SEC’s Chief Accountant Focuses on Audit Committees
March 3, 2014 9:10 AM
Paul Beswick, Chief Accountant of the Securities and Exchange Commission’s Office of the Chief Accountant, focused on the role of audit committees during his February 22, 2014 presentation at the Practising Law Institute’s SEC Speaks conference, indicating that audit committees would be a priority for the Commission in 2014. Mr. Beswick highlighted the importance of communication between the committee and the external auditor and ongoing monitoring of the auditor’s work. Consistent with a recent OCA theme, Mr. Beswick emphasized that companies and audit committees share responsibility for safeguarding auditor independence with the auditor. Mr. Beswick also urged audit committees to provide more than “boilerplate” committee reports and to consider including information about their oversight processes and that would be relevant to investors in ratifying the selection of the external auditor. To conclude his presentation, Mr. Beswick offered the following “key takeaways”:
- “Audit committees are in a unique position to represent investors and play an important role in promoting high-quality, transparent financial reporting to investors.”
- “Monitoring independence is an ongoing responsibility of the audit committee.”
- “Frequent dialogue with management and a direct line of communication with the auditor are an important part of the oversight role.”
- “Audit committees are encouraged to think critically about disclosures to investors about the committee’s work.”
Mr. Beswick again expressed concern over “audit fees [that] fluctuate with the state of the economy.” He noted, “the ‘bottom line’ should not drive the decision to retain or hire an auditor. The decision should focus on which auditor is going to protect the interests of shareholders best.”
In his comments about the role the audit committee plays in ensuring auditor independence, Mr. Beswick also noted that it is “critical” that the audit committee understand the nature and scope of proposed services. Mr. Beswick cited the Commission’s January 24, 2014 Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934, which discussed auditor provision of non-audit services by a company’s audit firm. The Section 21(a) report, which involved the provision of loaned staff from the audit firm to provide tax services for the client, cautioned audit committees to “carefully consider” the nature and scope of non-audit services provided by an auditor or accountant and to examine “the degree of control that the audit client exercises over audit firm personnel.”
Contributed by Emily McGowan
Financial Accounting Foundation Assesses Fair Value Accounting Standard
February 28, 2014 12:31 PM
The Financial Accounting Standards Board’s Statement No. 157 (now known as Accounting Standards Codification Topic 820), which was adopted in 2006, provides a framework for measuring fair value and for disclosures regarding fair value determinations. Companies often find FAS 157 to be one of the most difficult standards to apply. Particularly where comparable market information is not readily available, determining fair value can involve the exercise of significant judgment and estimates, often based on “non-observable” inputs.
In February, the Financial Accounting Foundation, which oversees the FASB, issued a Post-Implementation Report on Fair Value Measurements to evaluate the effectiveness and impact of the standard. The report generally found that FAS 157 had achieved its expected benefits. Among other things, the Report found that FAS 157 “generally provides investors with decision-useful information,” though it also noted that “some investors have difficulty understanding fair value information provided in the financial statements and their level of satisfaction with that information varies.”
Notably, the Report found that some stakeholders believe that FAS 157 had resulted in significant changes to financial reporting and operating practices. The Report pointed to the Public Company Accounting Oversight Board’s “increased focus on auditing fair value measurements,” which has “resulted in greater focus by preparers and auditors on testing and documenting significant assumptions and inputs used in fair value measurements.” This in turn may affect the complexity of valuation techniques used to measure fair value, the time required to complete required valuations and the use of external valuation expertise to measure fair value.
The Report concluded that FAS 157 had resulted in significant ongoing compliance costs. The most significant impacts were increases in audit fees, audit requirements and the use of third-party pricing services and valuation consultants. The Report noted that the costs were not exclusively the result of FAS 157 requirements but also related to “regulatory environment factors” arising from the Sarbanes-Oxley Act, SEC reviews and PCAOB inspections. It also said that the financial crisis may have “amplified” these costs.
PCAOB to Host Audit Reporting Roundtables
February 27, 2014 2:55 PM
The Public Company Accounting Oversight Board announced that it will hold public meetings on April 2–3, 2014, on its proposal to enhance the auditor’s report and expand the auditor’s responsibilities for other information contained in companies’ annual reports. The meetings will feature panels composed of investors and investor advocates, senior executives and audit committee chairs of major corporations, representatives from audit firms, academicians, and other interested parties. (See our previous post for more information about the PCAOB proposals.)
Update: SEC’s Financial Reporting and Audit Task Force
February 20, 2014 6:50 PM
WilmerHale has released a newsletter reporting developments about the SEC’s Financial Reporting and Audit Task Force. It reports on recent comments by the Vice Chair of the Task Force about the objectives, administration and early initiatives of the Task Force since its formation was announced by the SEC last July. Read the newsletter.
Momentum Builds for Disclosure Simplification
February 20, 2014 8:50 AM
Members of the Securities and Exchange Commission have taken up the banner of “disclosure simplification.” In October 2013, SEC Chair Mary Jo White addressed “information overload” in SEC disclosures and called for “meaningful review” of SEC disclosure requirements. (Her speech is discussed in an earlier post.) In December 2013, as required by the JOBS Act, the SEC staff issued a Report on Review of Disclosure Requirements of Regulation S-K. The staff recommended that the Commission undertake a comprehensive review of current SEC disclosure requirements. Based on this report, Chair White directed the staff to develop specific recommendations for updating the disclosure rules and to seek input from both companies and investors. The SEC’s Office of Chief Accountant will coordinate with the Financial Accounting Standards Board (FASB) to identify ways to improve the effectiveness of disclosures in corporate financial statements and to minimize duplication with other disclosure requirements.
Chair White and other members of the SEC continued to emphasize disclosure simplification in recent speeches:
- In a keynote address at the 41st Annual Securities Regulation Institute on January 27, Chair White emphasized that she envisioned a comprehensive review of the disclosure system, not just revision of particular rules: “We can all probably identify particular disclosure requirements that we might eliminate or modify, but that is not the kind of review and reform I am primarily focused on—and it certainly is not the kind of thoughtful and comprehensive review that I think our disclosure rules demand. I believe we should rethink not only the type of information we ask companies to disclose, but also how that information is presented, where and how that information is disclosed, and how we can take advantage of technology to facilitate investors’ access to information and make it more meaningful to them.”
- In a speech to the US Chamber of Commerce, also on January 27, Commissioner Michael Piwowar expressed concerns about “disclosure overload” and endorsed a “top-to-bottom” review of the SEC’s disclosure regime, though he focused particularly on identifying “special-interest disclosures that may have crept into our present disclosure regime and are counterproductive to creating informed investors.”
- Commissioner Daniel Gallagher also spoke out in favor of disclosure simplification in a January 24 speech to the Forum for Corporate Directors. In contrast to Chair White, Commissioner Gallagher does not favor a comprehensive review of the disclosure system. Rather, he “would prefer to address discrete issues now rather than risk spending years preparing an offensive so massive that it may never be launched.”
Notwithstanding these public statements, any comprehensive disclosure reform will be a long-term project and may be constrained by the SEC’s available resources, which may have to be dedicated, among other things, to completion of pending Dodd-Frank and JOBS Act rulemakings and other priorities.
Along the same lines, the Financial Accounting Standards Board is also re-emphasizing its disclosure framework project. In December 2013 remarks at an AICPA conference, FASB Chair Russell Golden stated that the goal of the disclosure framework project “is to both improve disclosure content—make it more useful to investors—and at the same time, where we can, reduce the amount of disclosure content.” In January, the FASB added a “simplification initiative” to its research agenda.
PCAOB Criticizes Auditing Firms’ Engagement Quality Reviews
February 10, 2014 3:40 PM
In December 2013, the Public Company Accounting Oversight Board issued a report on its Observations Related to the Implementation of the Auditing Standard on Engagement Quality Review. The report assessed auditing firms’ implementation of the PCAOB’s Auditing Standard No. 7, Engagement Quality Review, based on the PCAOB’s 2011 inspections of registered public accounting firms. In general, AS 7 requires that an engagement quality reviewer (often informally referred to as a “concurring partner”) perform procedures to review the significant judgments and conclusions in an audit and provide concurring approval of the issuance of the audit report. The report considered whether, as to audits in which inspections had identified deficiencies resulting in insufficiently supported audit opinions, the engagement quality reviewer should have identified the deficiencies before the firm issued its opinion. The report stated that in approximately 39 percent of 111 audits by seven large domestic accounting firms in which the staff identified that the audit report was insufficiently supported, the audit deficiency should have been identified by the engagement quality reviewer. The PCAOB added that 2012 inspections indicated that engagement quality review deficiencies remained high. The PCAOB recommended that firms take various actions to prevent engagement quality review deficiencies. It also suggested that the report “may be useful to audit committees in fulfilling their oversight responsibilities, including by helping to prepare them for meaningful discussions with their auditors about the engagement quality review component of their audit.”
PCAOB Ends Mandatory Rotation Project
February 7, 2014 1:10 PM
At an SEC meeting on Wednesday, February 5, James Doty, Chairman of the Public Company Accounting Oversight Board, stated that the PCAOB is no longer actively pursuing its project on mandatory rotation for public company audit firms. The PCAOB first proposed to look at mandatory rotation in August 2011 and held several public roundtables on the subject in 2012. Mandatory rotation engendered substantial opposition from companies, audit committees and accounting firms. The House of Representatives passed a bill barring the PCAOB from implementing it. While it has been evident for some time that the PCAOB likely would not move forward with a mandatory rotation or related proposal (such as mandatory re-tendering), Chairman Doty’s comments represent an official acknowledgement of that fact. According to news reports, Chairman Doty added that the PCAOB would “continue to think about what impacts independence.”
While mandatory rotation appears to be dead in the United States, the European Union continues to move towards it. In December, representatives of the EU member states approved a requirement that audit firms rotate engagements with public-interest entities every 10 years—with provisions for longer periods when engagements are put out for bid or joint audits are performed. Public-interest entities include banks, insurance firms, and listed companies. The new regulations are subject to further EU legislative approvals.
ALJ Sanctions Chinese Accounting Firms in Document Production Dispute
January 29, 2014 9:25 AM
On January 22, an SEC administrative law judge issued an initial decision in the SEC’s proceeding against five Chinese accounting firms arising from the firms’ failure to produce documents in connection with SEC investigations. The firms, which included associated firms of the Big Four and another firm, declined to produce the documents on the ground that production would violate applicable laws of the People’s Republic of China. The SEC initiated an administrative proceeding against the firms in late 2012. The ALJ rejected the firms’ arguments and found that they had willfully violated section 106 of the Sarbanes-Oxley Act, which requires registered public accounting firms to produce workpapers and other documents upon request by the SEC or PCAOB. The ALJ censured all of the firms and barred each of the Chinese Big Four firms from “appearing and practicing” before the SEC for six months.
The initial decision is not final and is subject to appeal to the full SEC and, potentially, to a federal court of appeals. The Chinese Big Four firms have indicated that they intend to appeal.
The decision will not affect any audits of year-end 2013 financial statements. If its stands, the ALJ’s six-month bar could, depending on the timing, have significant impacts. At this point, the ultimate resolution of this dispute cannot be predicted.
KPMG Audit Committee Survey Addresses Disclosure, Risk Oversight and Other Issues
January 22, 2014 12:55 PM
KPMG’s Audit Committee Institute has released its 2014 Global Audit Committee Survey. The survey reflects the comments of nearly 1500 audit committee members from around the world. The survey has numerous findings, but perhaps the most noteworthy one concerns the question of whether audit committees should provide additional reporting to investors. Of the respondents, 40% did not favor any additional disclosures. Smaller numbers favored various types of additional disclosure. Of the possible alternatives, 30% favored additional disclosures regarding the committee’s role in risk governance; 25% favored additional disclosures regarding auditor oversight and evaluation oversight/evaluation; and lesser percentages favored other options. Only 22% of the respondents favored additional disclosures regarding financial statement/audit issues and how they were addressed.
Other findings were consistent with themes from recent years. These include concerns by many audit committees about their being made primarily responsible for oversight of major business risks other than financial reporting and control risks and the “increasingly difficult” demands this was causing. There also appear to be continuing concerns among audit committee members about the information they received about cyber security and the impact of emerging technologies. The survey also identified other areas in which audit committee members believed the quality of information could be improved, including the company’s growth and innovation plans, global systemic risks and supply chain dependencies, and non-financial drivers of long-term performance. Finally, the survey found that most companies do not have a CFO succession plan in place and that many audit committee members would favor expansion of internal audit’s role in risk management.
