July 7, 2015
At an open meeting held on July 1, 2015, the Securities and Exchange Commission ("SEC") issued a concept release addressing the prospect of enhanced disclosures for audit committees. The much-publicized concept release is available here and requests comment on a number of possible changes to existing SEC disclosure requirements about the work of audit committees, focusing in particular on audit committees’ selection and oversight of independent auditors. The SEC said that it has issued the release in response to views expressed by some that current disclosures may not provide investors with sufficient information about what audit committees do and how they perform their duties. The release seeks feedback on whether certain audit committee disclosures should be added, removed or modified to provide additional meaningful disclosures to investors.
The concept release contains approximately 75 numbered paragraphs, each of which asks a series of questions on a broad range of matters involving the audit committee’s work. As described in greater detail below, the scope of the issues addressed in the release raises the possibility that future rule changes could significantly expand the length of audit committee reports and other proxy disclosures about audit committees, require disclosure about matters that arguably are not material to investors, and lead to increased risk of exposure for companies and their audit committee members.
We encourage audit committees and their companies to review the questions in the concept release and consider commenting so that the SEC has the benefit of audit committee insights before pursuing future rulemaking. Comments on the concept release are due 60 days following publication of the release in the Federal Register, which means the comment period likely will close in early September 2015.
Recent Trend Toward Enhanced Audit Committee Disclosure
Although the SEC’s audit committee disclosure requirements have not changed significantly since 1999, a number of large companies have voluntarily moved to enhance their audit committee-related disclosures in recent years. These supplemental disclosures have included further details on the processes audit committees use to oversee the independent auditor, such as information about selecting the auditor, reviewing the auditor’s independence, considering the tenure of the auditor, and overseeing the negotiation of the auditor’s fees. In addition, many companies have reorganized audit committee disclosures in their proxy statements, so that a package of audit committee-related disclosures – in the form of the audit committee report, the auditor fee disclosures, and the ratification discussion – appears sequentially as part of an effort to communicate more efficiently and effectively.
This evolving trend of enhanced audit committee-related disclosures has been spurred in part by requests from investor advocates and also from influential surveys and reports prepared by governance organizations. For example, in November 2013, the National Association of Corporate Directors, the Center for Audit Quality and several other prominent governance organizations issued "Enhancing the Audit Committee Report: A Call to Action" (available here). The "Call to Action" report encouraged companies to voluntarily provide additional relevant disclosures about their audit committees’ practices.
SEC Concept Release
The SEC’s concept release focuses primarily on enhanced disclosures about the audit committee’s selection and oversight of the independent auditor. Broadly, the release seeks comment on whether the current disclosure requirements are sufficient to help investors understand and evaluate audit committee roles and responsibilities. More specifically, the release sets forth three main areas for potential disclosure and requests comments on questions the SEC poses related to these areas. These three areas, which are discussed in greater detail below, focus on: (1) the audit committee’s oversight of the independent auditor, (2) the audit committee’s process for selecting the independent auditor, and (3) the audit committee’s consideration of the independent auditor’s qualifications.
1. Audit Committee’s Oversight of the Independent Auditor
Communications Between the Audit Committee and Independent Auditor
In the release, the SEC notes that standards of the Public Company Accounting Oversight Board ("PCAOB") require the auditor to communicate with the audit committee prior to the issuance of the auditor’s report about various topics, and that the audit committee report must disclose that these communications took place. The release inquires whether new SEC rules should require:
"not just whether and when all of the required communications occurred, but also the audit committee’s consideration of the matters discussed. Such communications and related disclosures could address, for instance, the nature of the audit committee’s communications with the auditor related to items such as the auditor’s overall audit strategy, timing, significant risks identified, nature and extent of specialized skill used in the audit, planned use of other independent public accounting firms or other persons, planned use of internal audit, basis for determining that the auditor can serve as principal auditor, and results of the audit, among others, and how the audit committee considered these items in in its oversight of the independent auditor."
