With proxy season just around the corner, audit committees are discussing how to answer growing demand for more disclosure—and whether the demand for more information is really a demand for more robust oversight of auditors.
“There is clearly an increase in at least the dialogue that audit committees are having related to expanding disclosures,” says Terry Ward, a partner with PwC’s Governance Insights Center. “There is a theme of transparency that is out there. It’s difficult to say, but I would expect we will see an incremental increase in companies that are enhancing disclosures.”
Audit committees are weighing the risks and benefits as studies the past few years by the Center for Audit Quality and others have shown an increasing number of audit committees are voluntarily expanding their disclosures, primarily around their oversight of external auditors. “Investors are becoming more vocal,” says Cindy Fornelli, executive director of the CAQ. “As audit committees are realizing that investors are demanding more engagement and more interaction with boards of directors, disclosure is the easiest way for most companies to do that.”
The weight of demand grew in a big way since last proxy season, when the Securities and Exchange Commission published a concept release in summer 2015 suggesting a number of possible expansions or enhancements of audit committee disclosures that could be mandated. Brian Croteau, deputy chief accountant at the SEC, said in a speech in December that feedback to the proposal was generally supportive of efforts to improve disclosures. However, many of the 100 comment letters discouraged the SEC from developing detailed new requirements, some even encouraging the SEC to let the laws of supply and demand take hold.
Advocates of more disclosure, like Fornelli, believe that could happen. “As more audit committees make these types of disclosures, it will assure the SEC that companies are doing this voluntarily,” she says. That will be especially true if the SEC sees not just large companies making the disclosures, but even the smallest as well. “If the SEC sees this type of tailored, individualized disclosure, it will only be a good thing.” She says when the CAQ studies the next round of annual disclosures, she expects to find even more voluntary disclosure.
“There is a theme of transparency that is out there. It’s difficult to say, but I would expect we will see an incremental increase in companies that are enhancing disclosures.”
Terry Ward, Partner, Governance Insights Center, PwC
As audit committees discuss whether to make expanded disclosures about their oversight of external auditors, some wonder whether they put themselves at increased risk, says Ward. “There are still a number of audit committees out there that believe enhancing their disclosures could increase their liability,” says Ward. “But we’re also hearing prominent attorneys saying they believe there’s maybe even more risk to just continuing the boilerplate language that’s very common.”
Even further, some audit committees are weighing whether the call for more disclosure is a leading indicator of a demand for more oversight activity or more robust oversight, says Ward. “A lot of audit committees are taking this as a theme of being asked to do more,” he says. “That’s one thing some audit committees don’t think about, that this demand for enhanced disclosure is not necessarily asking audit committees to do more.”
PWC ON AUDIT COMMITTEE DISCLOSURE
Below, PwC offers some insights on the coming proxy season in relation to audit committee disclosure.
As the 2016 proxy season approaches, many audit committees are evaluating whether to enhance their public disclosures. Following on the transparency theme, which continues to be important to stakeholders, there is an increasing call for audit committees to voluntarily provide more relevant and useful information to investors and other stakeholders relating to how they perform their oversight duties and responsibilities.
SEC rules require audit committees to make certain disclosures in a company’s annual proxy statement. The majority of these rules have not been updated since 1999 and disclosures have largely been boilerplate. However, in July 2015, the SEC issued a concept release, Possible Revisions to Audit Committee Disclosures, seeking feedback to better understand whether additional audit committee disclosure requirements (with a focus on the committee’s oversight of the independent auditors) would be useful to investors and, if so, what information would best meet their needs.
The SEC staff received over 100 responses to the concept release. Although there was a variety of views, a common theme was for any future rulemaking to be principles-based to allow companies flexibility in describing how audit committees carry out their duties. The SEC staff continues to encourage expanded disclosures and has indicated that they are evaluating next steps on possible new rules, but the timeframe is unclear.
