Pushback rises on disclosure of auditor, audit committee talks

Despite calls for more transparency around the discussions between audit committees and auditors, angst still runs deep about giving investors any kind of visibility into that dialogue.

A recent study by EY shows that audit committees continue to make incremental increases in the voluntary disclosures they provide to investors through proxy statements, but they still say very little about their interactions with external auditors. At the same time, a new rule that would require auditors to say more in their audit reports is getting some last-ditch pleas for relief at the Securities and Exchange Commission.

On the audit committee front, the EY analysis of Fortune 100 audit committee disclosures in 2017 found, little by little, more audit committees are broaching topics they aren’t required to address. A solid majority, for example, or 87 percent, explicitly state they are responsible for appointing, compensating, and overseeing external auditors. That’s up from less than half in 2012.

More than half of audit committees in the analysis explain the factors they consider in assessing the external auditor’s qualifications and the quality of their work. Only 17 percent of the same companies addressed that topic in 2012.

Audit committees increasingly are addressing other hot-button topics as well, such as their role in selecting the lead audit partner, their independence from management, and audit fees. Yet one subject clearly remains taboo with audit committees—their interactions with auditors. EY says only 3 percent to 4 percent of audit committees say anything at all about topics they discussed with external auditors, and that figure has held persistently low since the analysis began in 2012.

“There’s always a concern about saying more than is necessary or is needed. It might be something that could come back to bite them or get them in trouble later on.”

Alan Siegfried, Adjunct Faculty Member, University of Maryland

“There’s always a concern about saying more than is necessary or is needed,” says Alan Siegfried, an audit committee member at a privately held bank and an adjunct faculty member at the University of Maryland. “It might be something that could come back to bite them or get them in trouble later on.”

Yes, litigation is a risk to be weighed, says Larry Rittenberg, chair of the audit committee at Woodward, a publicly traded manufacturing company. “There is some appreciation for the potential litigation risk if you lay out some things and it turns out you didn’t do it well, or you lay out fairly broad things you do and you may not actually as deeply as some people might expect.”

As an alternative, audit committees prefer to steer investors to their charter, which explains all of their various activities and duties, says Rittenberg. They would also prefer to point out the auditing standards, which explain what auditors should be doing in their interaction with audit committees. “There are a lot of people who think that information on interaction is already there, laid out in the standards and the charter,” he says.

Where audit committees have increased their disclosure, the topics they address are relatively easy ones, says Phil Wedemeyer, a retired auditor who now serves on audit committees for publicly held Atwood Oceanics and Willbros Group. He’s also a director at a third public company.

“Where you see increases, most of them seem to be giveaways,” he says. “There’s no cost to it; they’re just confirming they’re independent or making an explicit statement that they’re responsible for oversight. Those are no-brainers. If it’s important for me to say I’ve complied with the law, I don’t have any problem doing that.”

On the audit side, however, a pending new standard might soon require auditors to give investors some visibility into that dialogue with the audit committee—but not without an eleventh-hour pitch to the SEC to quash or revise the rule.

TRENDS IN AUDIT COMMITTEE DISCLOSURES

In the table below, EY compares trends in audit committee disclosures in 2012 versus 2017.

Source: EY

The Public Company Accounting Oversight Board approved a new standard that would require auditors to include in their audit reports disclosure of “critical audit matters” that arose during the audit. CAMs are defined along three key criteria. They are matters that were discussed or were required to be discussed with the audit committee. They were related to accounts or disclosures that were material to the financial statements. And they involved “especially challenging, subjective, or complex auditor judgment.”

Before the standard can take effect, however, it must be approved by the SEC. That is standard operating procedure for all PCAOB standards, but this one is getting a little more pushback than usual. Although investors and investor advocates generally support the standard, companies and auditors in many cases are still objecting to various aspects of the requirements.

The SEC routinely performs its own round of public comment on PCAOB standards before giving them final approval. This particular standard drew more than the usual measure of suggestions that the SEC should revise the standard or send it back to the PCAOB for more work.

The U.S. Chamber of Commerce and more than two dozen companies and associations together submitted a letter saying the rule should not be finalized in its current form because “it sets problematic standards for materiality and will be detrimental to public companies.” Based on the way the standard is written, the group says the standard may require auditors to disclose a wide range of immaterial information that companies themselves are not required to disclose.

The groups believe the cost of complying with the standard will outweigh the benefits. They ask the SEC to send the standard back to the PCAOB for further consideration of their objections and concerns.

Even auditors are asking the SEC to intervene before approving the standard. In its comment letter to the SEC, PwC says it supports the objective but has concerns about the implications, especially exposure of auditors to “increased and unwarranted risk of meritless litigation” simply by expanding the number and variety of statements attributable to the auditor. While auditors are worried the standard might increase their litigation risk, research suggests just the opposite, that CAM disclosures might act as disclaimers to insulate auditors.

The firm asks the SEC to “expeditiously undertake rulemaking” to address implementation and execution by auditors. The firm appeals to the SEC to adopt “complementary rules” that would clarify when an auditor’s statements under the standard would give rise to liability under federal securities laws. Some measure of protection from litigation would “promote vigorous implementation and execution” of the standard by freeing auditors to focus on useful, informative disclosures rather than disclosures that also guard against litigation risk.

Wedemeyer shares some of the concerns about CAM disclosures by auditors, especially the idea that it could actually hinder communications between audit committees and auditors. Because the standard defines a CAM as potentially any matter discussed between audit committees and auditors, some worry audit committees will be hesitant to have frank dialogue with their auditors. “It’s something that has to be considered, but that’s an area that will have to work itself out,” he says.

Certainly, audit committees won’t be stepping up their voluntary disclosure about their discussions with auditors, Wedemeyer says. “There’s a real feeling that it’s really not helpful to the process,” he says.