The release then lays out 11 paragraphs with specific questions on potential disclosures in this area, including whether there should be disclosures about: (a) the "nature or substance of the required communications between the auditor and the audit committee"; (b) all required communications from the auditor or some subset of the required communications, and how the audit committee considered the nature of such communications; (c) for multi-location audits, how the audit committee considered the scope of the audit, locations visited by the auditor, and the relative amount of account balances related to such locations compared to the consolidated financial statements; and (d) the extent to which additional matters (beyond those required by PCAOB and SEC rules) were discussed with the auditor and what level of detail should be required. The release also asks about the effects of expanded disclosures on market participants, and whether expanded disclosure requirements could chill communications between the committee and independent auditor.
Meetings Between the Audit Committee and Independent Auditor
The concept release notes that the number of audit committee meetings is already required disclosure, but inquires whether additional disclosure about meetings with the independent auditor would be appropriate. For example, the release asks whether companies should have to disclose the frequency of the audit committee’s private sessions with the auditor and the topics discussed in these sessions.
Internal Quality Review and PCAOB Inspection Reports
The concept release notes that NYSE rules require audit committees to obtain a report from the independent auditor that describes the firm’s internal quality-control procedures and any material issues raised by the firm’s most recent internal quality-control review or peer review. The release asks whether companies should be required to disclose information about whether there have been discussions between the audit committee and the auditor about this report – and PCAOB inspection results – and about the nature of any such discussions. With respect to PCAOB inspections, the release asks whether there should be disclosures about how the audit committee considered the results described in PCAOB inspection reports in overseeing the independent auditor. The release also inquires whether there is a risk that these disclosures could undermine the confidentiality of nonpublic PCAOB inspection results.
Auditor’s Objectivity and Professional Skepticism
The concept release states that "[h]eightened oversight by the audit committee of the auditor’s objectivity and professional skepticism should promote greater audit quality." To that end, the release seeks comment on: (a) whether investors would find useful disclosure about "whether, and if so, how the audit committee assesses, promotes and reinforces the independent auditor’s objectivity and professional skepticism"; and (b) what types of disclosures audit committees could provide to satisfy such a disclosure requirement.
2. Audit Committee’s Process for Selecting the Independent Auditor
Noting that the audit committee’s responsibility to appoint and retain the independent auditor can involve a wide range of activities, the concept release seeks comment on a range of potential disclosures about the criteria used to assess the independent auditor and the actions the audit committee took in reaching a decision to select the auditor for the coming year.
How the Audit Committee Assessed the Auditor
The concept release seeks feedback on the types of disclosures that could be made about the audit committee’s process for evaluating the performance and qualifications of the auditor. These include the audit committee’s rationale for selecting or retaining the auditor, a description of the audit committee’s involvement in approving the auditor’s compensation, the nature and extent of non-audit services provided by the auditor and the committee’s evaluation of how such services impacted its assessment of the auditor’s independence and objectivity, and the committee’s use of any audit quality indicators in evaluating the independent auditor.
RFPs for the Independent Audit
The concept release also asks whether disclosures about any requests for proposal ("RFPs") relating to the audit would be useful to investors and the types of disclosures that companies could provide. Among other things, the release indicates disclosures could address whether the audit committee sought proposals for the independent audit (and if so, why), the committee’s process in reviewing any such proposals, and the factors the audit committee considered in selecting the independent auditor.
Board Policy Regarding Shareholder Ratification Vote
The concept release asks whether there should be additional disclosures about the shareholder vote to ratify the selection of the independent auditor. The release asks whether it would be useful for companies to provide disclosure about whether the board of directors has a policy on shareholder ratification and about the audit committee’s consideration of the voting results. The release also seeks comment on whether auditor ratification should continue to be considered a "routine matter" for which brokers may use discretionary voting if the SEC adopts additional disclosure requirements in this area.
3. Qualifications of the Independent Auditor
Noting that the audit committee’s oversight responsibility for the independent auditor positions the committee to gain an understanding of the key participants in the audit and their qualifications, the concept release seeks comment on potential disclosures about the qualifications of both the audit firm selected by the audit committee and members of the engagement team.