The movement beyond the boilerplate language that pervades proxy statements continues to receive significant support from a variety of stakeholders, including investors, proxy advisory firms, and policy organizations. For example, in November 2013, a group of U.S. governance organizations issued Enhancing the Audit Committee Report –A Call to Action, which encouraged public company audit committees of all sizes and industries to voluntarily and proactively enhance their public disclosures. Also, large institutional investors and other corporate governance advocates increasingly emphasize expanded audit committee disclosures in their recommendations and positions.
In November 2015, the Center for Audit Quality along with Audit Analytics issued the Audit Committee Transparency Barometer to gauge how audit committees communicate their financial reporting oversight activities. The Barometer showed notable enhancements in certain disclosures related to the oversight of the external auditor. According to the Barometer, some key highlights of the 2015 proxy season included enhancements in disclosures from the prior year related to audit firm selection/ratification, audit firm compensation, audit firm evaluation/supervision, and selection of the audit partner. These disclosures appeared in a variety of places in proxy statements, such as in the audit committee report and the sections related to auditor ratification and fees paid to the external audit firm.
What immediate actions should audit committees think about?
We encourage audit committees to enhance proxy disclosures in 2016. We offer a few actions for audit committees to consider:
Ask those who prepare the proxy statement to draft a sample disclosure including certain or all of the disclosure categories tracked in the 2015 Barometer,
Benchmark proxy disclosures of peers and competitors, and
Review proxy disclosures of companies that have already embraced enhanced disclosures, including General Electric Company, Prudential Financial, Inc., and Target Corporation.
These actions may facilitate the audit committee’s process to critically evaluate its past disclosure and decide whether it believes any enhancements may be appropriate to help investors and others understand the important work that audit committees are doing. There is no “one size fits all” solution to proxy disclosures due to the variation in company characteristics. However, enhanced disclosures are worthy of a fresh look and a healthy debate by audit committees.
Phyllis Deiso, a partner and SEC practice leader for audit firm RSM, says she sees audit committees that use the exercise of expanding disclosure as a time to reconsider or review their processes and procedures with respect to external audit oversight. “This is definitely on the radar screens for audit committees,” she says. “How much should we disclose, and what are our processes? Beyond what they disclose, it has caused audit committees to focus or refocus on what they actually do to reappoint the external auditor.”
Especially with respect to the decision to reappoint the existing auditor, audit committees have become more sensitive to whether that process is “perfunctory,” says Deiso. “Audit committees may be saying: ‘we don’t have any service issues and we feel the fee is fair, so should we formalize that assessment?’” she says. “Should we put more rigor around that and document it?”
Dan Goelzer, a partner with law firm Baker & McKenzie and a former member of the Public Company Accounting Oversight Board, says he sees some indication that increased voluntary disclosure is leading to some more thoughtful examination by audit committees of actions they take. “Something that’s becoming a more common area of disclosure today is auditor tenure,” he says. “It makes them think more about that issue. Should we be thinking about changing auditors? If we’re making disclosure as to tenure, the issue is on the radar screen as to whether to make a change.”
Enhanced disclosure around the audit committee’s involvement in selection of the engagement partner is driving some new discussions among audit committee members, Goelzer says. “If they are seeing others making disclosures along those lines, that may stimulate audit committees to think: Do we want to be thinking along those lines as well?”
Tom White, a partner at law firm WilmerHale, says audit committees that have already expanded disclosures voluntarily in the past are not likely to expand any further this year. “They are generally sticking with the amount and type of disclosure that they’ve provided previously,” he says. “Some that didn’t expand their disclosure the past couple of years are starting to get with the trend.”
Not all audit committees are on board, however, says Amy Rojik, an assurance partner with audit firm BDO. She sees plenty of audit committees, especially at smaller companies, taking a “wait and see” approach. “They are asking: What value am I going to get in spending time on this?”
Some audit committees may be overwhelmed with the onslaught of demands brought on by market conditions and emerging risks, like cyber-security, says Rojik. “It’s not a hesitation to be transparent,” she says. “Some are tasked with so many things they are doing on a daily basis to navigate the complexity of the day-to-day operations. They are asking: Is this just some other compliance exercise we are going to have to go through?”