On the long and winding road to giving investors more detail about who performs the audits they rely upon, regulators are exploring yet more new forks in the path.
The Public Company Accounting Oversight Board, now trying for the third time to write a rule for audit firms to follow, has proposed requiring firms to submit a new form that names the engagement partner and other participants from outside the principal audit firm who assisted on each audit engagement. At the same time, the Securities and Exchange Commission has issued a concept release exploring dozens of ideas to enhance audit committee disclosures—not the least of which is to require audit committees to give up the engagement partner’s name.
The PCAOB’s proposed Form AP—“Auditor Reporting of Certain Audit Participants”—would collect the name of the engagement partner and others who helped with the audit. It would be filed with the PCAOB within 30 days after the filing of an audit report with the Securities and Exchange Commission, and the forms would be posted on the PCAOB’s website in a searchable database.
“We have been on a long journey to reach this point, and this is still only a way station,” PCAOB member Lewis Ferguson said as the board approved release of the proposal. “We are seeking comment on a new approach to getting public disclosure of information while limiting to the greatest extent possible the difficulty, costs, and liability risks to those providing the information.”
The PCAOB began the journey by exploring whether to have auditors sign the audit report. That idea met heavy resistance from the audit profession over concerns it would increase their professional liability under securities laws. Then came the second try: naming the engagement partner in the audit report, but no requirement for a signature. Liability cries continued, and even the PCAOB members couldn’t agree among themselves on requiring the disclosure in the audit report, forcing the board to consider other alternatives.
Ferguson, a lawyer by profession, says the idea of a separate filing apart from the audit report addresses at least part of the liability concern. Some might still worry, however, about whether it still exposes auditors to additional liability under Section 10(b) of the Securities and Exchange Act.
“This is a better answer than signing the auditor’s report, but nobody really knows if it will do much of anything to improve audit quality.”
Dee Mirando-Gould, Executive Director, MorganFranklin Consulting
“The law in this area is unsettled and developing,” he said. “Does naming the engagement partner make him or her more likely to be named in a Section 10(b) lawsuit? I don’t think so. In any event, I am not convinced that whatever increased risk disclosure of this information may pose under Section 10(b) outweighs the public interest in having the information made publicly available.”
That will be a topic for debate, says Dee Mirando-Gould, a former auditor and former staffer at the PCAOB, now executive director at MorganFranklin Consulting. “This is a better answer than signing the auditor’s report, but nobody really knows if it will do much of anything to improve audit quality,” she says.
The PCAOB proposal mentions the idea that disclosure will nudge them to increase their performance, so to enhance their reputation and improve their competitive edge. “I thought that was inappropriate,” says Mirando-Gould. “This is not a game or a competition. This idea of one person winning over another person—everyone can win, if everyone does a good job.”
Cindy Fornelli, executive director of the Center for Audit Quality, says she hasn’t conducted a legal analysis yet of whether the proposal still raises liability concerns, but she believes that disclosure in the proposed new form adequately addresses concerns around consent, as Ferguson asserted.
“As the CAQ has noted in prior comment letters, we do not believe that transparency around the name of the engagement partner increases the sense of accountability,” she says. “That is achieved through the system of quality controls that the firms have in place, the investments made in training, and the work that is being done on root cause analysis. Auditors already feel a huge sense of responsibility.”
Below is an excerpt from the PCAOB’s Form AP Proposal, in which the board discusses the benefits to disclosing in Form AP.
The use of Form AP would afford the Board flexibility in establishing the timing of disclosure versus a requirement to disclose in the auditor’s report. While the Board believes the information should be made available promptly, some time could be allowed for firms to compile the necessary information, particularly for firms that choose to submit multiple forms at the same time. The Board is considering a basic filing deadline of 30 days after the date the auditor’s report is first included in a document filed with the SEC, with a shorter deadline of 10 days for initial public offerings (“IPOs”) to ensure that the information would be available before any IPO road show. This time period takes into account recommendations made by the commenters that suggested disclosure on a reporting form. Some of these commenters suggested a periodic filing requirement, such as quarterly reporting; others suggested filing within a specified time after the completion of the audit, such as 4 days, 30 days (consistent with Form 3), or 45 days (consistent with audit documentation requirements). Another commenter suggested that the required information should be reported prior to the filing of the definitive proxy statement. The Board is soliciting comment on the filing deadline.
