures related to the audit committee’s responsibility for compensating the auditor and pre-approving all fees paid to the auditor have increased. Twenty-one percent of companies disclosed that the audit committee was responsible for the auditor’s fee negotiations. In 2012, none of the companies provided this disclosure. Eighty percent of companies noted that they consider non-audit services and fees when assessing the independence of the external auditor, compared to 11 percent in 2012.

More companies are also disclosing how they appoint and retain external auditors. Auditor tenure was disclosed by 59 percent of the reviewed companies, an increase from 25 percent of companies that did so in 2012. The median disclosed tenure was 18 years.

Another issue in the SEC concept release is where the enhanced audit committee disclosures will be presented. “Is it in the proxy? Is it on the company’s website? Is it in the 10k? That’s an open question,” said DeLoach. “Wherever it ends up, I suspect it won’t have an effect on the 2015 reports or the 2016 proxy season. I suspect it will have an effect on 2016 reports and the 2017 proxy season.”

As with earlier PCAOB proposals to disclose the name of the engagement partner on an audit, the SEC concept release is likely to face similar controversy. “The accounting industry has resisted that,” said DeLoach. “I frankly understand why they would resist that. There are potentially powerful unintended consequences of undertaking that. I think audit engagement partners already have a strong incentive when their firm’s name is on the report to get it right.”

Another potentially controversial proposal is to disclose the tenure of the audit firm. “I think there are questions around whether this stuff really belongs in the audit committee disclosures,” said DeLoach. “Does the name of the audit partner belong in the audit committee disclosures? I think there’s that question as well. The SEC has posed more than 70 questions in the concept release with the objective of getting feedback from the market concerning these matters. Historically the Commission has always taken market feedback and constructively tried to respond to it in its rulemaking, and I think the commission will continue to do that.”

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