OVERVIEW

On July 1, 2015, the US Securities and Exchange Commission (SEC) issued a concept release relating to its audit committee reporting requirements.1 This release references two Public Company Accounting Oversight Board (PCAOB) releases, one dated June 302 and the other dated July 1.3 These three releases 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, the releases suggest an SEC and PCAOB effort to enhance audit committee performance and investor understanding of the performance of both audit committees and independent auditors. This may 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.

The SEC concept release seeks comment on whether revisions to the SEC's audit committee reporting requirements, and particularly the committee's disclosure about how it oversees the independent auditors, would be useful to investors. Through 74 numbered sets of questions, the SEC seeks comments on, among other things, the following: (1) the adequacy of the existing audit committee reporting requirements; (2) additional possible disclosures related to the way audit committees oversee independent auditors, the process audit committees follow when they determine to appoint or retain auditors, and the qualifications of the independent auditors and certain members of the engagement team, including the consideration of audit quality indicators, such as those discussed in the PCAOB concept release on audit quality indicators; (3) the location of any additional disclosures, such as in one place in the proxy statement, in the Form 10-K, or in a prospectus; and (4) the applicability of any additional disclosures to smaller reporting companies and emerging growth companies. Several of the questions ask specifically whether the additional disclosure should be in the following: the audit committee's report; the independent auditors' report, as the PCAOB has considered with respect to the possible additional disclosures related to the identity of the engagement partner and certain participants in the audit; or somewhere else.

The PCAOB supplemental request seeks comments on whether it should require independent auditors to disclose in a new PCAOB form rather than in the auditors' report, as it had proposed in 2013, the name of the audit engagement partner and information about certain other participants in the audit. The PCAOB's 2013 proposal had generated substantial concerns that adopting the proposal would subject the persons named in the auditors' report to liability under section 11 of the Securities Act of 1933.4 The PCAOB supplemental request notes that commenters suggested that the audit committee's report provide the disclosure about participants in the audit.

The PCAOB concept release seeks comment on the content and possible uses of 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 concept release identifies 28 potential audit quality indicators (identified in the release as "AQIs") in the areas of audit professionals, the audit process, and audit results. Noting that "[t]he goal of the AQI project is to improve the ability of persons to evaluate the quality of audits in which they are involved or on which they rely and to enhance discussions among interested parties,"5 the concept release seeks comment on the content and potential value of audit quality indicators to audit committees, accounting firms, investors, and regulators.

Comments are due on the SEC concept release by September 8, 2015. Comments on the PCAOB supplemental request are due by August 31, 2015, and comments are due on the PCAOB concept release by September 29, 2015. The PCAOB plans to convene a roundtable to discuss the audit quality indicators during the fourth quarter of 2015.

We urge companies to carefully consider these releases and submit comments, at least to the SEC, to influence the SEC's next steps. Such action is important given the breadth of the possible new disclosures, which may also expand the responsibilities of audit committees and could result in a check-the-box approach to audit committee oversight of independent auditors and audit procedures.

BACKGROUND

A former chair of the SEC described the audit committee's role as representing one leg of a three-legged stool, the other legs of which represent the roles played by management engaged in preparing financial statements and the independent auditors.6 Since that analogy was made in 2001, the enactment of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley) required various rule and listing standard changes designed to strengthen the independence and expertise of audit committee members. These changes require that the audit committee have the responsibility to do the following: select, oversee, determine the compensation payable to, and evaluate the performance of the auditors; handle complaints and concerns regarding the company's accounting, auditing, and internal controls; and have the authority and appropriate funding to engage outside advisers.7 In addition, in 2003, the New York Stock Exchange adopted listing standards that specifically identify a number of duties and responsibilities of audit committees that have become best practices for all audit committees, regardless of where they are listed.8

Despite these developments and the three-legged stool analogy, the SEC's disclosure rules relating to the role and responsibilities of audit committees are sparse in contrast with the extensive requirements applicable to the preparation and audits of financial statements. The SEC concept release points out that the audit committee reporting requirements have remained basically unchanged since 1999,9 with the exception of the rules and listing standards implementing the Sarbanes-Oxley provisions related to audit committee independence, 10 the audit committee financial expert,11 the audit committee pre-approval of auditor services and required auditor communications to the audit committee.12 In addition, citing the Audit Committee Collaboration, the SEC concept release observed that some have noted that the SEC's disclosure rules "do not provide investors with sufficient useful information regarding the role of and responsibilities carried out by the audit committee in public companies."13

