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Securities Regulation and Corporate Governance > Posts > SEC Approves New PCAOB Auditor Reporting Standard
SEC Approves New PCAOB Auditor Reporting Standard

On October 23, 2017, the Securities and Exchange Commission (the “Commission”) approved the Public Company Accounting Oversight Board’s (the “PCAOB”) new standard requiring significant enhancements to the auditor’s report on an issuer's financial statements, including the communication of critical audit matters (“CAMs”).  The Commission’s order approving the new standard and related amendments to other auditing standards is available here; the PCAOB’s previous release approving the standard and related amendments is available here; and our June 2, 2017 client alert discussing the PCAOB’s standard is available here.

As discussed in our client alert, the new standard dramatically alters the audit reporting model for public companies.  Specifically, the standard requires the disclosure of CAMs identified by the auditor during the course of the audit.  A CAM is defined as any matter arising from the audit that was communicated or required to be communicated to the audit committee and that relates to accounts or disclosures that are material to the financial statements and involved especially challenging, subjective, or complex auditor judgment.  Additionally, the standard requires new disclosures regarding auditor tenure, independence, and responsibilities.

The Commission’s order approving the standard acknowledges a number of concerns raised by issuers and other stakeholders in the rulemaking process, including the following:

 

  • Potential for Increased Litigation.  Concerns have been expressed that the additional disclosure requirements imposed by the new standard may give rise to increased litigation.  In a statement commenting on the adoption of the new standard (available here), SEC Chairman Clayton said that he “would be disappointed if the new audit reporting standard, which has the potential to provide investors with meaningful incremental information, instead resulted in frivolous litigation costs, defensive, lawyer-driven auditor communications, or antagonistic auditor-audit committee relationships.”  In light of these concerns, the Commission noted in its order that the PCAOB will be monitoring the implementation of the new standard to consider whether unintended consequences may require additional changes. The PCAOB will do this through a post-implementation review to be completed as soon as reasonably possible.
  • Potential for Unnecessary or Boilerplate Disclosure. In its order, the Commission acknowledged the concern of some commenters that CAMs may not provide meaningful incremental disclosure.  But, the order indicates that the Commission was persuaded that the reporting of CAMs still will be beneficial and useful to investors.  The Commission also signaled in its order that the definition of CAM adopted under the new standard is a relatively high hurdle and thus should mitigate the risk of auditors reporting too many CAMs.
  • Potential to “Chill” Communications Between Auditors and Audit Committees. Concerns also were expressed that the requirement for auditors to communicate CAMs will result in “chilled” conversation among audit committees, management and auditors.  The Commission acknowledged that there exists a risk that such communications could be chilled; however, it agreed with the PCAOB’s conclusion that this risk is mitigated by separate auditing standards (AS 1301) that require specific matters to be communicated to audit committees. “In this regard,” the Commission noted, “we believe it would be highly unusual for a matter to meet the definition of a CAM and not be required to be communicated to the audit committee.”
  • Disclosure of Original Information by Auditors.  Concerns have also been expressed that the new standard may, in some circumstances, require auditors to disclose information not previously disclosed by an issuer.  From the Commission’s perspective, these concerns have been mitigated in part by the inclusion of a materiality component to the definition of CAM and by limiting the potential reporting of original information to areas uniquely within the perspective of the auditor (e.g., a description of the principal considerations that led the auditor to determine that a matter is a CAM and how the matter was addressed in the audit).  Although the Commission noted its agreement that, in general, the preparation and disclosure of information about an issuer should be the primary responsibility of the issuer, the order also says that “[n]othing prohibits exceptions to this general principle, and indeed, existing requirements contemplate a role for the auditor in disclosing original information.”  In this regard, the Commission noted that there is “no PCAOB standard, SEC rule, or other financial reporting requirement prohibiting auditor reporting of information that management has not previously disclosed.”  The Commission further stated that the focus of any required disclosure on the audit from the auditor’s perspective should limit the extent to which original information would need to be provided by the auditor.  To the extent original information would need to be communicated in a CAM, the Commission noted that it would anticipate that the auditor, management and the audit committee would engage in a dialogue about that communication.

Effective Dates. The new requirements that are not related to CAMs (including the disclosures regarding auditor tenure and independence), will be effective for all audits of fiscal years ending on or after December 15, 2017.  This means that, for calendar year companies, their upcoming Form 10-Ks filed in early 2018 for their 2017 fiscal year, must include this new disclosure. The requirements related to CAMs will be effective for the audits of large accelerated filers for fiscal years ending on or after June 30, 2019, and for audits of all other companies, for fiscal years ending on or after December 15, 2020.

Special thanks to Michael Titera, Matthew Haskell and Michael Mencher for their assistance with this update.


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