Form AP would provide information only about completed audits, so there would be no requirement to file in connection with interim reviews. Form AP would be required to be amended only when there was an error or omission in the original submission. Changes from one year to the next (for example, a change in engagement partner) would not necessitate an amendment and would be reflected on a Form AP that would be filed when the next auditor’s report was issued. Since the obligation to file Form AP would be tied to the issuance of the auditor’s report, if the auditor’s report is reissued and dual-dated, a new Form AP would be required even when no other information on the form changed.
To ease compliance, firms would file Form AP through the PCAOB’s existing web-based Registration, Annual, and Special Reporting system using the username and password they were issued in connection with the registration process. The system requirements for filing Form AP would be similar to the system requirements for filing annual and special reports with the PCAOB. The Board would develop a template, also known as a schema, that would allow firms to submit multiple forms simultaneously using an extensible markup language (“XML”).
Forms AP filed with the Board would be available on the Board’s website. The Board’s website would allow users to search Forms AP by engagement partner, to find the audits of companies (i.e., issuers, brokers, and dealers) that he or she led (after the requirement’s effective date), and by company, to find the engagement partner and other firms that worked on its audit. Over time, the PCAOB could enhance the search functionality as needed and could allow users to download the search results. It is anticipated that the information filed on Form AP would be available on the Board’s website indefinitely.
PCAOB member Jay Hanson said during the PCAOB meeting that he is encouraging folks to look at the SEC’s concept release in tandem with the PCAOB’s proposal, to consider the full scope of possible options to elicit the disclosure investors are demanding without undue cost or consequences.
“The issues explored by the SEC may overlap with our request for comment that we are issuing,” he said. “I would urge commenters to consider the projects together and provide feedback on how best to balance the disclosures to be provided by auditors and those to be provided by audit committees.”
About That SEC Release
The SEC’s concept release explores requiring audit committees to provide much more than the name of the engagement partner. The SEC asks if audit committees should also provide names for others involved with the audit, insight on the selection of the audit firm, the firm’s tenure on the same engagement, the interaction with the audit team, the way the audit committee oversees the audit, and plenty more.
Joe Carcello, executive director of the Center for Corporate Governance at the University of Tennessee, says it’s not clear why the SEC and the PCAOB might both compel disclosure of the same information.
“I’m not sure what incremental information you would get from having it in two places,” he says. “The SEC may want to see if there’s a strong groundswell of support that says this disclosure should be made by the audit committee” instead of the audit firm. That would be put in the proxy statement, which is issued before annual meetings where shareholders ratify the auditor’s appointment.
In addition to the PCAOB’s formal proposal and the SEC’s concept release on audit committee disclosures, the PCAOB also revealed for the first time the framework it is beginning to develop for how to judge audit quality. That PCAOB concept release provides a series of “audit quality indicators” for the market to consider, including a dozen or more that speak to audit professionals themselves.
PCAOB Chairman James Doty said in proposing the new form naming the engagement partner that the inspection process reveals to the board significant differences in audit outcomes depending on the engagement team. “Even within a single firm, and notwithstanding firm-wide or network-wide quality control systems, the quality of individual audit engagements vary,” he said. “The role of the engagement partner in promoting quality, or allowing it to be compromised, is of singular importance to the ultimate reliability of the audit.”
The development of a set of audit quality indicators could have a major effect on the audit profession, says Tom Ray, former chief auditor of the PCAOB, now a lecturer at Baruch College and a consultant. Indeed, that project could be even more significant than eliciting disclosures about audit participants. “It goes back to the old adage that what’s measured is what people do,” he says.