As year-end fast approaches, there has been no shortage of regulatory developments relevant to the upcoming financial reporting season. Several of these developments are summarized below.
- SEC Appoints New Board Members to PCAOB. On November 8, 2021, the Securities and Exchange Commission (SEC) announced that it had appointed four new board members to the Public Company Accounting Oversight Board (PCAOB), who join the current sole member and Acting Chairperson, Duane DesParte. The four new members include Erica Y. Williams, Christina Ho, Kara M. Stein, and Anthony (Tony) C. Thompson, with Ms. Williams serving as Chairperson upon her swearing in. Two of the new board members have deep connections to the SEC, with Ms. Williams having served for over a decade at the SEC in various roles, including Deputy Chief of Staff to three former SEC Chairs and Assistant Chief Litigation Counsel in the SEC’s Division of Enforcement trial unit. Ms. Stein previously served as a Commissioner of the SEC from 2013 to 2019. Additional biographical details for each of the new board members are included in the SEC’s announcement.
- PCAOB Posts First Six 2020 Inspection Reports for Annually Inspected Firms and Provides an Update and Preview on its 2020 Inspection Observations. On November 1, 2021, the PCAOB posted the first six 2020 inspection reports for annually inspected audit firms. These inspection reports follow the release of the PCAOB’s October 2021 Spotlight: Staff Update and Preview of 2020 Inspection Observations, which summarizes the PCAOB’s findings from its inspections of 153 audit firms and portions of 617 audits of fiscal years ending during 2019 and the first half of 2020.
The PCAOB staff’s high-level observations include:
- The staff continues to identify a number of recurring deficiencies year over year, but the number of findings in 2020 among annually inspected firms generally declined relative to 2019. Common deficiencies in 2020 include internal control over financial reporting (ICFR), revenue and related accounts, accounting estimates, inventory, critical audit matters and independence. Notably, deficiencies in auditing ICFR most commonly involved ICFR related to revenue and related accounts and has steadily increased since the 2018 inspection year.
- The staff also observed a number of “good practices” that it believes may be effective in enhancing audit quality. These include incremental audit steps in response to the COVID-19 pandemic, real-time monitoring of in-process audit engagements, increasing supervision of the work performed by specialists, use of practice aids to assist engagement teams in identifying risks, enhancements related to engagement quality reviewers and providing focused industry training and work programs.
Inspection reports for individual firms contain more granular detail about the PCAOB’s inspection findings with respect to that particular firm including the frequency and nature of observed deficiencies.
- SEC Acting Chief Accountant Highlights Auditor Independence and Issues Reminder to Gatekeepers. On October 26, 2021, SEC Acting Chief Accountant Paul Munter released a statement entitled The Importance of High Quality Independent Audits and Effective Audit Committee Oversight to High Quality Financial Reporting to Investors. The statement noted the upcoming twentieth anniversary of the Sarbanes-Oxley Act of 2002 and reminded gatekeepers (auditors, management and audit committees) to “maintain constant vigilance in the faithful implementation of the requirements of SOX by fulfilling their shared responsibilities to continue to produce high quality financial disclosures that are decision-useful to investors and maintain the public trust in our capital markets.”
Focusing on auditor independence, the statement underscored the importance of maintaining an auditor’s independence in both fact and appearance. Auditors, audit clients and audit committees were urged to pay particular attention to the nature and scope of all services provided by the independent auditor, including audit and permissible non-audit services. Particularly in light of active M&A and other transaction activity that could expand the entities considered an “audit client” or an “affiliate of the audit client” or result in new entities with significant influence over an audit client, the statement stressed the need for vigilance in monitoring non-audit services given their potential to jeopardize an auditor’s independence.
- SEC Approves PCAOB Rule 6100 for Making Determinations Under the HFCAA. On November 5, 2021, the SEC announced that it had approved the Public Company Accounting Oversight Board’s Rule 6100, Board Determinations Under the Holding Foreign Companies Accountable Act. Approval of this rule adds another component to the regulatory framework necessary to implement the Holding Foreign Companies Accountable Act (HFCAA), which provides for the delisting of companies that for three consecutive years are audited by an audit firm located in a foreign jurisdiction that the PCAOB is unable to inspect because of a position taken by an authority in that jurisdiction. Commenting on the approval of the rule, SEC Chair Gensler noted that the SEC “remain[s] on track” to finalize before the end of the year the SEC’s required rulemaking under the HFCAA, which rules were included in interim final rules promulgated earlier this year.
To finalize the HFCAA regulatory framework, the SEC’s short-term Reg Flex agenda contemplates a rule proposal by April 2022 that would (a) implement and remove trading prohibitions as required by the HFCAA and (b) “enhance listing standards of U.S. national securities exchanges to prohibit the initial and continued listing of issuers that are subject to such trading prohibitions.” Amidst this regulatory activity, the Senate passed the Accelerating Holding Foreign Companies Accountable Act in June 2021, which, if signed into law, would accelerate the delisting of foreign companies under the HFCAA after two consecutive years, instead of three consecutive years as in the HFCAA.
- SEC Reopens Comment Period for Dodd-Frank Clawback Rules. On October 14, 2021, the Securities and Exchange Commission reopened the comment period on proposed rules requiring the adoption of listing standards for the recovery of erroneously awarded compensation, as mandated under the Dodd-Frank Act. The SEC originally proposed the clawback rules in 2015 (See our July 15, 2015 client alert). Comments on all aspects of the original proposal are invited, in addition to comments on additional questions posed in the reopening release. Notably, the reopening release seeks comment on whether “an accounting restatement due to the material noncompliance of the issuer with any financial reporting requirement under the securities laws” should be read more broadly than initially proposed (e.g., whether a “little r” restatement should also trigger a clawback) and whether the proposed “reasonably should have concluded that the issuer’s previously issued financial statements contain a material error” standard for triggering a lookback should be revised. Changes in this regard could dramatically expand the scope of the rule beyond the initial proposal. The public comment period will remain open for 30 days following publication of the reopening release in the Federal Register, though commenters have already requested and extended comment period given the scope of the request for comment.