by Cydney Posner
While the SEC and PCAOB ponder what to do with auditor and audit committee reports, an increasing number of large companies have begun to include more audit committee disclosures on a voluntary basis, according to an analysis by the EY Center for Board Matters. The study looked at proxy statements of Fortune 100 companies for the last four consecutive years.
They study found that, since 2012, Fortune 100 companies have, on a voluntary basis, significantly increased the information available about audit firm selection, retention and oversight, as reflect in the data below. Many companies are now enhancing their disclosures with the low-hanging fruit: disclosing that the audit committee is responsible for the appointment, compensation and oversight of the auditor; that selection of the outside auditor is in the best interests of the company and its shareholders; and that the audit committee considers non-audit services and fees when assessing the independence of the external auditor.
Not surprisingly, however, not many companies tackled the trickier issues: for example, there is virtually no movement with regard to disclosure of the topics discussed by audit committee with the auditors: in 2015, only 8% identified topics that the audit committee raised with the outside auditors (other than those required by regulation), the same percentage as in 2012. The few companies that did provide this disclosure indicated that the topics included risk controls and compliance, cybersecurity and other information technology matters, pension funding and other investments.
Sidebar: Notably, a 2013 proposal from the PCAOB would have required auditors to make disclosures regarding far more delicate issues — “critical audit matters.” Essentially, the concept was intended to capture the matters that “kept the auditor up at night.” These were generally defined as matters the auditor addressed during the audit that
- involved the most difficult, subjective or complex auditor judgments;
- posed the most difficulty in obtaining sufficient appropriate evidence; or
- posed the most difficulty with respect to forming an opinion on the financial statements.
(See this news brief.)
With regard to auditor retention decisions, less than half of companies (39%) disclose the rationale of the audit committee in appointing the auditor, including the factors used in assessing the auditor’s quality and qualifications. However, that percentage has more than doubled since 2012, when only 17% of the companies studied disclosed that information. Among companies that did include this disclosure, these assessments were based “on criteria such as the independence and integrity of the external auditor and its controls and procedures; performance and qualifications, including expertise on the company and global reach relative to the company’s business; quality and effectiveness of the external auditor’s personnel and communications; appropriateness of fees; length of tenure and benefits of a longer tenure; and Public Company Accounting Oversight Board reports on firm and peers.” While none of the companies studied disclosed in 2012 that the audit committee was involved in lead partner selection, in 2015, 61% disclosed that information. The incidence of disclosure of the length of outside auditor tenure has also jumped: in 2012, only 25% of companies included that disclosure, while in 2015, 59% disclosed audit firm tenure. Of course, disclosure of auditor tenure is another aspect of the 2013 PCAOB proposal. Moreover, the SEC’s recent concept release (see this PubCo post ) floats a number of possible disclosure mandates, in addition to auditor tenure, including the factors used by the audit committee in assessing independence and quality of the outside auditor, the audit committee’s rationale for auditor selection and the nature of the audit committee’s involvement in evaluating and approving the auditor’s compensation.
Some of the other changes in disclosure in 2015 as identified by EY are set forth below:
- 71% of companies specified that the audit committee is responsible for the appointment, compensation and oversight of the auditor, compared to 41% in 2012.
- 9% of companies explained the reason for year-over-year changes in fees paid to the external auditor, doubling the percentage of companies that did so in 2012.
- 58% of companies explicitly stated their belief that their selection of the external auditor was in the best interests of the company and/or shareholders, up from 3% in 2012.
- 41% of companies disclosed that the audit committee considered the potential impact of rotating their external auditor, up from 3% in 2012.
- 80% of companies noted that they consider non-audit services and fees when assessing the independence of the external auditor, compared to 11% in 2012.
- 21% of companies disclosed that the audit committee was responsible for the auditor’s fee negotiations. In 2012, none of the companies provided this disclosure.
EY also observed that, beginning in 2015, some companies began to discuss the benefits of longer audit firm tenure while providing a description of measures to protect auditor independence.
Why is this going on now? EY suggests that, in addition to the various proposals and concept releases from the PCAOB and SEC, there have been a number of developments over the past year that have encouraged additional reporting. For one, some institutional investors have publicly called for disclosure of additional information relating to the audit and the audit committee’s oversight of the auditor. One investment fund issued proxy voting guidelines citing its expectations for disclosure relating to audit committee responsibilities and processes, issues on the audit committee’s agenda and key decisions made. Similarly, a union pension fund has requested certain companies to indicate, among other things, the auditor’s tenure and the audit committee’s responsibility for auditor selection, oversight and fee negotiations, as well as periodic consideration of auditor rotation. Companies outside the Fortune 100 have also enhanced their audit committee disclosures. EY notes that, in December 2014, The Center for Audit Quality and Audit Analytics published the Audit Committee Transparency Barometer, which showed increased levels of voluntary disclosure regarding audit committee oversight of the auditor among the S&P 500 large-cap companies, S&P MidCap 400 companies and S&P SmallCap 600 companies.