Highlights From Annual AICPA Conference
December 30, 2013 11:06 AM
The American Institute of Certified Public Accountants’ annual conference on SEC and PCAOB developments often generates news about the thinking of key regulators. This year, much of the discussion from regulators at the conference, which was held December 9-11, was a reiteration of continuing themes. Matters of particular interest to audit committees include:
- Accounting Firm Expansion of Non-Audit Businesses. PCAOB Chairman James Doty and SEC Chief Accountant Paul Beswick reiterated concerns expressed at last year’s conference regarding some accounting firms’ expansion into non-audit businesses. Noting that “[t]he public considers audit firms to be ‘gatekeepers,’ and not consultants, Mr. Beswick stated, “You earn the public’s trust by improving audit quality and by strengthening a firm’s audit function.” Mr. Doty stated, “We need roundtables and task force attention on the implications of the regeneration of non-audit consulting at the global firm.”
- Auditor Independence. Discussing auditor independence, SEC Deputy Chief Accountant Brian Croteau emphasized that responsibility for compliance with the auditor independence rules is a “shared responsibility” between the audit committee and the auditors, not, as some may think, primarily the responsibility of the auditor. He suggested improvements to policies and procedures be considered “to help ensure that services to be provided by the company’s auditor are appropriately evaluated by management and audit committees, in addition to auditors, prior to commencement.” In particular, Mr. Croteau noted that the independence rules require that the auditor be independent not just of the audit client, but also the client’s affiliates, and recommended that that policies and procedures make sure that the complete population of affiliates is known to the company and its auditors. He also suggested that when a company changes auditors, it consider maintaining the independence of the predecessor auditor for a period of time, in case it is necessary to audit a restatement of prior period financial statements.
- Mandatory Rotation. On the controversial issue of mandatory auditor rotation, PCAOB Chief Auditor Martin Baumann discussed the PCAOB’s pending proposal to require disclosure of auditor tenure in the auditor’s report. He alluded to the arguments about whether long auditor tenure can adversely affect audit quality. But neither he nor Mr. Doty suggested that the PCAOB expects to take any action on mandatory rotation other than the proposed disclosure requirement.
- Audit Quality v. Fee Reduction. SEC Chief Accountant Beswick urged audit committees, when deciding whether to hire or retain an auditor, to focus on audit quality and “not always choose the low cost provider.” He expressed concern that “audit committees may be focusing too much on the amount of the fee and not focusing enough on the expected audit quality.” Mr. Beswick suggested that in the event of an audit failure, if the audit committee was “solely fee hunting,” this might “raise questions about the diligence of the members of the audit committee in fulfilling their responsibilities.”
- Audit Quality Indicators. In a related topic, Greg Jonas, PCAOB Office of Research and Analysis Director, discussed the PCAOB’s ongoing audit quality indicator (AQI) project. As described by Mr. Jonas, the Board’s project seeks to answer two questions: “Can we develop a portfolio of quantitative measures that provide new insight into audit quality? If so, how can we deploy those measures in a manner that best promotes quality?” The PCAOB expects to issue a concept release on this topic in the first quarter of 2014.
- ICFR. Several speakers focused on internal control over financial reporting. Notably, Mr. Croteau suggested that PCAOB findings regarding inadequacies in audits of ICFR “are likely indicators of similar problems with management’s evaluations of ICFR, and thus potentially indicative of risk for unidentified material weaknesses.” Mr. Croteau also questioned whether all material weaknesses are being properly identified, noting that “[i]t is surprisingly rare to see management identify a material weakness in the absence of a material misstatement.” This view was echoed by members of the SEC Enforcement Division Staff.
PCAOB Re-Proposes Rules to Require Disclosure of Engagement Partners and Audit Participants
December 10, 2013 10:26 AM
On December 4, the Public Company Accounting Oversight Board voted to re-propose controversial rules to require audit firms to disclose in their audit reports the name of the lead engagement partner on the audit and other accounting firms or persons who took part in the audit. The re-proposal is the latest development in a process that dates back to 2005 and includes a 2009 concept release and a prior rule proposal in 2011. The proposal is described in this PCAOB fact sheet and set forth in the PCAOB Re-Proposing Release.
The new proposal follows the 2011 proposal in most respects. The principal elements are:
- The auditor’s report would be required to include the name of the engagement partner for the audit for the most recent period covered by the report. The engagement partner would not be required to “sign” the report, which will continue to be signed in the name of the firm. Unlike the 2011 proposal, audit firms would not be required to separately disclose the name of the engagement partner in their annual PCAOB reports.
- The auditor’s report would also be required to include information about accounting firms and other persons besides the principal auditor who performed audits of components of an issuer or who performed services in the most recent audit. The proposed rules will require disclosure where other participants account for at least 5% of the total audit hours in the most recent period’s audit. This is an increase from the previous proposal, under which the threshold was 3% of total audit hours. The re-proposed rules will also allow the disclosure to be stated within a range of percentages or as a single number. The prior proposal required that the percentage be stated as a single number. The other major change to the prior proposal is that disclosure will not be required of the name of participants in the audit other than accounting firms.
The new rules would apply to audits of emerging growth companies under the JOBS Act.
There appears to be a significant division within the Board about the proposals. While they voted to issue the proposal, Board members Jay Hanson and Jeannette Franzel raised concerns about various aspects of the proposal, and Mr. Hanson stated that he was not sure he could vote for the proposal in its present form. The other three members of the Board, led by Chairman James Doty, appear to be strongly in favor of the proposal. Mr. Doty indicated that he hopes to have a vote on the final rules in the first half of 2014.
FASB Standard-Setting Update
December 5, 2013 3:46 PM
Here is the latest "Summary of Current FASB Developments" prepared by Randy McClanahan of Johnston Barton Proctor & Rose LLP in Birmingham, Alabama, for the fall meeting of the ABA Business Law Section Law and Accounting Committee. The summary includes current updates on the Financial Accounting Standards Board’s going concern, revenue recognition, and lease accounting projects.
ISS Seeks Input on Auditor Ratification
December 3, 2013 8:46 AM
Institutional Shareholder Services, a proxy advisory firm, is seeking input from financial market participants with respect to its policy approaches on several issues, including votes ratifying the selection of auditors. ISS’s consultation paper states that ISS rarely recommends against ratification of auditors, other than in certain exceptional circumstances. ISS notes that in recent years some shareholders, the Public Company Accounting Oversight Board, and other audit industry observers have “raised concerns about excessive tenure potentially compromising the independence of auditors.” ISS indicates that it is exploring potential approaches to its policy on auditor ratification for 2015 or beyond. These approaches are (1) update ISS’s policy to consider auditor tenure as a factor in determining the vote recommendation on proposals to ratify auditors and (2) maintain the status quo—do not change the current policy.
ISS asks for comments on which of the two options a commenting organization favors and, if it favors considering auditor tenure, at what tenure, in number of years, does the commenter “consider service to be excessive, i.e., whereby the auditor is no longer independent? (5, 10, 15, 25, other-please specify).” ISS also asks commenters if there are other factors that they would urge ISS to consider in making recommendations on auditor ratification.
ISS’s consultation period closes in February 2014.
Governance and Policy Organizations Call for Enhanced Audit Committee Disclosures
November 26, 2013 3:46 PM
A group of governance and policy organizations calling itself the Audit Committee Collaboration has issued a paper entitled Enhancing the Audit Committee Report: A Call to Action. The group “call[s] on public company audit committees of all sizes and industries to voluntarily and proactively improve their public disclosures to more effectively convey to investors and others the critical aspects of the important work that they currently perform.” The group’s recommendations include enhanced disclosure about:
- The scope of the audit committee’s duties
- The audit committee’s composition
- Factors considered when selecting or reappointing an audit firm
- The audit committee’s involvement in the selection of the lead audit engagement partner
- Factors considered when determining auditor compensation
- How the audit committee oversees the external auditor
- How the audit committee evaluates the external auditor
Citing a recent Ernst & Young study (discussed in a previous item), the paper notes that many companies have provided more audit committee disclosure than is currently mandated by current SEC rules. Current SEC rules require companies to disclose specified information about the audit committee’s membership, qualifications and independence; a report from the committee about its consideration of the accountant’s independence and communications from auditors, and its recommendations regarding filing of the company’s Form 10-K; and quantitative data about auditor fees. The disclosures do not include much of the more qualitative information suggested in the paper, and they are not required to be included in a single place in the disclosure document.
The paper acknowledges the “perennial concern about information overload,” but nonetheless urges audit committees to “critically evaluate their disclosures and carefully consider whether improvement can be made to provide investors with more relevant information that conveys an informed, actively engaged and independent audit committee is carrying out its duties.”
PCAOB Creates Audit Committee Website
November 25, 2013 2:35 PM
As part of its “audit committee outreach,” the Public Company Accounting Oversight Board has added a new web page called Information for Audit Committees. The page collects in one place various PCAOB documents relating to audit committees, including statements about its inspection process and findings, its new auditing standard on audit committee communications, and relevant speeches by board and staff members. As in the past, the Board emphasizes its commitment to “constructive engagement with audit committees in areas of common interest, including auditor independence and audit quality.”
PCAOB Establishes Center for Economic Analysis
November 14, 2013 11:25 AM
On November 6, the Public Company Accounting Oversight Board announced that it is establishing a Center for Economic Analysis. According to the PCAOB’s release, the Center “will advise the PCAOB on how economic theory, analysis, and tools can be better used to enhance the effectiveness of PCAOB program areas, including standard setting, inspections and other oversight activities. Additionally, the Center will promote and encourage economic research relating to the role of the audit in capital formation and investor protection.” The Center will be headed by University of Chicago Professor Luigi Zingales.
PCAOB Chairman James Doty’s comments refer only incidentally to the PCAOB’s “use of economic analysis in its rulemaking.” However, one role of the Center may be to assist in the development of cost-benefit analyses to support the PCAOB’s rulemaking and standard setting activities. The Sarbanes-Oxley Act does not require the PCAOB to perform cost-benefit analyses. Nonetheless, the PCAOB has recognized the need to provide such analysis to justify its rules and provide a basis for the SEC to consider whether to approve them. The JOBS Act expressly requires the SEC to consider economic factors in deciding whether to apply new PCAOB auditing standards to emerging growth companies but the PCAOB’s economic analysis likely will not be limited to that area.
PCAOB Issues Practice Alert on Internal Control Audits
October 31, 2013 2:10 PM
On October 24, the Public Company Accounting Oversight Board issued a Staff Audit Practice Alert on Considerations for Audits of Internal Control Over Financial Reporting. The Practice Alert builds upon a 2012 report that identified significant auditing deficiencies in audits of internal control over financial reporting. (This report is discussed here.) In light of these deficiencies, the Practice Alert discusses the application of PCAOB Auditing Standard 5 and other standards to specific aspects of the internal control audit.
While the Practice Alert is aimed principally at auditors, it does suggest that audit committees “might wish to discuss with their auditors the level of auditing deficiencies in this area identified in their auditors' internal inspections and PCAOB inspections, request information from their auditors about potential root causes of such findings, and ask how they are addressing the matters discussed in this alert. In particular, audit committees may want to inquire about the involvement and focus by senior members of the firm on these matters.”
SEC Chair White Outlines Path Forward on Disclosure Reform
October 21, 2013 5:40 PM
In a speech to the National Association of Corporate Directors on October 15, SEC Chair Mary Jo White discussed the potential for “information overload” in SEC disclosures. Chair White raised the question “whether investors need and are optimally served by the detailed and lengthy disclosures about all of the topics that companies currently provide in the reports they are required to prepare and file with us.” She reported that the Division of Corporation Finance will soon release a study mandated by the JOBS Act to review the Commission’s current disclosure requirements and consider how to approach modernizing and simplifying the requirements and to reduce the costs and other burdens of the disclosure requirements for emerging growth companies. (As noted in an earlier post, other Commissioners and SEC staff have also raised concerns about “information overload.”)
Chair White indicated that this study is “only the first step” for a meaningful review of the SEC’s disclosure requirements. She outlined various questions that a review of disclosure should address, including:
- Are there specific disclosure requirements that are simply not necessary for investors or that investors do not want?
