Regulators are preparing to draft new disclosure rules for audit committees, and some say the move could ignite a new debate about whether that should include disclosing the names of audit engagement partners.
The Securities and Exchange Commission is expected to issue a concept release “soon,” Brian Croteau, deputy chief accountant, said at a recent regional conference of the Institute of Management Accountants. The release will explore several areas where audit committees could have more to say to investors about their selection and oversight of external auditors. And SEC Chairman Mary Jo White, addressing a meeting last fall of an advisory group to the Public Company Accounting Oversight Board, said the concept release will consider the relationship between audit committees and independent auditors.
The PCAOB, meanwhile, has given itself until October to issue the next iteration of its rulemaking effort to give investors more information about the identity of the engagement partner and other participants in the audit beyond those employed by the principal audit firm. Dating back to 2009, the PCAOB began proposing that engagement partners sign the audit report, much the way CEOs and CFOs certify financial statements. Facing heavy resistance over concerns about increased liability, the board moved instead to require the name of the engagement partner in the audit report—which still didn’t satisfy those who perceived a heightened liability for auditors.
Even current members of the five-person PCAOB board have criticized the idea, leading board members to hint they are working on yet another idea: to require disclosure of the engagement partner in a separate form or filing with the PCAOB. During the long-running debate, some commenters have said the SEC should require the disclosure of the engagement partner through the audit committee, rather than requiring audit firms to provide that detail to the PCAOB.
“It’s an interesting question,” Croteau says, and it might prompt the SEC to solicit comments on audit committee disclosure ideas at the same time as the PCAOB is asking for ideas about audit firms. No dates have been set for either release, Croteau says, “but our staff and PCAOB staff have already been working on it, and I am hopeful both releases will be out for comment soon.”
Audit committee disclosure requirements have not changed since before the Sarbanes-Oxley Act of 2002, says Thomas White, partner at law firm WilmerHale. “There are a bunch of different rules that require different disclosures that appear in different places,” he says. “It hasn’t been fixed for a while now.”
“Demonstrate to lawmakers that additional requirements are not necessary so you don’t end up with a one-size-fits-all approach. Voluntary disclosure allows companies to tailor the disclosures to fit their company.”
Cindy Fornelli, Executive Director, Center for Audit Quality
White describes the currently required disclosures as “somewhat limited,” focused on identifying the qualifications and independence of audit committee members, communication of the audit committee with the external auditors, and audit fees. “Given the emphasis on audit committees as part of a company’s governance structure and the important role it plays with respect to financial statements, compliance, and the appointment, oversight, and compensation of the auditor, many have thought some additional disclosures by audit committees would be appropriate,” he says.
Michael Scanlon, a partner at law firm Gibson Dunn & Crutcher, says over the past five years, and especially the last two years, a number of large companies have voluntarily reviewed and increased their audit committee disclosures. Some shareholder activism and an initiative by several prominent governance organizations to issue a “Call to Action” report has led many audit committees to raise their game, he says. “The audit committees of those large companies have heard the calls for increased disclosure and have picked up and really enhanced their package of disclosures.”
The Call to Action report provided examples of more transparent audit committee disclosures and encouraged companies to follow suit in better explaining, for example, the scope of the audit committee’s duties, the make-up of the audit committee, the selection or re-appointment of the audit firm, the selection of the lead engagement partner, the factors that went into determining auditor compensation, and the oversight and evaluation of external auditors.
BETTER AC DISCLOSURES
Below is an excerpt from the “Call to Action: Enhancing the Audit Committee Report,” which provides examples of more transparent audit committee disclosures.
Importantly, we note a growing trend among a number of leading audit committees that are voluntarily addressing the need for enhanced audit committee reporting in order to strengthen confidence and communication. We give examples of their disclosure language, pulled directly from 2013 proxy statements, which demonstrate emerging practices in key areas. While not intending to be prescriptive or suggest a mandate, these leading disclosure examples provide benchmarks that other audit committees can use to evaluate how effectively their own disclosures:
Clarify the scope of the audit committee’s duties ?
Clearly define the audit committee’s composition
Provide relevant information about:
» Factors considered when selecting or reappointing an audit firm
» Selection of the lead audit engagement partner
» Factors considered when determining auditor compensation
» How the committee oversees the external auditor
» The evaluation of the external auditor
... we believe audit committees should critically evaluate their disclosures and carefully consider whether improvements can be made to provide investors with more relevant information that conveys that an informed, actively engaged and independent audit committee is carrying out its duties. If so, we encourage audit committees to begin taking the necessary steps with those charged with governance in their organizations to strengthen such disclosures accordingly. We recognize that some disclosures about audit committee-related activities may appear outside the audit committee report, elsewhere in the proxy statement, in the annual report, or on a company’s website. However, a complete understanding of the audit committee’s activities would require a close analysis of the information in each of these different places. For investors, navigating and mining for information across disparate sources is likely suboptimal. We encourage audit committees and boards to take a fresh look at the format and, in some cases, the different channels that communicate audit committee-related activities and strive to streamline, link to, or consolidate where possible.
Cindy Fornelli, executive director of the Center for Audit Quality (one of the groups that collaborated on the Call to Action report), said in a recent webcast that audit committees would be wise to step up their voluntary disclosures as a way to minimize the demand for new requirements. “Demonstrate to lawmakers that additional requirements are not necessary so you don’t end up with a one-size-fits-all approach,” she said. “Voluntary disclosure allows companies to tailor the disclosures to fit their company.”
In Scanlon’s view, audit committees likely will not quarrel with a requirement to disclose many of the pieces of information that some audit committees have voluntarily provided in recent years. “If you look at the enhancements that many large companies have made over the past year or two, and if those play out as mandated or encourage disclosures in the SEC’s concept release, that will be a fine thing,” he says.
Audit committees are likely to have more concern, however, if the SEC’s concept release heads down a path of requiring disclosure of what the audit committee and external auditor have discussed during the course of the year, Scanlon warns. The resistance might be similar to that raised when the PCAOB first explored having auditors provide something akin to a “discussion and analysis” in audit reports explaining the difficult issues that arose in the audit.
In White’s view, requiring audit committees to name engagement partners would address the biggest obstacle the PCAOB has encountered: the continued insistence that naming engagement partners in the audit report would expose auditors to increased liability. “Putting it in the audit committee disclosure in the proxy statement is one way to deal with the problem,” he says.
Scanlon believes the identification of the engagement partner will continue to be the disclosure hot potato. “I would be surprised if the SEC’s concept release went down that path,” he says. “Identifying the engagement partner is a tricky issue for liability reasons.”
Mark Cheffers, CEO at Audit Analytics, said during a webcast that Mary Jo White’s public remarks indicating the importance of high-functioning audit committees suggests that audit committees can expect more on their plates soon. “This to me foreshadows what I would consider to be increasing amounts of fiduciary and statutory obligations coming their way,” he said. “Audit committees are about to get more and more responsibility, and more and more exposure.”