Members of the Engagement Team
The concept release addresses whether to require disclosure of the names of the engagement partner and other key members of the engagement team, and if so, which members. The release also asks what other information about the engagement team or other audit participants should be disclosed, such as the length of time individuals have served in their roles, any relevant experience and licensing status.
Audit Committee Input in Selecting the Engagement Partner
The concept release asks whether there should be disclosure about the audit committee’s involvement in the selection of the engagement partner, and if so, the nature and extent of that disclosure.
The concept release asks whether the audit committee report should include information about the duration of the auditor’s tenure with the company and if so, whether the disclosure should be limited to the number of years or address other matters. These matters could include whether and if so, how, the audit committee considered tenure in evaluating the auditor’s independence or deciding to retain the auditor. The release also asks whether tenure information is more appropriately addressed elsewhere, such as in the auditor’s opinion or a filing with the PCAOB.
Additional Requests for Comment
In addition to the three categories of disclosures discussed above, the concept release seeks feedback on a number of additional questions. Among other things, the SEC has asked for input on: (a) whether any enhanced disclosures, if adopted, should be voluntary or mandatory; (b) whether investors would benefit from having all audit committee-related disclosures in one place; (c) where the disclosures should be made (for example, in the audit committee report within the proxy statement, elsewhere in the proxy statement, in the annual report, or on the company’s website); and (d) whether to require updates to the disclosures to reflect developments that occur between proxy statements and if so, how often (for example, quarterly or more frequently).
The release also seeks feedback on whether disclosure requirements should vary for smaller reporting companies and emerging growth companies. Although the release does not specifically invite comment on the effect of expanded disclosures on foreign private issuers, the manner in which any potentially required disclosures may impact audit committees (or similar governing bodies) of foreign private issuers also should be considered for comment.
The SEC’s concept release notes that many companies already disclose, as a matter of sound corporate governance, some of the issues discussed in the release. For example, the concept release notes that in 2014, 13% of S&P 500 companies discussed the audit committee’s consideration of qualifications, geographic reach, and audit firm expertise when appointing the independent auditor, 83% discussed how non-audit services might impact auditor independence, and 47% voluntarily disclosed the tenure of the company’s independent auditor.
Although not reflected in these data, the trend toward enhanced audit committee disclosures has principally focused on providing supplemental detail about the processes an audit committee uses during the year to fulfill its oversight responsibilities. As reflected above, the questions presented in the release invite discussion about possible disclosures on audit committee activities that go well beyond enhanced process-oriented disclosures. In many respects, the questions posed in the release signal the prospect of a dramatically more expansive disclosure regime for audit committees – one that, if pursued, is likely to raise concerns about increased liability and the possibility that auditor-audit committee communications and interactions might become chilled or sanitized. For example, a number of the questions contemplate expanded qualitative discussion about the "nature and substance" of audit committee interactions and activities, including communications with the independent auditor.
Given the existing scope of audit committee responsibilities, a significant expansion in the disclosure requirements creates the potential for additional burdens from a governance perspective. Although the SEC is unlikely to propose rulemaking that embraces the full array of potential disclosures hinted at by the numerous questions in the release, rulemaking on even some of these issues could have significant consequences. Audit committees and management thus should review the questions in the release and consider submitting a comment letter to the SEC in order to provide beneficial perspective. This insight could help in distinguishing where a balanced line might be drawn between the current package of disclosures and a disclosure regime that could result in substantial additional disclosures without any clear corresponding benefit to investors. Balance is needed to help minimize audit committee burdens and further the goal of avoiding disclosure overload, a goal that the SEC supports.
Comments should address which specific disclosures the company and audit committee expect to be useful to investors, as well as which disclosure items would be unhelpful, either because related existing requirements are sufficient or because the contemplated disclosure theme is unnecessary. In addition to providing the company’s stance, comments should provide supporting explanations.
Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm’s Securities Regulation and Corporate Governance practice group, or the following authors in the firm’s Washington, D.C. office:
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