- Are SEC rules the sole or primary cause of potential disclosure overload or do other sources contribute to it? Are changes to the disclosure requirements the only way to improve the quality of disclosure?
- Is there information that appears more than once in a filing and if so, is that so bad? Or is there a way to avoid repetition in a document?
- Are investors getting the information they need when they need it? Are there ways that the rules can improve investors’ access to a company’s disclosure?
Chair White did not identify specific next steps in this review after release of the Staff study, but she emphasized that “[i]t is an important priority for me.”
PCAOB Updates Standard-Setting Agenda
October 8, 2013 3:10 PM
The Chief Auditor of the Public Company Accounting Oversight Board issues a quarterly standard-setting agenda that identifies major standard setting projects and anticipated timetables. Among the updates disclosed in the Board’s September 30, 2013 agenda are the following:
- Audit Transparency. The agenda now indicates that the Board will issue a reproposal of its 2011 proposed standard regarding identification of the engagement partner and other participants in the audit. The timetable for action is now fourth quarter 2013 to first quarter 2014. Previously, action was contemplated by the end of 2013. The proposal to identify the individual engagement partner for an audit has been a controversial one since it was first floated in a July 2009 concept release.
- Related Parties. The agenda indicates that the Board will consider adoption of its proposed audit standards on related parties, unusual transactions, and financial relationships with executives officers. The standard was proposed in May 2013. The timetable here is also projected as fourth quarter 2013 to first quarter 2014.
- Other Accounting Firms, Individual Accountants and Specialists. The Board plans to propose a standard to improve audit procedures performed by other accounting firms, individual accountants, and specialists and in the lead auditor’s oversight of their work. The timetable here is also projected as fourth quarter 2013 to first quarter 2014.
The agenda also projects possible action on changes to the going concern auditing standard in fourth quarter 2013 to first quarter 2014. That action is dependent on action by other standard setters, particularly the Financial Accounting Standards Board, which is considering a proposed accounting standard to require disclosures regarding an entity’s going concern assumption. The Board also has projects underway regarding audit firm quality control standards, auditing accounting estimates, and subsequent events. No timetable is specified for these matters.
Finally, as to the project on “auditor independence, objectivity and professional skepticism,” which has been focused on mandatory audit firm rotation, the agenda says, as it has in recent quarters, “Next steps under consideration.”
SEC Enforcement Staff Announces “Operation Broken Gate”
October 2, 2013 4:05 PM
On Monday, September 30, the Securities and Exchange Commission announced that it had charged three auditors with violating federal securities laws or failing to comply with US auditing standards during their audits and reviews of financial statements. The charges alleged fairly egregious deficiencies in audits of OTC companies performed by individual CPAs and do not, in themselves, appear to break significant new ground. However, the SEC’s release suggested that these matters were part of a broader “ongoing effort to hold gatekeepers responsible for the important roles they play in the securities industry.” The SEC revealed it uses the internal designation “Operation Broken Gate” for its efforts to “identify auditors who fail to carry out their duties and responsibilities consistent with professional standards. Gatekeepers that fail to comply with professional standards put investors at risk due to the possibility of undetected fraud or other financial misstatements.”
The reference to “Operation Broken Gate” appears to be part of the Commission’s renewed emphasis on uncovering and prosecuting accounting fraud. As previously noted, the SEC’s new Financial Reporting and Audit Task Force will focus on the role of auditors and audit committees in the financial reporting process.
SEC Staff Underscores Renewed Emphasis on Accounting Fraud
September 27, 2013 4:11 PM
Last week, in a speech at an American Law Institute Continuing Legal Education event, SEC Co-Director of Enforcement Andrew Ceresney described several of the investigative initiatives that are planned for the Commission’s new Financial Reporting and Audit Task Force (read our previous post on this). According to Ceresney, these initiatives include “closely monitoring high-risk companies to identify potential misconduct, analyzing performance trends by industry, reviewing class action and other filings related to alleged fraudulent financial reporting, tapping into academic work on accounting and auditing fraud, and conducting street sweeps in particular industries and accounting areas.”
Some of the other key methods being used by the Task Force to identify potential accounting fraud violations include:
- Reliance on Whistleblowers. Task Force Chair David Woodcock recently remarked during a separate ALI-CLE panel that the Task Force will actively solicit whistleblowers for information about accounting and financial disclosure violations. Last year, 18.2% of whistleblower tips related to corporate disclosure and financials.
- Accounting Quality Model. According to Woodcock, the Task Force is currently working with the SEC’s Division of Economic and Risk Analysis to develop and improve the Accounting Quality Model. For more on how the model will isolate potential red flags and trends, see our previous post here.
- Tips from other regulators and investigative teams. Ceresney reports that other regulators are uncovering potential issues related to financial reporting and accounting fraud. These reports are in addition to “significant sources of information” provided to the Task Force from within the SEC.
According to Ceresney, two of the Task Force’s key areas of focus are audit committees and auditors. Emphasizing the “critical role” that audit committees and auditors play “in the financial reporting process,” Ceresney told the audience that the Task Force will hold both accountable for “failing to recognize red flags.” Other key focus areas of the Task Force will include losses and reserves, revenue recognition issues, auditor independence violations and fraud involving foreign issuers and executives.
Notably, Ceresney expressed “doubts” about the reasons behind the apparent “drop in actual fraud in financial reporting.” “I find it hard to believe that we have so radically reduced the instances of accounting fraud simply due to reforms such as governance changes and certifications and other Sarbanes-Oxley innovations,” he said during the September 19 speech. The SEC “will not know whether there has been an overall reduction in accounting fraud until we devote the resources to find out.”
The Task Force appears to be shaping up as a substantial initiative of the Commission under its new Chair and Enforcement Directors.
Contributed by Arian June
Many Audit Committees Provide Expanded Disclosure in 2013 Proxy Statements
September 23, 2013 9:31 AM
According to a new Ernst & Young report, many Fortune 100 companies have voluntarily provided increased audit-committee related disclosure in their 2013 proxy statements. The report suggested that the increase in voluntary disclosure represented a response to investors’ and policymakers’ expressed interest in greater audit committee transparency.
Among the significant changes identified by EY:
- 9% of companies voluntarily disclosed that the audit committee is responsible for audit fee negotiations, compared to 1% of companies in their 2012 proxies
- 23% stated that the selection of the auditor is in the best interests of the company/stockholders, compared to 4% in 2012
- 17% disclosed that the committee was involved in the selection of the lead audit partner, compared to 1% in 2012
- 50% stated that the audit committee is responsible for the appointment, oversight and compensation of the audit firm, compared to 37% in 2012
- 15% said that the committee considers the impact of changing auditors when assessing whether to retain the current external auditor, compare to 3% in 2012
The EY report also noted several areas in which a few companies had provided disclosure, which might signal practices that could become more widespread: an explanation of why audit fees changed from 2012 to 2013; topics that the audit committee discussed with the external auditor in 2013; and the year in which the current lead audit partner was appointed.
The EY report concludes that the focus on audit committee-related disclosures is likely to continue into the 2014 proxy season, and that “companies may decide that increased communication and transparency about audit and audit committee matters is in their self-interest as well as the public interest.”
FASB Standard-Setting Update
September 3, 2013 11:34 AM
Here is a Summary of Current FASB Developments provided by Randy McClanahan of Johnston Barton Procter & Rose LLP in Birmingham, Alabama, for the August meeting of the ABA Business Law Section Law and Accounting Committee. Among other important topics, Randy provides a valuable summary of FASB’s latest exposure draft for a new lease accounting standard.
PCAOB Proposes Changes to Auditor Reporting Standards
August 15, 2013 12:30 PM
On August 13, the Public Company Accounting Oversight Board issued its long-awaited proposed modifications to auditor reporting standards. The proposals follow a process that included a concept release issued over two years ago that discussed possible changes to the standard auditor’s report to provide more useful information to investors. The PCAOB proposes two new standards, one addressing the content of the auditor’s report, and the other imposing new auditor responsibilities regarding other information contained in an issuer’s annual report on Form 10-K. The proposals are contained in an almost 300-page release and summarized in a shorter fact sheet.
Reporting Standard. The proposed reporting standard would retain the current “pass/fail” system, under which the auditor provides either an unqualified opinion or a qualified, adverse or disclaimed opinion on an issuer’s financial statements. It also retains many other elements of the current form of audit report. The auditor’s report would be expanded to include more information, most notably a discussion of “critical audit matters” that would be specific to the particular audit. As explained by the PCAOB, the report “would focus on those matters the auditor addressed during the audit of the financial statements that involved the most difficult, subjective, or complex auditor judgments or posed the most difficulty to the auditor in obtaining sufficient appropriate audit evidence or forming an opinion on the financial statements.” The report would also include new elements related to auditor independence, auditor tenure and the auditor’s evaluation of other information outside the financial statements. The proposal also includes enhancements to the existing language in the auditor’s report related to fraud and notes to the financial statements.
Notably, the proposed reporting standard does not include a requirement for an “auditor’s discussion and analysis,” a controversial idea that had been floated in the 2011 concept release. At the same time, it appears to require more than just expanded “emphasis paragraphs,” which was another idea in the 2011 release.
Other Information. The other proposed reporting standard would expand the auditor’s responsibilities regarding information contained in the issuer’s annual report besides the financial statements, such as selected financial data, MD&A, and certain information incorporated by reference. Under the existing auditing standard, the auditor has a responsibility to “read and consider” other information in a securities filing, but it is not required to report on that review. The auditor considers whether the other information is materially inconsistent with the information in the financial statements. The new standard would 1) apply the auditor’s responsibility for other information specifically to an issuer’s annual reports on Form 10-K; 2) add procedures for the auditor to perform in evaluating the other information based on relevant audit evidence obtained and conclusions reached during the audit; 3) require the auditor to evaluate the other information for a material misstatement of fact as well as material inconsistency with the financial statements; and 4) require communication in the auditor’s report about the auditor’s responsibilities for, and the results of, the auditor’s evaluation of the other information.
The PCAOB has invited comments on the proposals, which are due December 11, 2013, and indicated that it plans to host a roundtable on the proposals in 2014.
GAO Issues Report on Internal Control Audits for Small Companies
July 17, 2013 12:20 PM
Earlier this month, the General Accounting Office issued a report on the impact of the exemption of small public companies from the Sarbanes-Oxley Act’s internal control attestation requirements. In 2010, the Dodd-Frank Act exempted public companies with market capitalization of less than $75 million from section 404(b) of the Sarbanes-Oxley Act, which requires that public companies obtain an annual audit by a registered public accounting firm of their internal control over financial reporting. The Act also directed the GAO to conduct a study of the impact of this exemption and report to Congress within three years of enactment of the Dodd-Frank Act.
The report found that since the implementation of the auditor attestation requirement, companies exempt from the requirement have had more financial restatements that nonexempt companies, and the percentage of exempt companies restating generally has exceeded that of nonexempt companies. The GAO considered, but did not reach any firm conclusions on, whether the costs of compliance with the attestation requirement by small companies exceeded the benefits. The report did cite evidence that compliance with the auditor attestation requirement has a positive impact on investor confidence.
The GAO’s only recommendation was that the SEC consider requiring exempted public companies to explicitly disclose whether they obtained an auditor attestation of their internal controls. The SEC advised the GAO that such information can be easily determined by investors from information that is already disclosed in the annual report. But the GAO nonetheless concluded that an explicit disclosure “would increase transparency and investor protection by making investors readily aware of this important information.”
House Passes Mandatory Auditor Rotation Ban
July 9, 2013 1:30 PM
Yesterday, the full House of Representatives passed by a large, bipartisan margin the bill (previously reported on June 20) to prohibit the Public Company Accounting Oversight Board from requiring mandatory auditor rotation. The bill also would require the General Accounting Office to conduct another study of mandatory auditor rotation and to report to Congress within one year after enactment.
New SEC Initiative to Combat Financial Reporting Fraud
July 3, 2013 2:39 PM
On July 2, the SEC announced the formation of a Financial Reporting and Audit Task Force. The task force, which will include attorneys and accountants from the Division of Enforcement, working with other offices of the SEC staff, “will concentrate on expanding and strengthening the Division's efforts to identify securities-law violations relating to the preparation of financial statements, issuer reporting and disclosure, and audit failures.” Its principal goal will be fraud detection and “increased prosecution of violations involving false or misleading financial statements and disclosures.” The SEC also announced the formation of a Microcap Fraud Task Force targeting fraud involving microcap companies and a Center for Risk and Quantitative Analytics.
