October 24, 2017

SEC Approves PCAOB’s Audit Report Standard: A Brave New World!

Yesterday, bumping up against a deadline to act, the SEC unanimously approved the PCAOB’s new audit reporting standard, AS #3101 – the first major overhaul of the audit report in more than 50 years. Here’s the SEC’s order. We’ll be posting memos in our “Audit Reports” Practice Area.

As Liz blogged at the time of the PCAOB’s adoption of the standard, audit reports will look fundamentally different under the new regime. Among other items, they will need to describe the auditor’s take on “CAMs”(“critical audit matters”) – matters communicated to the audit committee that relate to material accounts or disclosures and involve complex auditor judgment. These changes become effective for annual periods ending on or after June 30, 2019 for large accelerated filers & on or after December 15, 2020 for all other filers.

The new standard also requires audit reports to include information about auditor tenure, and to clarify the language addressing the auditor’s responsibilities.  It also completely revamps the report’s organization and formatting. These changes will become effective for audits of annual periods ending on – or after – December 15, 2017.

Critics of the proposal contend that the additional disclosures – and particularly the requirement to address CAMs – will lead to more litigation targeting auditors. Those concerns were addressed by SEC Chair Jay Clayton in his statement on the SEC’s approval of the proposed change:

I 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 — with Main Street investors ending up in a worse position than they were before.

I therefore urge all involved in the implementation of the revised auditing standards, including the Commission and the PCAOB, to pay close attention to these issues going forward, including carefully reading the guidance provided in the approval order and the PCAOB’s adopting release

The statement went on to note that the PCAOB will monitor the results of the new standard’s implementation – “including consideration of any unintended consequences.”

I’m old enough to remember the days of counting paragraphs in an auditor’s opinion – if there were more than 3, that meant the opinion was qualified.  But counting paragraphs was all anybody did – the rest was useless boilerplate.  That boilerplate was nibbled at around the edges over the years, but the report still didn’t convey much useful information.

Yesterday, the SEC didn’t just pare back the boilerplate – it blew up the boiler. Time will tell if anybody gets scalded. But CAMs have been disclosed in the UK for several years without much consequence…

Multi-Class Stock: Reports of Its Death Greatly Exaggerated?

This Wilson Sonsini memo says that – despite major indexes’ decisions to exclude them – multi-class capital structures aren’t going away anytime soon.  Here’s an excerpt:

To the extent institutional investors expected that promising companies, especially technology companies, would choose being listed in one of the indexes rather than implementing governance structures that these companies (and their boards and earliest investors) believed better suited their businesses in the long-term, the institutions have clearly been disappointed.

Indeed, in just the few weeks since the indexes announced their decision, there have been several prominent—and very successful—IPOs by tech companies with dual-class stock. Examples of such recent offerings include Roku and CarGurus, which have both benefited from substantial stock increases since the first day of trading; and data center operator Switch, which also continues to trade nicely above its IPO price.

The memo notes that several other companies with multi-class structures are planning to launch IPOs during the 4th quarter.

Multi-Class Stock: BlackRock Opposes Exclusion from Indexes

Here’s another sign that multi-class structures are … uh… “undead.” (Sorry, Halloween’s coming & I couldn’t resist.) BlackRock recently issued this statement saying that it opposes the exclusion of companies with multi-class stock from major indexes.  This blog from Davis Polk’s Ning Chiu discusses BlackRock’s position. Here’s an excerpt:

BlackRock believes that these actions limit access to the universe of public companies for their index-based clients, depriving them of opportunities for returns. Policymakers should set corporate governance standards through regulation. Index providers should reflect the “investable marketplace” in diverse and expansive benchmark indices, in order to facilitate investors’ use of those indicies and align them with the objectives of public equity investors.

BlackRock’s statement goes on to say that it is a strong advocate of equal voting rights – and, among other things, wants companies with dual or multi-class structures to periodically submit those structures to shareholders for approval.

John Jenkins