According to audit firm PwC, non-GAAP financial measures play an important role in financial reporting, “showing a view of the company’s financial or operational results to supplement what is captured in the financial statements,” and help to tell the company’s financial story, as the SEC has advocated in connection with MD&A, “through the eyes of management.” Yet, they also have the potential to open the proverbial can of worms, subjecting the company to serious SEC scrutiny and possible SEC enforcement if misused. Just a couple of weeks ago, the SEC announced settled charges against DXC Technology Company, a multi-national information technology company, for making misleading disclosures about its non-GAAP financial performance. According to the Order, DXC materially increased its reported non-GAAP net income “by negligently misclassifying tens of millions of dollars of expenses ” and improperly excluding them from its reported non-GAAP earnings. In addition to misclassification, DXC allegedly provided a misleading description of the scope of the expenses included in the company’s non-GAAP adjustment and failed to adopt a non-GAAP policy or to have adequate disclosure controls and procedures in place specific to its non-GAAP financial measures. Consequently, DXC “negligently failed to evaluate the company’s non-GAAP disclosures adequately.” DXC agreed to pay a civil penalty of $8 million. (See this PubCo post.) So what can a company’s audit committee do to help prevent the types of problems that have arisen at DXC and elsewhere? Audit committees may find helpful this recent article from PwC providing guidance for committees tasked with oversight of the use of non-GAAP financial measures.
In this new statement, SEC Chief Accountant Paul Munter—no longer “acting” Chief, he got the job—discusses some of the issues arising out of the increased use by lead auditors of other accounting firms and individual accountants (referred to as “other auditors”) on many issuer audit engagements. While, in this context, much of the responsibility falls on the lead auditors, audit committees also have an important oversight role, and Munter has some useful advice for audit committee members.
In this new Bulletin, consultant Protiviti identifies key issues for the 2021 audit committee agenda and—no surprise—at least half reflect the impact of COVID-19. The agenda includes four topics related to enterprise, process and technology risks and four related to financial reporting, with a reminder regarding ESG. Also available is an audit committee self-assessment questionnaire. The topics suggested for the audit committee agenda are summarized below.
Are the allegations in Hughes v. Hu an example of the SEC/PCAOB’s recent cautionary Statement on emerging market risks come to life? (See this PubCo post.) The case involves a Caremark claim against the audit committee and various executives of Kandi Technologies, a publicly traded Delaware company listed on the Nasdaq Global Select Market and based in an emerging market country. The complaint alleged that they consciously failed “to establish a board-level system of oversight for the Company’s financial statements and related-party transactions, choosing instead to rely blindly on management while devoting patently inadequate time to the necessary tasks.” You might recall that, in Marchand v. Barnhill (June 18, 2019), then-Chief Justice Strine, writing for the Delaware Supreme Court, started out his analysis with the recognition that “Caremark claims are difficult to plead and ultimately to prove out,” and constitute “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” (See this PubCo post.) Although Caremark presented a high hurdle, the complaint in Marchand was able to clear that bar and survive a motion to dismiss. In the view of the Delaware Chancery Court, Hughes proved to be comparable—the Court denied two motions to dismiss, holding that the allegations in the complaint were sufficient to support “a reasonable pleading-stage inference of a bad faith failure of oversight by the named director defendants.” Is clearing the Caremark bar becoming a thing?
As you know, critical audit matters are defined for purposes of the auditor’s report as “matters communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements; and (2) involved especially challenging, subjective, or complex auditor judgment.” The standard for CAMs became effective for audits of large accelerated filers (LAFs) for fiscal years ended on or after June 30, 2019, and will be required for companies other than LAFs (excluding emerging growth companies) for fiscal years ending on or after December 15, 2020. CAM disclosure is strictly the province of the auditors and included in the auditor’s report. But what has been the role of audit committees? Audit Analytics has performed an analysis of companies in the S&P 1500 to see what, if anything, they have disclosed in their proxy statements about the part that audit committees have played in connection with CAM identification and disclosure.
When a company’s CFO serves on another company’s board, does it help or hurt the financial reporting of the CFO’s company? It’s easy to imagine that the time commitment associated with outside board service would be a distraction from the CFO’s primary job and ultimately impair the CFO’s performance—especially since, as reported in CFO.com, a majority of finance chiefs on outside boards are appointed to the time-consuming audit committee. But, according to an academic study, “CFO Outside Directorship and Financial Misstatements,” just published in Accounting Horizons, a peer-reviewed journal of the American Accounting Association (link is to a version on SSRN), that’s not the case. In fact, the study demonstrated that outside board service can actually enhance the quality of the financial reporting of the CFO’s company.
In what were surely unprepared remarks to the American Institute of CPAs conference on SEC and PCAOB developments, as reported by Bloomberg BNA, SEC Chair Jay “the Dude” Clayton commented on the impact he expects the new form of auditor’s report could have on his mood: “‘If it results in quality, I’ll be happy….And if it results in boilerplate, I’ll be really bummed out.’”
2017 Audit Committee Transparency Barometer from the Center for Audit Quality shows continued increase in enhanced disclosures
Earlier this month, the Center for Audit Quality together with Audit Analytics posted their annual Audit Committee Transparency Barometer, which measured the quality of proxy disclosures regarding audit committees among companies in the S&P Composite 1500. The report shows continued voluntary enhancements to transparency and broadly increased disclosure around audit committee oversight of the external auditor. The report includes several useful examples of the types of disclosure discussed.
With the SEC now considering whether to approve AS 3101, the PCAOB’s new enhanced disclosure requirement for the auditor’s report (see this PubCo post), and SEC concept releases and other disclosure projects still hovering in the ether, there seems to be a steady march by companies toward inclusion of more supplemental audit committee disclosures on a voluntary basis, according to a new study by the EY Center for Board Matters. The study, which reviewed audit committee reporting in proxy statements by companies in the Fortune 100 for 2017, showed that companies in that elite group have demonstrated “[y]ear-over-year growth in voluntary audit-related disclosures in 2017 filings … similar to that seen in 2015 and 2016, indicating that companies and audit committees continue to reflect upon and make changes to the information that they communicate to shareholders.”
by Cydney Posner What are audit committee members’ greatest concerns? Audit committee members participating in KPMG’s 2017 Global Audit Committee Pulse Survey identified risk management as the biggest challenge for audit committees in 2017, with 42% of those surveyed characterizing their existing risk management programs as requiring “substantial work,” and […]