This announcement comes on the heels of several recent news reports that the SEC’s new chairman, Mary Jo White, intends to increase the SEC’s focus on detecting and combatting accounting fraud. The establishment of new task force appears to be consistent with those reports.
FASB Issues Proposed Going Concern Standard
July 2, 2013 1:30 PM
As previously reported, the Financial Accounting Standards Board decided in November 2012 to proceed with its project to require companies to provide enhanced disclosures where there are questions regarding their financial viability. Last week, as described in this FASB Summary, FASB finally issued its formal proposal to require companies to evaluate and disclose “going concern uncertainties.” FASB’s exposure draft emphasizes that financial statements reflect a presumption that a reporting entity will be able to realize its assets and meet its obligations in the ordinary course of business, and that there should be consistent standards for management’s evaluation of, and disclosures about, uncertainties that could affect that presumption.
The key terms of the proposal include:
- An entity would evaluate going concern uncertainties by assessing the likelihood that the entity would be unable to meet its obligations as they come due within the 24 months after the financial statement date.
- The entity would conduct this evaluation at each annual and interim reporting period.
- The entity would start providing footnote disclosures when it is either
- more likely than not that the entity will be unable to meet its obligations within 12 months without taking actions outside the ordinary course of business, or
- known or probable that the entity will be unable to meet its obligations within 24 months without taking actions outside the ordinary course of business.
- If the disclosure threshold was met, the entity would disclose a description of
- the principal conditions and events that give rise to the entity’s potential inability of meet its obligations,
- the possible effects those conditions and events could have on the entity,
- management’s evaluation of the significance of those conditions and events,
- mitigating conditions and events, and
- management’s plans that are intended to address the entity’s potential inability to meet its obligations.
- If the entity is an SEC reporting company, the entity would also be required to evaluate whether there is a substantial doubt about its going concern presumption. Substantial doubt would exist if, after assessing existing conditions and events and after considering all of management’s plans (including those outside the ordinary course of business), it is known or probable that the company will be unable to meet its obligations within 24 months. The company will be specifically required to word its disclosures using the terms “substantial doubt” and “ability to continue as a going concern.”
FASB’s proposal is likely to continue to be controversial, particularly with respect to SEC reporting companies, as many believe that requiring a company to make and disclose these types of negative assessments could become a self-fulfilling prophecy.
New SEC Case Emphasizes Importance of Internal Controls
June 24, 2013 1:04 PM
The SEC recently brought an unusual case in which the alleged violations of law related principally to failure to maintain adequate internal control over financial reporting. In its complaint against PACCAR, the SEC identified errors in certain PACCAR periodic filings regarding segment reporting, footnote disclosures regarding impaired receivables and related reserves, and certain offsetting line items in its cash flow statements. The SEC alleged violations of the Securities Exchange Act’s requirements that issuers file accurate periodic reports (section 13(a)), maintain adequate books and records (section 13(b)(2)(A)), and devise and maintain a sufficient system of internal accounting controls (section 13(b)(2)(B)). Interestingly, the complaint indicates that the errors were identified in response to comment letters from the SEC staff.
PACCAR agreed to settle the case, subject to court approval, by paying a $225,000 penalty and agreeing to injunctive relief. The SEC stated that the settlement takes into account that PACCAR and a subsidiary have implement remedial measures to enhance their internal controls and improve compliance with GAAP.
The PACCAR case is significant in that it demonstrates that the SEC will pursue “books and records” and internal control cases, even if there is no underlying accounting fraud or other misconduct. The case reinforces the importance of public companies’ maintaining effective internal control over financial reporting.
House Panel Approves Ban on Mandatory Auditor Rotation
June 20, 2013 9:43 AM
The House Financial Services Committee has approved a bill that would prohibit the Public Company Accounting Oversight Board from imposing mandatory auditor rotation. The bill, which passed with bi-partisan support, provides that the PCAOB shall have no authority “to require that audits conducted for a particular issuer in accordance with the standards set forth under this section be conducted by specific auditors, or that such audits be conducted for an issuer by different auditors on a rotating basis.” As with all proposed legislation, it is, at best, uncertain whether this bill will become law. But it does send something of a signal to the PCAOB.
ABA Issues New Auditor’s Letter Handbook
June 5, 2013 6:33 PM
The American Bar Association Business Law Section has issued the Auditor’s Letter Handbook—Second Edition. This handbook, the first update since 1998, compiles the key guidance for lawyers’ responses to requests to provide information to auditors. It includes the 1975 ABA Policy Statement Regarding Lawyers’ Responses to Auditors’ Requests for Information, AICPA and PCAOB auditing standards, and interpretations issued over the years. The handbook was prepared under the auspices of the Audit Responses Committee of the Business Law Section, of which your blog host is Vice Chair and incoming Chair.
COSO Issues New Internal Control Framework
May 28, 2013 2:15 PM
Section 404 of the Sarbanes-Oxley Act and SEC regulations require public reporting companies to provide an annual management report on the effectiveness of the company’s internal control over financial reporting (ICFR). Most companies are also required to obtain annual ICFR audits by their external auditors. The evaluation, and when required, the audit, must be based on a “suitable, recognized” control framework, and management and the auditor must identify that framework in their reports. Since the ICFR assessment rules came into effect, most companies have employed the Internal Control—Integrated Framework (Framework) issued in 1992 by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) as the basis for their ICFR assessments.
On May 14, 2012, COSO released an updated Framework following a 2 ½ year deliberative process. The new Framework represents an updating, not complete overhaul, of the original Framework. COSO’s press release explains that “the updated Framework is expected to help organizations design and implement internal control in light of many changes in business and operating environments since the issuance of the original Framework, broaden the application of internal control in addressing operations and reporting objectives, and clarify the requirements for determining what constitutes effective internal control.” One of the most significant changes in the new Framework is setting forth 17 principles, each of which is specifically assigned to one of the five components of a system of internal controls that were identified in the original Framework. The original Framework did not contain such principles or a requirement that any factors beyond the five components of internal controls be considered. (COSO also issued this executive summary of the new Framework.)
COSO stated that the original framework will be available until December 15, 2014, at which time COSO will “consider it superseded” by the new Framework. This suggests that companies assessing the effectiveness of ICFR as of the end of 2014 will have to apply the new Framework. During the transition period, which would include calendar year 2013, companies should disclose whether they employed the original or updated framework.
While the COSO Framework includes control elements that affect areas other than ICFR, such as operations and compliance, audit committees should focus on the parts of the Framework affecting ICFR. Audit committees should review with management and external auditors how the new Framework will affect their companies’ ICFR, management’s assessment of the effectiveness of ICFR, and (where required) the external auditor’s audit of ICFR.
PCAOB and China Reach Agreement on Sharing Information
May 24, 2013 2:15 PM
As noted in a prior item, US and Chinese securities regulators have been engaged in a standoff regarding the US regulators’ ability to exercise oversight over Chinese accounting firms that audit US-listed issuers and to obtain from the Chinese accounting firms documents relevant to investigations of Chinese issuers. China has not permitted the accounting firms to cooperate with US regulators, principally on grounds of national sovereignty and protection of “state secrets.” Today the Public Company Accounting Oversight Board announced that it has reached an agreement with the Chinese regulators addressing one aspect of the dispute. The agreement establishes a mechanism for the PCAOB, on the one hand, and the China Securities Regulatory Commission and the Ministry of Finance of China, on the other, to provide information to each other, including audit workpapers, in connection with investigations of possible violations of law or professional standards by a public accounting firm or associated person of such firm.
While this agreement is a significant step, it is worth noting what it does not do. It does not provide a mechanism for the PCAOB to conduct inspections of Chinese accounting firms that are registered with the PCAOB, though the PCAOB does indicate that it continues to seek an agreement on inspections. It also does not address the SEC’s ability to obtain documents and information from Chinese accounting firms in connection with investigations of Chinese issuers listed in the US. Nor does it resolve the pending litigation in which the SEC is seeking to enforce a subpoena for documents against one Chinese accounting firm and to obtain administrative sanctions from five Chinese firms for failing to comply with SEC document demands.
NASDAQ Withdraws Internal Audit Proposal
May 17, 2013 7:10 PM
NASDAQ announced today that it was withdrawing, for the time being, its proposal to require NASDAQ-listed companies to have an internal audit function. NASDAQ took this action in response to comments filed with the SEC about the proposal, many of which raised concerns about the impact of the rule, particularly on smaller companies. NASDAQ stated that it intended to revise the proposed rule in light of the comments and resubmit it to the SEC.
PCAOB Reproposes Auditing Standard for Related Party Transactions and Other Matters
May 13, 2013 2:10 PM
On May 7, the Public Company Accounting Oversight Board issued a proposed new auditing standard and amendments to existing standards intended to strengthen the requirements for audit steps regarding related party transactions, significant unusual transactions, and financial relationships and transactions with executive officers. The PCAOB previously issued a proposal covering these matters in February 2012. The PCAOB’s new proposal reflects its view that the three covered areas pose higher than normal risk of material misstatement and an increased risk of fraud and that enhanced standards are therefore warranted. If adopted and approved by the SEC, the new standards would be effective for fiscal years beginning on or after December 15, 2013.
Among the notable aspects of the new proposal:
- The PCAOB responds to concerns that the original proposal would have required the auditor to make substantive evaluations about a company’s executive compensation arrangements. The PCAOB emphasizes that the new standard would require the auditor, as part of its risk assessment process, to consider incentives or pressures for the company to achieve a particular financial position or operating result, but would not require the auditor to assess the appropriateness or reasonableness of a company’s compensation arrangements with its executive officers.
- The new auditing standard would specify required communications with the audit committee about related parties, including required inquiries of the audit committee or its chair regarding related party relationships or transactions and specified disclosures by the auditor to the committee about the results of its audit of related party matters. The PCAOB states that these requirements would “complement” the new communications requirements for unusual transactions in Auditing Standard 16.
- Consistent with recent PCAOB undertakings to engage in more economic analysis, the PCAOB release includes a discussion of potential economic implications of the proposed standards, including anticipated benefits to investors and potential increased costs as a result of the additional procedures that would be required. The release requests comments on the economic impact of the standards generally, as well as in response to the specific requirements for application of the new or amended standards to emerging growth companies under the JOBS Act.
Senators Reintroduce PCAOB Transparency Bill
April 30, 2013 3:50 PM
Senators Jack Reed (D-Rhode Island) and Chuck Grassley (R-Iowa) have reintroduced legislation requiring that formal disciplinary proceedings initiated against accountants by the PCAOB be public. Under the Sarbanes-Oxley Act, such proceedings are non-public unless and until a sanction is entered by the PCAOB and any stay of enforcement of the sanction pending appeal to the SEC is lifted. As the senators’ press release points out, comparable proceedings before the SEC and other financial regulatory agencies are public. According to Senator Reed, “Investors and companies alike should be aware when the auditors and accountants they rely on have been charged or sanctioned for violating professional auditing standards.”
Members and staff of the PCAOB have advocated this change in law for some time, and the legislation was previously introduced in 2011. As with most financial regulatory legislation, the prospects for this bill in the current Congress are at best uncertain.
FASB Appoints New Chairman
April 25, 2013 9:26 AM
The Financial Accounting Standards Board announced on April 23 that Russell Golden has been appointed its new Chairman for a term beginning July 1, 2013. Mr. Golden, who succeeds Leslie Seidman, has been a member of the FASB since 2010 and previously was its technical director. Mr. Golden’s objectives will include “putting the interests of investors first; working to make financial reporting as clear, transparent and useful as possible; and never losing sight of the balance between costs and benefits.”
Insider Trading Scandal Hits KPMG
April 16, 2013 5:20 PM
Last week, news broke that a Los Angeles partner of KPMG had provided a friend with material non-public information about several KPMG audit clients, and the friend had traded on that information. KPMG terminated the partner and resigned as auditor of two clients for whom the partner was lead partner. In addition, KPMG withdrew its audit reports for prior years for the two clients, on the basis that it was not independent because of the former partner’s alleged insider trading. Federal prosecutors have brought criminal charges against the partner, and the SEC has instituted a civil suit against him. According to KPMG, the partner’s “rogue actions” violated the firm’s “rigorous policies and protections, betrayed the trust of clients as well as colleagues, and acted with deliberate disregard for KPMG’s long-standing culture of professionalism and integrity.”
