Demanding more from auditors

Managers of the nation's largest stock funds have called on the Public Company Accounting Oversight Board to open a direct line of communication between independent auditors and corporate shareholders.

They also want a vote on the selection (or dismissal) of audit firms, and curbs on the ability of outside auditors to limit their liability in the event of a botched audit.

The pitch was delivered by the D.C.-based Council of Institutional Investors in response to the PCAOB's proposal to promote more robust information-sharing between outside auditors and corporate audit committees.

The council - which represents the managers of major corporate, public and union pension funds - expressed general support for the PCAOB's plan, but made it clear that those proposed standards don't go far enough to suit fund managers: Instead of merely fostering a more open dialogue with company audit committees, the audit overseer should aggressively pursue improvements to the auditor's standard reporting model and consider "changes that would enhance the communications between auditors and shareholders."

According to the group's general counsel, Jeff Mahoney, the primary means by which the auditor currently communicates with shareowners is through the auditor's report - a situation he described as unfortunate.

"Many shareowners and other users of audited financial statements are dissatisfied with content of the auditor's report that, incredibly, has seen little change since the 1930s," he said.

In March, the PCAOB proposed an auditing standard on "Communications with Audit Committees," and a series of related amendments to interim standards.

The proposal addressed requirements for auditors to communicate with the audit committees of public company boards of directors, and considers a number of factors, including the importance of accounting judgments and estimates in financial reporting.

The proposed standard includes a requirement for auditors to establish a mutual understanding of the terms of the audit engagement with the audit committee and to document that understanding in an engagement letter.

Officials at the institutional investors' group told the PCAOB that their plan for a clearer communication link between auditors and shareholders is consistent with the position taken by the Treasury Department's Advisory Committee on the Auditing Profession.

In its October 2008 final report to the Treasury Department, the committee endorsed suggestions that the PCAOB undertake a standard-setting initiative to consider improvements to the auditor's standard reporting model, and concluded that auditors must more effectively communicate their responsibility regarding fraud detection with investors and the capital markets.

The PCAOB's proposed standard would not sidestep audit committees to provide investors with a direct communication channel to independent auditors, but it would set new requirements for what outside accountants must provide to audit committees.

In addition to requiring that these committees be informed of insights and evaluation regarding the quality, clarity and completeness of the company's financial statements, auditors would be obliged to provide details of any significant risks that they identify.

The PCAOB plan would also call for "an understanding between the auditor and audit committee of the services to be performed," and would clarify "communications regarding the auditor's perspective on the company's critical accounting policies and practices and its critical accounting estimates."

The board's proposed standard would not, however, give shareholders the right to vote on the company's choice of independent auditor - a power that the institutional investors group wants granted to stockholders on an annual basis. The audit board also failed to include a provision prohibiting corporations from agreeing to engagement letter provisions that limit the liability of outside auditors - another step championed by the Council of Institutional Investors.

In calling for changes in the proposal, the institutional fund managers urged the PCAOB to "require that for any engagement letter that includes a provision that potentially limits the legal liability of the outside auditor, the letter include an explanation as to why the provision does not reduce audit quality."

The council argued that such a provision would be "consistent with the views of the staff of the U.S. Securities and Exchange Commission and the U.S. federal banking agencies, who generally agree that limits on auditor liability place investors at risk."