Nevertheless, for the last several years, an increasing number of companies have voluntarily included in proxy statements prepared for shareholders' annual meetings expanded disclosure about the role and responsibilities of audit committees and the reasons why audit committees recommend that shareholders ratify the selection of independent auditors. Some of these changes in audit committee disclosures have resulted from investor requests for specific additional information about an audit committee's evaluation of auditors because of investors' concerns about the long-tenure of many public companies' auditors.14 More recently, the increasing focus on information about audit committees may be related to comments made by officials at the SEC.

In February 2014, the then–chief accountant of the SEC suggested that audit committees consider expanding their reports included in proxy statements to assist investors in understanding how audit committees oversee auditors and determining whether to ratify an audit committee's selection of an auditor.15 Shortly thereafter, in May 2014, SEC Chair Mary Jo White stated in a speech that she had asked the SEC staff to consider whether improvements to the audit committee reporting requirements should be made.16 She noted that investors were expressing interest in increased transparency into audit committee activities, given audit committees' critical role in financial reporting oversight, but that audit committee reporting requirements had not changed significantly in a number of years. A report analyzing proxy statements filed by 80 Fortune 100 companies between 2012 and August 16, 2014 reported a significant increase in the disclosures made about the role and responsibilities of audit committees since 2012.17 The report identifies the following voluntary expansions in audit committee reporting:

  • Greater consolidation of audit-related disclosures.
  • An increase in the provision of a link to the audit committee charter: 15% of companies provided such a link, more than twice the 6% level in 2012.
  • Disclosures related to the audit committee's review and evaluation of auditors:
    • 65% of companies specified that the audit committee is responsible for the appointment, compensation, and oversight of the auditors, compared to 40% in 2012.
    • 46% of companies explicitly stated the audit committee's belief that their selection of the auditors is in the best interests of the company and/or shareholders, up from 4% in 2012.
    • 44% of companies disclosed that the audit committee was involved in the selection of the audit firm's lead engagement partner. In comparison, only 1% of companies did this in 2012.
    • 31% of companies explained the audit committee's rationale for appointing their auditors, including the factors used in assessing the auditors' quality and qualifications. Only 16% percent of companies did this in 2012.
    • 8% of companies disclosed the topics that the audit committee discussed with the auditors—beyond matters required to be discussed under regulatory rules.
  • Disclosures related to the audit committee's authority to approve all audit engagement fees and terms:
    • 80% of companies noted that the audit committee considers nonaudit services and fees when assessing the independence of the auditors.
    • 19% of companies disclosed that the audit committee was involved in the auditors' fee negotiations, up significantly from just 1% in 2012.
    • 8% of companies' audit committees acknowledged a change in fees to the auditors and explained the circumstance for the change, doubling the percentage of companies that did so in 2012.
  • Disclosures related to the tenure of their auditors: o Auditor tenure was disclosed by half of the audit committees of reviewed companies, an increase from 26% in 2012.
    • 28% of companies disclosed that the audit committee considers what would be the impact of rotating their auditors, up from 3% in 2012.

Consistent expanded disclosure is not being made, however, according to the SEC concept release.18 In addition, the SEC's chief accountant noted in December 2014 that commenters on the PCAOB's projects related to disclosure of the names of the individual auditors involved in audits and the expansion of the auditors' report had suggested that audit committee reporting could be improved.19

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Footnotes

1. Securities Act Release No. 9862, "Possible Revisions to Audit Committee Disclosures" (July 1, 2015), available at http://www.sec.gov/rules/concept/2015/33-9862.pdf (hereinafter referred to as "SEC concept release").

2. PCAOB Release No. 2015-004, "Supplemental Request for Comment: Rules to Require Disclosure of Certain Audit Participants on a New PCAOB Form" (June 30, 2015), available at http://pcaobus.org/Rules/Rulemaking/Docket029/Release_2015_004.pdf (hereinafter referred to as "PCAOB supplemental request").

3. PCAOB Release No. 2015-005, "Concept Release on Audit Quality Indicators" (July 1, 2015), available at http://pcaobus.org/Rules/Rulemaking/Docket%20041/Release_2015_005.pdf (hereinafter referred to as "PCAOB concept release").