This case should not be viewed as indicative of any systemic internal compliance issue at accounting firms. Rogue individuals in other professions, including law, investment banking and consulting, have also engaged in insider trading notwithstanding the legal prohibitions and stringent internal policies and procedures. Audit committees should, nonetheless, consider reviewing with their auditors the audit firm’s policies and procedures against misuse of confidential client information.
Based on some commentators’ comments, the scandal may give new impetus to the PCAOB’s long-pending proposal to require an audit firm to disclose the name of the engagement partner on each audit report. The PCAOB first issued a concept release on this topic in July 2009, and issued a proposed standard in October 2011. The PCAOB’s current standard-setting agenda targets April-September 2013 for action on the proposal.
FASB Standard-Setting Update
April 12, 2013 4:00 PM
Randy McClanahan of Johnston Barton Procter & Rose LLP in Birmingham, Alabama, provided his latest Summary of Current FASB Developments at the recent meeting of the ABA Business Law Section Law and Accounting Committee in Washington. Randy’s summary discusses major standard-setting projects on the FASB’s agenda this year, including lease accounting, recognition and measurement of financial instruments, and revenue recognition.
Former SEC Senior Special Counsels Brown, Zepralka Join WilmerHale
April 9, 2013 9:00 AM
We shared with you in a previous post that Meredith Cross, former Director of the Division of Corporation Finance at the Securities Exchange Commission (SEC), was rejoining the firm. WilmerHale has also announced that former SEC Senior Special Counsels Lillian Brown and Jennifer Zepralka have joined the firm. They both worked closely with Ms. Cross while at the SEC.
Susan Murley, co-managing partner of WilmerHale, believes the arrival of Ms. Brown and Ms. Zepralka “will greatly enhance our team’s public company counseling, crisis management and securities law expertise.” (Read WilmerHale's announcement here.)
White Confirmed as SEC Chairman
April 8, 2013 6:30 PM
The Senate has unanimously confirmed Mary Jo White as the new Chairman of the SEC. As she indicated at her confirmation hearings, Ms. White’s priorities as chair will include:
- Finishing the rulemaking required by the Dodd-Frank and JOBS acts.
- Further strengthening the enforcement function at the SEC; and
- Working to ensure that the SEC has the expertise and technology to keep pace with “today’s high-speed, high-tech, and dispersed marketplace.”
Among the remaining Dodd-Frank rulemakings are the mandated disclosure rules regarding pay-for-performance, pay equity and executive compensation clawback. Unlike these provisions, many of the other pending rulemakings have statutory deadlines. Thus, it continues to be difficult to predict when the SEC will act on the executive compensation rules.
Recent Developments in Europe May Influence US Debate on Mandatory Rotation
April 3, 2013 1:20 PM
Throughout the Public Company Accounting Oversight Board’s review of mandatory audit firm rotation, PCAOB Chair James Doty has indicated that the PCAOB will look at how perceived issues of professional independence are being considered internationally. For example, in a February 8, 2013, speech, Mr. Doty stated that the PCAOB would “watch and evaluate the implications of international developments,” including EU consideration of mandatory auditor rotation. In the same speech, Mr. Doty also questioned “whether audit committees can be enlisted to monitor and enforce auditor skepticism” as alternatives to structural changes such as mandatory rotation or mandatory tendering (i.e., periodically putting the audit out for bid but not requiring a change of auditors). Noting a recent survey that indicated that only 38% of audit committees claimed to have formal and comprehensive external auditor evaluation processes, he stated that “equipping audit committees to perform the rigorous monitoring that would be needed to test and enforce skepticism would also require a significant change in the way audit committees operate.”
In light of Mr. Doty’s comments, some recent developments in Europe are of interest:
First, last month the European Parliament’s economic affairs committee adopted a proposal for mandatory retendering of the audit engagement every seven years for significant public companies. Companies would have to show that they had considered two candidates for the audit and give reasons for the selection, subject to oversight by a national regulator. This proposal, if implemented, would represent a step back from the European Commission’s 2011 proposal to require mandatory audit firm rotation every six years (or nine years, if two firms conduct an audit). The Parliament’s legal affairs committee has primary responsibility for the EU audit reform legislation, and it has yet to act on it.
Additionally, in February, the UK Competition Commission issued a report on an investigation into the market for audit services for large public companies in the UK. The report found that the overwhelming majority of these companies are audited by one of the “Big Four” accounting firms. The report concluded that competition in the audit market is restricted by factors which inhibit companies from switching auditors and by a tendency for auditors to focus on satisfying management rather than shareholder needs. (The Commission’s findings are summarized here.)
The Commission is now considering ways to encourage greater competition, including mandatory tendering and rotation; increasing information and transparency with more frequent external audit quality reviews and expanding reporting in audit reports or the audit committee report; and strengthening accountability and independence by giving audit committees and shareholders greater control of external audit.
Interestingly, among the many matters discussed in its 300-page report, the Commission stated that there are limitations on the ability of the audit committee, in particular, the audit committee chair, “at least in its current incarnation, to ensure audit quality and independence of the auditor.” The report provided various reasons for this conclusion. Among others, it questioned whether the audit committee chair’s “high-level, supervisory role” enabled it to ensure that auditors responded to shareholder needs rather than management demands. It also implied that audit committee chairs’ time commitments may not be sufficient to oversee complex audits.
CAQ Issues ICFR Guide
April 1, 2013 8:40 AM
The Center for Audit Quality has issued a useful Guide to Internal Control Over Financial Reporting. While discussing the regulatory requirements, the Guide is particularly helpful in outlining in plain English, with examples, how a system of ICFR works. The Guide also highlights the oversight responsibility of the audit committee for a company’s ICFR: “The audit committee’s activities usually include review of the assessment of financial reporting risk; discussion with management of significant control deficiencies and their potential impact on financial reporting; and evaluation of the quality of financial reporting and related disclosures. Management officials with responsibility for ICFR are expected to keep the audit committee apprised of the operation and effectiveness of controls. If the company has an internal audit staff, its work often includes testing controls and informing the audit committee of its findings relative to ICFR.”
PCAOB to Propose Reorganization of Auditing Standards
March 22, 2013 10:13 AM
The Public Company Accounting Oversight Board has announced that it will consider a proposal for the reorganization of auditing standards at a meeting on March 26. Current PCAOB auditing standards, which apply to audits of U.S. public companies and broker-dealers, are an amalgam of AICPA auditing standards that existed when the PCAOB began operations in 2003 and new auditing standards, and related amendments of existing standards, adopted by the PCAOB since 2003. The PCAOB said its proposal will reorganize the standards “into a topical structure with a single integrated numbering system, along with certain implementing amendments to its rules and standards. The proposed reorganization is intended to present the standards in a logical order that generally follows the flow of how one conducts an audit. The proposed reorganization also is intended to help users navigate the standards more easily.”
NASDAQ to Require Companies to Have Internal Audit Function
March 12, 2013 9:00 AM
The NASDAQ Stock Market has proposed a new rule requiring NASDAQ-listed companies to “establish and maintain an internal audit function to provide management and the audit committee with ongoing assessments of the Company’s risk management processes and system of internal control.” The function may be outsourced to a third party service provider other than the Company’s independent auditor. The NASDAQ proposal closely mirrors the NYSE’s existing requirement of an internal audit function, though it adds requirements that the audit committee meet periodically with the internal auditors and that the audit committee discuss with the outside auditor the responsibilities, budget and staffing of the internal audit function. The SEC recently published the NASDAQ proposal for public comment. If approved by the SEC, companies listed on NASDAQ before June 30, 2013 will be required to establish the internal audit function no later than December 31, 2013, and companies listed on NASDAQ after June 30, 2013 will be required to do so before listing.
Bar Group Asks NYSE to Revise Risk Oversight Rule
March 12, 2013 8:40 AM
The New York Stock Exchange’s Corporate Governance Standards provide that the audit committee shall “discuss policies with respect to risk assessment and risk management.” (See Rule 303A.07(b)(iii)(D).) The somewhat ambiguous commentary to this rule seems to require the audit committee to exercise general oversight over a company’s risk management. Noting that it is management’s job to assess and manage a company’s exposure to risk, the commentary provides that “the audit committee must discuss guidelines and policies to govern the process by which this is handled.” While stating that companies can manage and assess risk through “mechanisms other than audit committee,” the NYSE also says that the processes “should be reviewed in a general manner by the audit committee.” In light of the increasing focus in recent years on risk management, including by the SEC in new disclosure rules and guidance, many audit committee members and others have questioned whether the audit committee is the best location for the risk oversight function, particularly for risks other than those related to financial reporting.
Recently, the Committee on Financial Reporting of the New York City Bar submitted a letter to the NYSE urging the Exchange to consider whether the rule reflects an optimum approach to risk management in the current environment. The Committee recommended that while audit committees should retain responsibility for risks associated with financial reporting, it should not be required to assume broader risk management oversight responsibility. It suggested that the responsibility for oversight of risk assessment and risk management be placed at the board level. The board would have the ability to delegate aspects of risk management to the audit committee or other committees as the board deems appropriate.
PCAOB Members Reappointed
March 4, 2013 8:40 AM
The SEC has reappointed two members of the Public Company Accounting Oversight Board. They are Steven Harris, who has been a member of the PCAOB since 2008 and whose term will expire in 2017, and Jay Hanson, who joined the PCAOB in 2011 and whose term will expire in 2018. These reappointments will provide continuity in the PCAOB’s membership as it considers such matters as the auditor’s reporting model and mandatory auditor rotation.
SEC Speaks About Disclosure Reform
February 26, 2013 10:00 AM
SEC officials addressed the need to examine current disclosure models at last week’s “SEC Speaks” conference in Washington. Commissioner Troy Paredes’ remarks on February 22 highlighted the importance of disclosure as “the cornerstone of the federal securities laws.” But he also commented at length on “information overload.” Asserting that “disclosures have continued to pile up, with some of them being of questionable value,” he suggested that “we should be open to the idea that certain current disclosures should be more narrowly focused or otherwise scaled back, if not excluded entirely from what is mandated to be disclosed.” He added, “At a minimum, going forward we should not add to the problem by expanding what companies must disclose to include information that is not material to evaluating a company’s business.” Commissioner Paredes called for “a top-to-bottom review of our disclosure regime,” including means of presentation that are more accessible and that evolve to accommodate changes in how individuals react and keep themselves informed, such as through social media and mobile devices.
In a similar vein, SEC Chief Accountant Paul Beswick reportedly told the conference on February 23 that the SEC will issue a staff paper on disclosures within the next few months and will hold a disclosure roundtable in the late spring or early summer. Mr. Beswick referred to comments on the Financial Accounting Standards Board’s concept release on the Disclosure Framework which noted an apparent increasing frequency of information traditionally housed in MD&A, particularly forward-looking information, being moved to the financial statement footnotes. (Here is a link to FASB's summary of comments received on the Disclosure Framework release.)
SEC Approves PCAOB 2013 Budget and Fees
February 25, 2013 8:00 AM
The Securities and Exchange Commission approved the Public Company Accounting Oversight Board’s 2013 budget at an open meeting on February 13, 2013. The PCAOB’s approved budget is approximately $245.6 million, an 8% increase over 2012. The PCAOB’s expenses are principally funded by accounting support fees imposed on issuers and broker-dealers. The SEC expressed support for the PCAOB’s new strategic plan and its six near-term objectives. (The strategic plan can be found here. Board Member Jeannette Franzel discussed these objectives in a recent speech discussed in a previous blog item.) The SEC also directed the PCAOB to report quarterly on its inspection programs, including providing statistics about inspections performed in 2013, information about the timing of inspection reports, and updates on the PCAOB’s efforts to establish cooperative arrangements with foreign regulators. The SEC order noted that the PCAOB budget may be subject to reduction if the so-called budget “sequestration” goes into effect.
