by Cydney Posner
With the PCAOB likely to adopt some form of enhanced disclosure requirement for the auditor’s report (see this PubCo post and this PubCo post regarding the reproposal of disclosure of “critical audit matters”), and the SEC contemplating the addition of a number of disclosure mandates for audit committees (see this PubCo post ), there seems to be a slow march by companies to the inclusion of more supplemental audit committee disclosures on a voluntary basis — pressure from investors or an attempt to head off disclosure mandates perhaps? — according to a 2016 study by the EY Center for Board Matters. The study looked at the proxy statements of 78 of the 2016 Fortune 100 (companies that had filed proxy statements each year from 2012 to 2016).
Currently, audit committee members are required to confirm in their reports only that they have reviewed and discussed the financial statements with management, that they have received certain disclosures from the outside auditors and discussed with them independence matters as required under Auditing Standard No. 16 (now codified as AS No. 1301) and that they have recommended inclusion of the financials in the Form 10-K. The SEC’s 2015 concept release floated a number of possible additional disclosure mandates, including the factors used by the audit committee in assessing independence and quality of the outside auditor, auditor tenure, 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. Since that release, SEC Chair Mary Jo White and other SEC personnel have continued to highlight disclosure by auditors and audit committees, such as in a keynote address by White indicating that the audit committee report “serves as a place for engaging with shareholders on important subjects, and the report must continue to meet the needs of investors as their interests and expectations evolve with the marketplace (see this PubCo post).
The EY 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. Many companies are now enhancing their disclosures with low-hanging fruit: explicitly disclosing that the audit committee is responsible for the appointment, compensation and oversight of the auditor (82%); that selection of the outside auditor is in the best interests of the company and its shareholders (73%); and that the audit committee considers non-audit services and fees when assessing the independence of the external auditor (81%).
Not surprisingly, however, few companies have tackled the thornier issues (ouch!): for example, in 2016, the percentage of companies that identified the topics discussed by audit committee with the auditors actually declined to 6% compared with 8% in 2015 and 8% in 2012. The few companies that did provide this disclosure indicated that the topics included internal control, enterprise risk management, cybersecurity and other IT matters, subsidiaries and accounts, and tax and legal matters.
With regard to auditor retention decisions, 50% of the companies studied disclosed the factors used by the committee in assessing the auditor’s quality and qualifications, representing a significant increase from 42% in 2015 and only 17% in 2012. The factors disclosed included “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 PCAOB reports on firm and peers.” In addition, 53% of companies in 2016 disclosed that, when assessing whether to retain the current auditor, the audit committee considered the impact of changing auditors, up from 47% in 2015 and 3% in 2012.
The incidence of disclosure of the length of outside auditor tenure has also jumped over the long haul: in 2012, only 24% of companies included that disclosure, while in 2016, 63% disclosed audit firm tenure and 62% did so in 2015. As noted above, some companies also discussed the benefits of longer audit firm tenure.
The study also found a dramatic increase (to 73%) in the proportion of companies disclosing that the audit committee was involved in the selection of the lead audit partner, an increase from 67% in 2015 and only 1% in 2012. Only 13% of companies disclosed the year that the lead audit partner was appointed, up slightly from 12% last year and 3% in 2012.
With regard to fees paid to the auditor, 31% of companies in 2016 provided information about the reasons for changes in fees, compared to 21% in 2015 and 9% in 2012. While SEC rules require disclosure of amounts and categories of fees (and most companies do explain the types of services included within each fee category), there is no requirement to disclose the underlying reasons for changes. Among the reasons given for changes were one-time events such as mergers or acquisitions. Of companies that showed changes of +/- 5% or more in audit fees (43 companies), about 20% provided explanations for the change, most commonly where fees increased. In 2012, none of the companies stated that the audit committee was responsible for fee negotiations, but in 2016, 29% included that disclosure and 26% did so in 2015.
The study also observed that there is an emerging trend to hype (I mean, disclose) the audit committee’s key accomplishments during the past year, including “work on acquisitions, cybersecurity and other information technology matters, environmental sustainability topics, disclosure effectiveness, and updating the committee charter.”
With regard to audit committee composition, 51% of companies disclosed that they have three or more financial experts on their audit committees, up from 47% in 2015 and 36% in 2012. (Also see this post from thecorporatecounsel.net blog and this post from ComplianceWeek.)