4. See, e.g., Comment Letter of the Society of Corporate Secretaries & Governance Professionals on PCAOB Release No. 2013-009, "Improving the Transparency of Audits: Proposed Amendments to PCAOB Auditing Standards to Provide Disclosure in the Auditor's Report of Certain Participants in the Audit" (March 12, 2014), available at http://pcaobus.org/Rules/Rulemaking/Docket029/047c_SCSGP.pdf.

5. PCAOB concept release, supra note 3, at 4.

6. Arthur Levitt, SEC Chairman (1993-2001), Letter to Audit Committee Chairmen (Jan. 5, 2001), available at www.sec.gov/news/headlines/ltr2audc.htm.

7. Section 301 of Sarbanes-Oxley required the SEC to direct the exchanges to prohibit the listing of any company that did not comply with the requirements related to the audit committee's independence and duties and responsibilities.

8. NYSE Listed Company Manual section 303A.07(b), available at http://nysemanual.nyse.com/LCMTools/PlatformViewer.asp?searched=1&selectednode=chp%5F1%5F4%5F3%5F1&CiRestriction=303A&manual=%2Flcm%2Fsections%2Flcm%2Dsections%2F.

9. The existing requirements related to the audit committee's report and the existence of an audit committee charter were adopted in Securities Exchange Act Release No. 42266, "Audit Committee Disclosure" (Dec. 22, 1999), available at http://www.sec.gov/rules/final/34-42266.htm. Item 407(d) of Regulation S-K requires an audit committee's report to address whether the audit committee has reviewed and discussed the financial statements with management, whether the audit committee has discussed with auditors those matters in the auditing standard related to audit committee communications, whether the audit committee has received and discussed certain independence matters, and whether the audit committee recommended to the board that the financial statements be included in the Form 10-K.

10. Securities Act Release No. 8220, "Standards Relating to Listed Company Audit Committees" (Apr. 9, 2003), available at https://www.sec.gov/rules/final/33-8220.htm.

11. Securities Act Release No. 8177, "Disclosure required by Sections 406 and 407 of the Sarbanes-Oxley Act of 2002" (Jan. 23, 2003), available at http://www.sec.gov/rules/final/33-8177.htm.

12. Securities Act Release No. 8183, "Strengthening the Commission's Requirements Regarding Auditor Independence" (Jan. 28, 2003), available at http://www.sec.gov/rules/final/33-8183.htm.

13. SEC concept release, supra note 1, at 5. See Audit Committee Collaboration, "Enhancing the Audit Committee Report - A Call to Action" (Nov. 20, 2013). The report recommends that audit committees of public companies of all sizes and industries proactively strengthen their reporting because of the authors' view "that greater transparency about the audit committee's roles and responsibilities is one way of increasing investor confidence, and an opportunity to communicate more clearly to shareholders about audit committee-related activities." Id. at 2. The members of the collaboration are the following organizations: the National Association of Corporate Directors; Corporate Board Member/NYSE Euronext; Tapestry Networks; the Directors Council; the Association of Audit Committee Members, Inc.; and the Center for Audit Quality. The report is available at http://thecaq.org/docs/audit-committees/enhancing-the-audit-committee-report-a-call-to-action.pdf?sfvrsn=2.

14. In this regard, the SEC concept release notes that academic research is somewhat mixed as to the impact of auditor tenure on audit quality. SEC concept release, supra note 1, at 46.

15. Slide Presentation (PDF): Regarding Audit Committees at SEC Speaks 2014 (Feb. 22, 2014), available at http://www.sec.gov/News/Speech/Detail/Speech/1370540846980.

16. Remarks at the Financial Accounting Foundation Trustees Dinner (May 20, 2014), available at http://www.sec.gov/News/Speech/Detail/Speech/1370541872065.

17. E&Y Center for Board Matters, "Let's talk: governance – Audit committee reporting to shareholders 2014 proxy season update" (Aug. 2014), available at http://www.ey.com/Publication/vwLUAssets/ey-lets-talk-governance-august-2014/$FILE/ey-lets-talk-governance-august-2014.pdf.

18. SEC concept release, supra note 1, at 18.

19. Remarks before the 2014 AICPA National Conference on Current SEC and PCAOB Developments (Dec. 8, 2014), available at http://www.sec.gov/News/Speech/Detail/Speech/1370543609306.

This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.