In response to questions from the SEC Commissioners, PCAOB Chairman James Doty indicated that the PCAOB would continue to expand its use of economic analysis in standard setting activities. As to mandatory rotation, he stated that he did not know if the PCAOB would put out a proposal and noted that the Board’s consideration of mandatory rotation had given it an idea of other measures that could be taken short of mandatory rotation. Mr. Doty also indicated that the PCAOB was watching the EU’s consideration of rotation proposals. Commissioner Daniel Gallagher observed that the PCAOB should not allow the issue to drag on indefinitely. Mr. Doty also said that if the pending dispute between US and Chinese regulators is not resolved, enforcement actions against Chinese accounting firms for non-cooperation with document requests would become “an increasing priority.”
SEC Commissioner Gallagher Addresses Federal Role in Corporate Governance
February 6, 2013 4:36 PM
In a January 29 speech to the Corporate Directors Forum, SEC Commissioner Daniel Gallagher called for limiting the federal government’s role in regulating corporate governance. He observed that, “[d]espite the original intent of the drafters of the [Securities Exchange Act of 1934] to leave corporate governance in the hands of the states, Congress and federal regulators have been increasingly engaged in corporate governance matters, albeit via indirect routes.” Among other things, he points to Section 404 of the Sarbanes-Oxley Act, the executive compensation and specialized disclosure provisions of the Dodd-Frank Act, and the SEC’s proxy access rules (ultimately struck down) as areas of unwarranted federal intervention. In Commissioner Gallagher’s view, “states are inherently better suited to address varied and complex corporate governance issues.”
The PCAOB’s 2013 Agenda
February 6, 2013 4:00 PM
In a recent speech in New Orleans, Board Member Jeannette Franzel highlighted several of the Public Company Accounting Oversight Board’s recent initiatives and plans for 2013. These include:
- Strategic Plan. The board has adopted a new long-term strategic plan. Among the objectives of the plan are 1) identifying audit quality measures, 2) enhancing the PCAOB’s processes and systems for analyzing inspection findings, 3) improving the timeliness, content and readability of inspection reports; 4) improving the timeless of remediation determinations and providing additional information on the remediation process; 5) enhancing the standard-setting process; and 6) enhancing outreach to audit committees.
- Audit Quality Measures. One of the priorities in the strategic plan is developing “a generally understood and measurable concept of audit quality.” Ms. Franzel noted that “divergence in views on audit quality has contributed to the ‘expectations gap’ over what an audit should be.” The PCAOB has begun a project to identify audit quality measures in the areas of audit process and results and to develop methods of objectively measuring those audit quality indicators. Ms. Franzel suggested such information will, among other things, enable investors and audit committees to “demand better audit quality, and shift audit firm competition over price to competition over quality.”
- Professional Skepticism. In December 2012, the PCAOB staff issued a practice alert focusing on the auditor’s responsibility to exercise professional skepticism in audits. Ms. Franzel stated that PCAOB inspections have identified numerous audits where the Board found that the auditors did not consistently and diligently apply professional skepticism. The practice alert includes examples of lack of professional skepticism, identifies potential impediments to the application of professional skepticism and discusses how firms can promote professional skepticism.
- Inspections. With respect to inspections and remediation determinations, Ms. Franzel acknowledged that timeliness of inspection reports has been a challenge. She indicated that the Board is making progress in clearing its backlog and is seeking to improve its the timeliness of inspection reports. The Board also intends to review the content and readability of the inspection reports.
- Standard-setting. The PCAOB expects to devote significant time and resources to preparing analyses to assist the SEC in making determinations under the JOBS Act regarding applicability of new auditing standards to emerging growth companies. The Board is also “continuing to explore ways to further incorporate economic analysis into our rulemaking process.” The PCAOB also has initiated a project to reorganize PCAOB auditing standards and to integrate AICPA auditing standards (which have served as “interim” auditing standards since 2003) with auditing standards issued by the PCAOB.
PCAOB Criticizes Internal Control Audits
February 6, 2013 3:30 PM
In December 2012, the Public Company Accounting Oversight Board issued a Report containing observations from its 2010 inspections of major U.S. accounting firms about deficiencies in audits of internal control over financial reporting. Among other findings, the PCAOB staff found that in 15 percent of audit engagements that were inspected, the audit firm had failed to obtain sufficient audit evidence to support its opinion on the effectiveness of the audit client’s internal control over financial reporting, and that in most of these cases the staff identified deficiencies in the financial statement audits as well. The PCAOB indicated that this percentage had increased in its 2011 inspections.
The PCAOB suggested that audit committees “may find this report useful in fulfilling their responsibilities with respect to independent auditors.” It identified certain matters that committees could discuss with auditors. These include how the controls to be tested address risks of material misstatement for relevant assertions of significant accounts and disclosures, and the auditor’s assessment of risks, evaluation of control deficiencies and whether the auditor has adjusted control testing and substantives audit procedures in response to identified control deficiencies.
SEC Staff Developing “Accounting Quality Model”
January 21, 2013 2:36 PM
In a recent speech, Craig M. Lewis, the Chief Economist of the Securities and Exchange Commission and director of its Division of Risk, Strategy and Financial Innovation, described an initiative to develop an “Accounting Quality Model.” According to Mr. Lewis, the model will seek “to provide a set of quantitative analytics that could be used across the SEC to assess the degree to which registrants’ financial statements appear anomalous.” The model will be designed to identify possible instances of “earnings management,” though Mr. Lewis is quick to say that earnings management (as he defines it) is not necessarily indicative of fraud but may reflect permissible applications of GAAP. Without delving too much into the technicalities, the model will identify “total accruals” (difference between cash flow and income before extraordinary items), and then seek to determine, based on a large set of factors, which of those accruals are discretionary and which are non-discretionary. If the discretionary accruals are out of line compared to peer companies, then the company may be flagged for further analysis. Mr. Lewis indicates that the model’s analytics can be used for various purposes, including informing the Division of Corporation Finance’s filing review process, use by the Enforcement Division to focus its investigative process, and evaluating claims by tipsters. For most companies, this new model is unlikely to have much impact. But the fact that the Commission staff is developing this model illustrates the SEC’s continuing efforts to enhance its ability to carry out its regulatory objectives by “integrat[ing] rigorous data analytics into the core mission of the SEC.”
Meredith Cross To Rejoin WilmerHale
January 16, 2013 5:00 PM
WilmerHale is pleased that Meredith Cross, former Director of the Division of Corporation Finance at the Securities Exchange Commission, will rejoin the firm. As Director, Meredith was responsible for overseeing the SEC’s review process for securities offerings and issuer’s periodic SEC filings, as well as for major rulemakings under the Dodd-Frank and JOBS Acts and other important regulatory matters. We look forward to her bringing to clients her experience and deep understanding of the regulatory and legal intricacies that public companies face today. (WilmerHale’s announcement can be found here.)
Impact of New Derivatives Regulations on Nonfinancial Companies
January 9, 2013 11:05 AM
Companies that use derivatives should note that the Dodd-Frank Act’s sweeping new derivatives provisions are beginning to be implemented. Many of the Dodd-Frank Act’s requirements apply to nonfinancial public and private companies that use derivatives. Some companies may be able to rely on an “end user” exception from some of the regulations’ requirements, especially the requirements that derivative transactions be cleared through a registered derivatives clearing organization and traded on a regulated exchange or exchange-equivalent. Importantly, a public company that wishes to rely on this exception will need approval by its board of directors or a committee to which the decision is specifically delegated. For more information, see WilmerHale’s new guide, The New Swaps Regime: A Primer for Nonfinancial Companies. WilmerHale will also present a webinar on this subject on January 22, which will address in greater detail the Dodd-Frank Act’s implications for nonfinancial corporations that use derivatives. Register for the webinar.
SEC Names New Chief Accountant
December 26, 2012 10:05 AM
The Securities and Exchange Commission has named Paul Beswick as its Chief Accountant. Mr. Beswick has been Acting Chief Accountant since July. The SEC's Office of the Chief Accountant is responsible for establishing and enforcing accounting and auditing policy, and for overseeing the professional performance of public company auditors generally. Among other things, the Office has taken the lead in studying the adoption of International Financial Reporting Standards in the US and is responsible for oversight of the Public Company Accounting Oversight Board.
US/China Regulatory Dispute Intensifies
December 26, 2012 10:00 AM
Companies with operations in China, and their audit committees, should keep an eye on the dispute between securities and accounting regulators in the United States and China. Recently, the Securities and Exchange Commission sued five Chinese accounting firms (all associated with global accounting networks) for failing to produce documents related to SEC investigations of Chinese companies listed in the US. Meanwhile, members of the Public Company Accounting Oversight Board have expressed frustration about the PCAOB’s inability to inspect Chinese registered public accounting firms that audit Chinese companies listed in the US. Both the SEC’s and the PCAOB’s efforts have been impeded by their inability to reach satisfactory cooperation agreements with the China Securities Regulatory Commission. China, for its part, has objected to disclosure of documents to US regulators and inspection of China-based accounting firms on sovereignty and state secrecy grounds.
The SEC’s lawsuit seeks sanctions against the firms under its Rule 102(e), which can include barring the firms from auditing financial statements of US issuers. Members of the PCAOB have also implied that the PCAOB may take regulatory action against Chinese firms if the Board is unable to inspect those firm as required by the Sarbanes-Oxley Act; this could include deregistering the firms or other restrictions on their activities. Any sanction by the SEC or the PCAOB can only be imposed after an adjudicatory proceeding, and the agencies have substantial discretion in deciding what sanctions to impose. It is important to bear in mind, however, that such sanctions could do more than just prevent Chinese accounting firms from issuing audit reports on Chinese companies listed in the United States and cause the delisting of such companies in the US. The sanctions could, depending on their nature and scope, also create problems for auditors of US companies who must rely on Chinese accounting firms to audit, or perform audit procedures relating to, financial statements of the Chinese operations of the US companies.
SEC Approves PCAOB Standard for Auditor Communications
December 18, 2012 11:00 AM
On December 17, the Securities and Exchange Commission approved the Public Company Accounting Oversight Board’s Auditing Standard 16—Communications with Audit Committees. The new standard will apply to audits for fiscal years beginning on or after December 15, 2012. Note that AS 16 has also been incorporated into the PCAOB’s standard for reviews of interim financial statements (SAS No. 100 or AU 722). Therefore, some aspects of the standard will come into play in the first quarter of 2013 for issuers with calendar fiscal years. In addition, the SEC expressly determined under the requirements of the JOBS Act that application of AS 16 to emerging growth companies is “necessary or appropriate in the public interest, after considering the protection of investors and whether the action will promote efficiency, competition, and capital formation.” (For more information on AS 16, see our newsletter, PCAOB Focuses on Audit Committee Interactions with Auditors.)
News from the AICPA’s Annual Conference
December 10, 2012 9:12 AM
The American Institute of Certified Public Accountants’ annual conference on Current SEC and PCAOB Developments is always a source of news about accounting and financial reporting matters. Among the noteworthy items at this year’s conference, held on December 3-5 in Washington:
- PCAOB Inspections and Audit Committee Outreach: James Doty, Chairman of the Public Company Accounting Oversight Board, highlighted the PCAOB’s new five-year strategic plan (more on that in a subsequent post), in particular its objective to provide more timely audit firm inspection reports. He also indicated that the PCAOB anticipated issuing summary reports on insights from inspections, and other topics, prepared “with an eye on, among other things, getting useful information to audit committees.” Mr. Doty also observed that “[a]udit committees have a role in fostering not just integrity in management’s reporting, but the vitality and viability of the independent audit” and stated an audit “is not something to be procured from the lowest cost supplier.” (Mr. Doty’s keynote address can be found here.)
- IFRS: Paul Beswick, Acting Chief Accountant of the Securities and Exchange Commission, had little to report on SEC consideration of International Financial Reporting Standards. He noted that the staff “will work with our new Chairman [Elisse Walter] and our existing Commissioners on determining the next steps in this process. So please stay tuned.” (Mr. Beswick’s remarks can be found here.)
- Disclosure Framework: Mr. Beswick announced that the SEC staff intends to hold a roundtable next year to consider issues relating to the appropriate “dividing line” between what information should appear in the financial statements versus the “broader financial reporting package,” such as MD&A.
