To fulfill their oversight responsibilities, audit committees typically evaluate the outside auditor at least annually to determine, in part, whether the auditor should be engaged for the subsequent fiscal year. The Center for Audit Quality has just published a new updated External Auditor Assessment Tool, which is “designed to assist audit committees in carrying out their responsibilities of appointing, overseeing, and determining compensation for the external auditor.” Beyond oversight, the CAQ observes that a “[r]obust, two-way dialogue that includes providing constructive feedback to the external auditor may improve audit quality and enhance the relationship between the audit committee and the external auditor.” Like many other helpful CAQ tools, this tool provides a number of sample questions to help audit committees satisfy their oversight obligations with regard to the outside auditor. (The discussion below includes only a sampling of the CAQ’s questions provided in the Assessment Tool.) The CAQ also provides a sample form that can be used to solicit input about the outside auditor from company personnel who have had substantial contact with the auditor.
SEC adopts amendments for FAST Act Modernization and Simplification of Regulation S-K (revised and updated)
Yesterday, once again without an open meeting, the SEC adopted changes to its rules and forms designed to modernize and simplify disclosure requirements. The final amendments, FAST Act Modernization and Simplification of Regulation S-K, which were adopted largely as originally proposed in October 2017 (see this PubCo post), are part of the SEC’s ambitious housekeeping effort, the Disclosure Effectiveness Initiative. (See this PubCo post and this PubCo post.) The amendments are intended to eliminate outdated, repetitive and unnecessary disclosure, lower costs and burdens on companies and improve readability and navigability for investors and other readers. Here is the SEC’s press release.
The final amendments make a number of useful changes, such as eliminating the need to include discussion in MD&A about the earliest of three years of financial statements, permit omission of schedules and attachments from most exhibits, limiting the two-year lookback for material contracts, and streamlining the rules regarding incorporation by reference and other matters. The final amendments also impose some new obligations, such as a requirement to file as an exhibit to Form 10-K a description of the securities registered under Section 12 of the Exchange Act and a requirement to data-tag cover page information and hyperlink to information incorporated by reference. .
Certainly one of the most welcome changes is the SEC’s innovative new approach to confidential treatment, which will allow companies to redact confidential information from exhibits without the need to submit in advance formal confidential treatment requests. This new approach will become effective immediately upon publication of the final amendments in the Federal Register. The remainder of the final amendments will become effective 30 days after publication in the Federal Register, with the exception of new cover page data-tagging requirements, which are subject to a three-year phase-in.
PCAOB to engage in “proactive communications” with audit committees; sample questions for audit committees
In this PCAOB staff inspection brief, issued at the end of last week, the PCAOB discusses its new strategic plan, which includes conducting “an ongoing dialogue” with audit committee chairs when their companies’ audits are subject to PCAOB inspection. The purpose is to provide the committees with “further insight” into the PCAOB process, including the inspections, and to obtain the views of committee chairs. The brief also outlines what audit committees should expect from the PCAOB’s 2019 inspections and provides a number of sample questions that audit committees may want to consider asking their auditors with regard to current inspection issues. The PCAOB expects to publish additional updates for audit committees regarding observations and findings.
As previously discussed in this PubCo post, one of the risk areas that SEC staff have advised they will be monitoring and have urged companies to address—and soon—is the effect of the LIBOR phase-out. LIBOR, the London Interbank Offered Rate, is calculated based on estimates submitted by banks of their own borrowing costs. In 2012, the revelation of LIBOR rigging scandals made clear that the benchmark was susceptible to manipulation, and British regulators decided to phase it out by 2021. LIBOR has been used extensively as a benchmark reference for short-term interest rates for various commercial and financial contracts—including interest rate swaps and other derivatives, as well as floating rate mortgages and corporate debt. As cited by SEC Chair Jay Clayton, according to the Fed, “in the cash and derivatives markets, there are approximately $200 trillion in notional transactions referencing U.S Dollar LIBOR and…more than $35 trillion will not mature by the end of 2021.” (See also this PubCo post.)
Studies have shown that, following announcement of a restatement, stock prices are abnormally negative for the period 20 to 30 trading days after the announcement. But what happens after the restatement is actually filed? In a study from Audit Analytics, the authors found that, following the date of the restated financials, there were no significant abnormal returns in either the first 30-day window or after a 90-day window, but, in the second 30-day window, the authors found long-term abnormal positive returns “of up to 3.28% following the resolution of the restatement process and filing of the restated financial statements.”
A bipartisan group of senators has introduced a new bill, the Fostering Innovation Act of 2019 (S. 452), that would amend SOX to provide a temporary exemption from the auditor attestation requirements of Section 404(b) for low-revenue issuers, such as biotechs. The bill is designed to help those EGCs that will lose their exemptions from SOX 404(b) five years after their IPOs, but still do not report much revenue. For those companies, proponents contend, the auditor attestation requirement is time-consuming and expensive, diverting capital from other critical uses, such as R&D. According to the press release, the bill would provide “a very narrow fix that temporarily extends the Sarbanes-Oxley Section 404(b) exemption for an additional five years for a small subset of EGCs with annual average revenue of less than $50 million and less than $700 million in public float.” I know it’s Valentine’s Day, but does it also feel a bit like Groundhog Day? That’s because, in 2016, the House passed the Fostering Innovation Act of 2015—the very same bill. That bill went nowhere, but the question is: have we now reached an inflection point for SOX 404(b)?
Now back to work, SEC Enforcement once again takes up the issue of internal control over financial reporting. In this instance, the SEC announced settled charges against four public companies for failing to remediate internal control weaknesses—for years! We’re talking seven to ten years. The companies seemed to be under the misimpression that, as long as they disclosed the material weaknesses, they were in the clear. But they learned the hard way that that was not the case. According to Melissa Hodgman, an Associate Director in Enforcement, “Companies cannot hide behind disclosures as a way to meet their ICFR obligations. Disclosure of material weaknesses is not enough without meaningful remediation. We are committed to holding corporations accountable for failing to timely remediate material weaknesses.”