- Auditor Independence: Mr. Beswick noted that some accounting firms are actively growing non-audit consulting practices. He questioned “whether accountants’ expanding practices into areas unrelated to their primary competencies weakens public trust.” He also expressed concern that such expansion has the potential to “distract a firm’s leadership and other personnel from providing appropriate attention to their audit practice” and suggested that it “runs the risk of damaging the accountant’s reputation.” PCAOB Chair Doty also alluded in his remarks to the fact that large audit firms’ revenues from consulting are growing rapidly while audit fees have stagnated and suggested that “[t]his threatens to weaken the strength of the audit practice in the firm overall.”
- Mandatory Firm Rotation: PCAOB Member Jay Hanson was quoted in press reports to the effect that many obstacles to implementation of mandatory rotation make him believe it is unlikely the PCAOB will go forward. PCAOB Chair Doty reiterated his oft-stated view that it was “important to reexamine how we protect the auditor’s independence, including by considering term limits.”
- Internal Control Over Financial Reporting (ICFR): Both Mr. Beswick and Brian Croteau, Deputy Chief Accountant, noted that even though some smaller issuers and emerging growth companies have been exempted from the ICFR audit requirement of Section 404(b) of the Sarbanes-Oxley Act, management’s responsibilities for evaluating and reporting on ICFR are not in any way changed. Mr. Croteau also noted that the Committee of Sponsoring Organizations (COSO) has a project to update its 1992 internal control framework, which is the framework applied by virtually all public companies in designed their ICFR systems. (Mr. Croteau’s remarks can be found here.)
- PCAOB Standard-Setting: PCAOB Chief Auditor Martin Bauman noted the Financial Accounting Standards Board’s project to require periodic management evaluations of the company’s ability to continue as a going concern. He indicated that the PCAOB intends to propose a revised standard for the auditor’s consideration of going concern shortly after the FASB issues its exposure draft on going concern in 2013. Mr. Bauman also confirmed that the PCAOB intends to issue a proposal for changes in the auditor’s report during the first half of 2013. (Mr. Bauman’s remarks can be found here.)
Auditing Standard 16 Developments
December 3, 2012 9:13 AM
The Public Company Accounting Oversight Board’s new Auditing Standard 16—Communications with Audit Committees—remains pending before the Securities and Exchange Commission. Only a handful of comments on the standard have been filed. The comment letter filed by the United States Chamber of Commerce objected to AS 16 on the principal ground that the PCAOB did not conduct an adequate cost-benefit analysis to support applying AS 16 to emerging growth companies, as defined in the Jumpstart Our Business Startups (JOBS) Act. The JOBS Act exempts emerging growth companies from new PCAOB auditing standards, unless the SEC affirmatively finds that applying the standard to audits of such companies “is necessary or appropriate in the public interest, after considering the protection of investors and whether the action will promote efficiency, competition, and capital formation.” Interestingly, the PCAOB filed a written response disagreeing with some of the Chamber’s comments. The deadline for SEC action on the standard is December 17.
Meanwhile, audit committees, companies and their advisers should focus on the new standard’s requirement that the auditor inquire of the audit committee “whether it is aware of matters relevant to the audit, including but not limited to violations or possible violations of laws and regulations.” Auditors already have responsibilities to implement audit procedures to consider the effect of possible legal violations by the audit client. Section 10A of the Securities Exchange Act imposes obligations on public company auditors with respect to the detection, investigation and reporting of illegal acts. Current Auditing Standard 12 requires auditors to make inquiries of audit committees regarding matters related to fraud, alleged fraud or suspected fraud affecting the company, as well as tips or complaints about the company’s financial reporting (including through the whistleblower hotline) and the audit committee’s responses to such tips and complaints. Similarly, management is required to provide information in response to inquiries from the auditors about compliance with laws and regulations and to make certain representations regarding legal compliance in its management representation letter. AS 16 adds another formal step to this process. Audit committees will need to respond forthrightly to the auditor’s inquiries but at the same time should be carefully advised about how to respond. Among other things, committee members will need to ensure that they present information in a way that does not risk encroaching on attorney-client or attorney work-product privileges.
FASB Standard-Setting Activity
November 30, 2012 12:30 PM
Randy McClanahan of Johnson Barton Proctor & Rose LLP in Birmingham, Alabama, regularly provides the ABA Business Law Section Law and Accounting Committee with invaluable summaries of the status of major accounting standards under consideration by the Financial Accounting Standards Board. These summaries are a great way for non-accountants to follow standard-setting developments. Read Randy’s November 2012 summary.
DOJ and SEC Issue FCPA Guidance
November 20, 2012 3:30 PM
On November 14, the Department of Justice and the Securities and Exchange Commission jointly issued guidance on the Foreign Corrupt Practices Act. As discussed in this WilmerHale Client Alert, the guidance provides detailed information on the agencies’ joint FCPA approach and priorities. This guidance is important for audit committees for several reasons. Many committees have oversight responsibilities with respect to legal and regulatory compliance, which can encompass anti-corruption laws. And the FCPA’s requirements for public companies to maintain accurate books and records and effective internal accounting controls—which are separate from the FCPA’s anti-bribery provisions—relate directly to the company’s financial reporting. In fact, the guidance explains that internal controls over financial reporting includes “various components” such as “the tone set by the organization regarding integrity and ethics,” “risk assessments,” “policies and procedures designed to ensure that management directives are carried out,” “information and communication” and “monitoring.” The DOJ and SEC provide detailed information in the guidance on the elements of an adequate FCPA compliance program. Audit Committees and/or Boards should review their companies’ compliance programs with management in light of the guidance. The guidance also provides suggestions with respect to appropriate FCPA due diligence in M&A transactions.
-- Tom White with Kimberly Parker
FASB Moving Forward on Going Concern Standard
November 14, 2012 4:47 PM
The Financial Accounting Standards Board (FASB) has decided to proceed towards developing a new financial reporting standard for management’s assessment of going concern. Historically, US auditing standards have required an auditor to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern for at least one year. However, accounting standards have not included a requirement for management to assess a company’s ability to continue as a going concern. FASB has been considering whether to adopt such rules for several years.
As described in FASB’s Action Alert summarizing its November 7 meeting, under the new model:
- Management would assess at each reporting period (including interim periods) an entity’s potential inability to continue as a going concern and the need for related disclosures. Management would consider the likelihood of an entity’s potential inability to meet its obligations as they become due for a reasonable period of time.
- Management would be required to provide financial statement disclosures when management concludes that it is more likely than not that the entity will not be able to meet its obligations in the ordinary course of business for a reasonable period of time. In assessing the need for disclosure, management would be able to consider the effect of mitigation plans, unless they involve actions outside of the ordinary course of business.
- If management concludes it is probable that the entity will not be able to meet its obligations in the ordinary course for a reasonable period of time, it must state that there is substantial doubt about the entity’s ability to continue as a going concern. In making this determination, management may consider the effect of all management plans.
- For these purposes, a reasonable period of time would be 12 months from the end of the reporting period. In addition, management’s assessment would consider the effect of existing events or conditions that are probable of resulting in an entity’s inability to meet its obligations beyond the initial 12 months, but not to exceed a total period of 24 months.
- FASB does not specify any bright-line percentages for defining more likely than not and probable.
FASB intends to hold additional discussions on the going concern project in December 2012 and issue an exposure draft implementing the standard by March 2013.
CAQ Issues Guide on PCAOB Inspections
November 12, 2012 11:38 AM
The Center for Audit Quality, which represents accounting firms that audit public companies, has issued a Guide to PCAOB Inspections (October 2012) that describes the Public Company Accounting Oversight Board’s process for inspecting firms that audit public companies and for reporting on the results of the inspections. The Guide covers some of the same territory as the PCAOB’s recent release on Information for Audit Committees on the PCAOB Inspection Process. The Guide states that the PCAOB’s reviews have “a significant influence on audit quality” and concludes that “[I]nvestors can take comfort from the fact that audit firms are subject to rigorous and regular PCAOB inspections.”
Court Considers Sarbanes-Oxley Act Privilege for PCAOB Inspections
November 1, 2012 3:15 PM
A recent case from the Western District of Missouri highlights the significant privilege issues that surround the Public Company Accounting Oversight Board’s inspection and disciplinary processes. In Bennett v. Sprint Nextel Corp., the court held that documents and information prepared by KPMG for a PCAOB inspection were privileged under Section 105(b)(5)(A) of the Sarbanes-Oxley Act and therefore not subject to production in civil litigation. The documents in question included direct communications between the PCAOB inspectors and KPMG about KPMG's audit of Sprint, the PCAOB's comment about inspection issues and KPMG's draft and final responses, documents that would have revealed specific questions or inquiries from the PCAOB, documents prepared internally by KPMG to gather information about the audit for purpose of the inspection and a presentation which was used by KPMG at the kick-off meeting with the inspectors and later provided to a handful of Sprint employees. The court concluded that all of these documents were privileged under the Sarbanes-Oxley Act because they were prepared "specifically for" the PCAOB within the meaning of Section 105(b)(5)(A), since, absent the inspection, they would not have existed.
The court also held that KPMG had not waived the Sarbanes-Oxley privilege. While the Sarbanes-Oxley Act and PCAOB rules do not provide that disclosure to third parties waives the PCAOB privilege, the court looked to waiver principles under the attorney-client privilege and work product doctrine. The court cited emails and board minutes as showing that KPMG had informed Sprint that the inspection had taken place, but the evidence did not show that the details or substance of the investigation was divulged. And even though the kick-off presentation was divulged to Sprint employees, this "limited communication [was] inadequate to cause a wholesale waiver."
The Bennett case illustrates why accounting firms are often reluctant to disclose the PCAOB’s non-public findings regarding their quality control systems. Under the Sarbanes-Oxley Act, these findings are not made public by the PCAOB if the firm remediates the quality control issues to the satisfaction of the PCAOB within 12 months. While firms are not barred from disclosing the PCAOB’s non-public findings to their audit client, doing so runs the risk that plaintiffs in civil litigation will assert that such disclosure waived the privilege applicable to the non-public inspection reports and other internal and external communications about the PCAOB’s inspections.
Contributed by Jaclyn Moyer
IFRS Foundation Issues Analysis of SEC Staff Report on IFRS
October 29, 2012 2:15 PM
On October 22, 2012, the Trustees of the IFRS Foundation, the governing body of the International Accounting Standards Board, issued a Staff Analysis addressing the Final Staff Report issued in July 2012 by the SEC’s Office of Chief Accountant regarding the SEC staff’s Work Plan to study incorporation of International Financial Reporting Standards into the US financial reporting system. The IFRS Foundation’s analysis responds to various concerns raised in the SEC staff report, including the role of the IASB as global accounting standard-setter, issues related to IFRS as global accounting standards, means of transitioning to IFRS, and other challenges in the transition to IFRS.
Notably, the IFRS Foundation’s analysis questions the viability of incorporating IFRS into US GAAP on a standard-by-standard basis (the so-called “condorsement” method). The analysis concludes: “While the size of the US economy relative to other jurisdictions presents significant challenges that are unique to the US, the experience of other countries suggests that many of the challenges can be overcome with the appropriate political will to make a commitment to the mission of a single set of global standards.”
PCAOB Holds Third Public Meeting on Mandatory Audit Firm Rotation
October 23, 2012 3:10 PM
On October 18, 2012, the Public Company Accounting Oversight Board held its third public meeting on mandatory audit firm rotation in Houston. Back in August 2011, the PCAOB, concerned about what it saw as continuing instances of lack of independence, objectivity and professional skepticism by auditors, issued a Concept Release regarding possible fundamental changes in the audit process such as mandatory periodic rotation of audit firms. The Board held previous hearings on the subject in Washington in March and San Francisco in June.
The Board heard from academics, public company financial and accounting officers, audit committee members, institutional investors, and representatives of the accounting profession and accounting firms. The Board also heard from a representative of the European Commission, who described the EC’s proposal to require mandatory rotation for auditors of certain public companies. (The participants’ written statements can be found here.)
As at prior meetings, the public company executives and audit committee members (including the CEO of the National Association of Corporate Directors) did not favor mandatory rotation. They also expressed skepticism about alternatives such as “mandatory retendering,” where an issuer would be required to put the audit out to bid periodically, but could decide to retain the incumbent. Much of the discussion focused on the role of the audit committee and whether audit committee oversight can be strengthened to help address the concerns identified by the PCAOB. Many participants expressed support for some degree of enhanced disclosure by audit committees about their decisions to select and retain auditors.
At the conclusion of the meeting, PCAOB Chairman James Doty appeared to indicated that the Board will continue to consider the subject. Notably, referring to the over 600 comment letters opposing MFR, he said that “numerosity should not determine this issue.”
New Guide for Audit Committee Annual Evaluation of the External Auditor
October 23, 2012 3:08 PM
A group of seven leading governance and professional organizations has issued an important Guide for Audit Committee Annual Evaluation of the External Auditor (October 2012). Audit committees’ prescribed functions have always encompassed evaluating the performance of the audit in connection with a decision to retain the auditor for a succeeding period. This guide provides a framework and specific recommendations for a process to be followed by the audit committee in conducting an annual assessment of an issuer’s external audit firm and the firm’s personnel. The guide highlights important areas for the assessment to cover, and suggests specific questions for the audit committee to ask in each area. The areas covered include:
- Quality of the services and sufficiency of resources provided by the auditor
- Communication and interaction with the auditor
- Auditor independence, objectivity and professional skepticism
The guide indicates that it is appropriate to obtain observations about the audit from management, internal audit and others within the company. It provides a sample survey for obtaining this input.
Finally, the guide suggests that “audit committees should consider advising shareholders that they perform an annual evaluation of the auditor and explain their process and scope of the assessment.” Such disclosures are not currently required by SEC rules.
CAQ Issues Practice Aid on Communications About PCAOB Inspections
October 23, 2012 3:06 PM
On October 10, the Center for Audit Quality, a professional organization composed of public company auditing firms, issued a practice aid to assist accounting firms in discussing the Public Company Accounting Oversight Board’s inspection process with audit committees. In August the PCAOB issued a release designed to provide information to audit committees about its inspection process for registered public accounting firms and to suggest inquiries committees might make to their auditors about inspections. The CAQ practice aid addresses the process from the audit profession’s perspective. Its recommendations are consistent with and reinforce the PCAOB’s guidance.
The practice aid encourages an audit firm to provide timely information to the audit committee if the company’s audit was selected for inspection. The practice aid also encourages the firm to provide information on changes in quality control systems as a result of the PCAOB inspection process. The guidance covers communications about:
- Whether the issuer’s audit was selected for inspection and, if so, the status of the inspection and any adverse findings by the PCAOB about the audit, the issuer’s financial statements or internal control over financial reporting, or the auditor’s independence
- Information about the firm’s response to the PCAOB’s findings about the audit of the issuer, including whether or not the firm performed additional audit procedures
- Information described in the PCOAB inspection report that, while not involving the issuer’s audit, involves issues and audit approaches similar to those that arose in the audit of the issuer’s financial statements
- What steps the firm is taking to address issues identified—in PCAOB reports or other quality inputs—with respect to its system of quality control
- Whether issues described in PCAOB reports describing inspection results generally related to the issuer’s audit and how the firm is addressing those issues.
SEC Commissioner Walter Comments on IFRS
October 23, 2012 3:01 PM
In an October 2 speech to the ABA International Law Section, SEC Commissioner Elise Walter discussed the prospects for incorporation of International Financial Reporting Standards in the U.S. Addressing international coordination of securities regulation, Commissioner Walter cited IFRS as an example of circumstances where the SEC’s efforts “might take longer than perhaps our foreign colleagues would hope.” She said, “While I continue to believe that converged standards are important to serving the interests of investors in the increasingly global capital markets, we cannot incorporate IFRS unless and until we are confident that it will serve U.S. investors well. For IFRS, I continue to think that we will get there eventually, but the timeframe is uncertain.”
Auditing Aspects of Conflict Minerals Rule
September 13, 2012 10:35 AM
On August 22, the Securities and Exchange Commission adopted its long-awaited rule on Conflict Minerals Disclosure. The rule was mandated by the Dodd-Frank Act to respond to human rights violations by armed groups in the Democratic Republic of Congo (DRC), who are financing their activities through trade in certain “conflict minerals” originating in that country. It requires new public disclosures with the Securities and Exchange Commission by companies for which conflict minerals are necessary to the functionality or production of products they manufacture or contract to manufacture. Such companies must conduct a reasonable inquiry to determine the minerals’ country of origin. If, based on that inquiry, the company knows or have reason to believe the minerals originated in the DRC or an adjacent country, the company must perform due diligence to determine whether or not the minerals finance or benefit the activities of armed groups identified as perpetrators of human rights abuses. The required due diligence measures include an independent private sector audit of the conflict minerals report, performed in accordance with U.S. government auditing standards. The auditor must meet the qualification and independence standards prescribed in government standards.
A conflicts mineral audit differs from, and will not be part of, a company’s financial statement audit. The SEC does confirm in its release that a reporting company can retain the same firm that audits its financial statements to perform the conflict minerals audit, without violating the SEC’s auditor independence rules. However, the audit of the conflict minerals report would be considered a “non-audit service” subject to the SEC’s audit committee pre-approval requirements. In addition, the fees related to the audit would need to be included in the “All Other Fees” category of the reporting company’s principal accountant fee disclosures in its proxy statement.
PCAOB Adopts New Auditing Standard on Audit Committee Communications
August 15, 2012 11:46 AM
On August 15, the Public Company Accounting Oversight Board adopted a new Auditing Standard No. 16 that prescribes the communications that an auditor must make to the audit committee of its client. The new standard seeks to enhance the “relevance, timeliness and quality” of the information conveyed by the auditor to the audit committee, particularly with respect to the auditor’s assessment of significant risk of financial statement misstatement and other matters that could affect the integrity of the financial statements, and to promote constructive dialogue, as opposed to “check the box” communications, between the auditors and the committee. While the Board emphasized that it has no authority over audit committees as such, it expressed the view that its new standard should assist the committee in fulfilling its oversight responsibilities.
Auditing Standard 16 is the first PCAOB standard adopted since passage of the JOBS Act. The JOBS Act provides that new auditing standards may be applied to audits of emerging growth companies only if the SEC specifically determines that the application of the standard “is necessary or appropriate in the public interest, after considering the protection of investors, and whether the action will promote efficiency, competition and capital formation.” The PCAOB’s standard by its terms will apply to emerging growth companies, and the PCAOB will ask the SEC to approve that.
In many respects, Auditing Standard 16 codifies communications practices already followed by many auditors and audit committees. Subject to SEC approval, it will be effective for audits for periods beginning after December 15, 2012.
Meredith Cross Comments on Contingency Disclosures
August 3, 2012 11:45 AM
At the ABA Business Law Section annual meeting on August 3, Director of the SEC Division of Corporation Finance Meredith Cross provided her perspective on loss contingency disclosures in light of the FASB’s recent decision to drop its disclosure project. Cross indicated that the FASB action probably will not change Corp Fin’s approach to the subject in comment letters. She said that Corp Fin was generally satisfied with the improvement in disclosures on loss contingencies but emphasized that companies needed to continue to pay attention to the issue. She said she did not expect that contingency comments will be included in every comment letter, though (consistent with a theme she articulated in other remarks) whether to include such comments will be a matter of “professional judgment” for the staff reviewer. The staff will continue to look closely at situations where a company announces a big settlement without having foreshadowed it at all in previous disclosures. She also said that the staff is sensitive to the need not to impair a company’s litigation posture and has been willing to allow aggregation of disclosures as one means of addressing the problem.
ABA Panelists Comment on JOBS Act Accounting Provisions
August 3, 2012 11:44 AM
On August 3, a panel on the JOBS Act at the annual meeting of the ABA Business Law Section in Chicago discussed the Act’s accounting standard deferral provision for emerging growth companies. That provision allows EGCs to take advantage of delayed effective dates for private companies of the applicability of new accounting standards. Panelists observed that to date few EGCs appear to have opted in to this provision. That is not totally surprising since as of now there are no new accounting standards with deferred effective dates and therefore no benefit to an EGC. The panelists noted, among other things, that not adopting new standards may create issues for EGCs such as lack of comparability to other companies, questions from investors as to what their financial statements would look like if “full public-company GAAP” were applied, and unfavorable disclosures about the effect of the deferral. These considerations may outweigh the temporary benefits of avoiding application of a new standard for a relatively short period, often just one fiscal year.
Apropos of this, Director of the SEC Division of Corporation Finance Meredith Cross indicated that EGCs who elect the accounting standard deferral should not expect transition relief for when they lose EGC status. A company that exceeds $1 billion in revenues in a fiscal year, it will have to report using public-company GAAP for that fiscal year. An EGC will have to carefully monitor its revenue projections and plan for converting to full-public company GAAP reporting if it appears that it will top the revenue threshold. This possibility also likely will impede use of the accounting standard deferral.
PCAOB Releases Information For Audit Committees on Its Inspection Process
August 1, 2012 9:05 AM
On Wednesday, August 1, the Public Company Accounting Oversight Board issued a release on “Information for Audit Committees About the PCAOB Inspection Process.” The release explains how the PCAOB conducts its inspections of auditors and what the reported results of an inspection signify. The PCAOB also provides suggestions to audit committees about matters that an audit committee should address with a company’s auditor. These include:
- whether the audit overseen by the audit committee was selected by the PCAOB for an inspection and whether any findings were made;
- potentially relevant inspection findings on other audits performed by the firm;
- the firm's response to PCAOB findings; and,
- the firm's remedial efforts in light of any quality control deficiencies that may have been identified by the PCAOB.
The PCAOB release is likely to be viewed as outlining best practices for audit committees in this area. Audit committees should review the release carefully and include these matters on their agendas for communications with auditors.
SEC Staff Issues IFRS Report
July 16, 2012 4:35 PM
Late on Friday, July 13, the Staff of the SEC’s Office of Chief Accountant issued its final report on its Work Plan to study incorporation of International Financial Reporting Standards into the U.S. financial reporting system. The Staff’s report brought to a close the latest phase of the SEC’s long running exploration of possible adoption of IFRS in the US. That phase began in February 2010, when the Commission reaffirmed its support for the goal of convergence of US generally accepted accounting principles and IFRS, and released a Staff Work Plan that laid out areas of inquiry for the SEC’s consideration of the issue. At that time, the SEC indicated it aimed to make a decision on adoption of IFRS by 2011 (a target it obviously did not meet).
The report concluded that adoption of IFRS as the US system of accounting standards was not favored by the vast majority of participants in the US capital markets. The Staff did find support for exploring other methods of incorporating international standards. This may include the so-called “condorsement” approach outlined by the staff in 2011. Under condorsement, US. GAAP and IFRS would remain separate systems but the Financial Accounting Standards Board would adopt international standards over time.
It remains to be seen what the Commission will do next concerning IFRS.
Not coincidentally, Friday the 13th was the last day for SEC Chief Accountant James Kroeker. Deputy Chief Accountant Paul Beswick has been appointed Acting Chief Acountant.
FASB Drops Contingency Disclosure Project
July 10, 2012 4:28 PM
On July 9, the Financial Accounting Standards Board brought to an end its longstanding project to consider expanding the disclosures to be included in financial statements about contingencies, particularly litigation contingencies. FASB initiated the project in 2007 based on concerns that companies’ disclosures were not adequately informing financial statement users about the potential impact of litigation on a company’s financial condition. FASB issued proposals to modify the standard—formerly known as “FAS 5” and now codified at Accounting Standards Codification 450-20—in 2008 and 2010—to provide significant additional disclosures about pending or threatened litigation. Both proposals engendered strong opposition from the business and legal communities due to concerns that expanded disclosures about a company’s litigation posture could prejudice the company’s position and invade the attorney-client privilege.
By a 5-2 vote, the FASB decided not to pursue the project further. The majority concluded that improving disclosures of loss contingencies was a matter of enforcing compliance with the existing disclosure standard, not adopting new standards.
Since 2010, the SEC staff has scrutinized companies’ contingency disclosures and issued numerous comment letters addressing whether companies were complying with the letter of ASC 450-20. In particular, the SEC has emphasized compliance with the existing requirement of ASC 450-20 that where a loss is “reasonably possible,” the reporting company must provide an estimate of the possible loss or range of loss, or explain why an estimate cannot be made. The staff has also stressed the need for reporting companies to reassess their disclosures each period to take into account developments in a lawsuit.
While FASB has decided to stand down, the SEC can be expected to continue its efforts to compel compliance with the standard. Auditors also can be expected to continue to focus on loss contingency disclosures.