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PCAOB Rule 3526 requires auditors to communicate with audit committees concerning relationships that might impact their independence.  Last week, the PCAOB issued guidance concerning the communications that are required under this rule when the auditor identifies one or more violations of applicable independence rules – but doesn’t think the violations disqualify it from continuing to serve as the auditor.  The PCAOB also issued this summary of the guidance. This excerpt from the guidance document details the disclosures required by the rule:

The Firm would comply with Rule 3526 by:

a. summarizing for the audit committee each violation that existed during the year;

b. summarizing for the audit committee the Firm’s analysis of why, for each violation and notwithstanding the existence thereof, the Firm concluded that its objectivity and impartiality with respect to all issues encompassed within its engagement had not been impaired, and why the Firm believes that a reasonable investor with knowledge of all relevant facts and circumstances would have concluded that the Firm was capable of exercising objective and impartial judgment on all issues encompassed within the Firm’s engagement;

c. if more than one violation existed during the year, providing to the audit committee a separate analysis of why, notwithstanding all of the violations taken together, the Firm concludes that its objectivity and impartiality with respect to all issues encompassed within its engagement has not been impaired, and why the Firm believes that a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the Firm was capable of exercising objective and impartial judgment on all issues encompassed within the Firm’s engagement;

d. engaging in dialogue with the audit committee regarding the violation(s) and the Firm’s related analyses (as described in (a)-(c) above);

e. documenting the substance of the Firm’s discussion(s) with the audit committee (as described in (d) above); and

f. affirming in writing to the audit committee that, except for the violation(s) expressly identified, the Firm would be independent in compliance with Rule 3520.

In a nutshell, the auditor must consider the impact of the violation or violations on its objectivity and impartiality. It then communicates that analysis to the audit committee, which makes its own decision about whether to continue to retain the audit firm.

There are several other components to the guidance, and one of the more interesting is the PCAOB’s view that in this situation, the auditor “should not state in its required annual affirmation that the auditor is independent, but instead indicate that the auditor would be independent except for the violation or violations that it has identified and discussed with the audit committee.”

However, the auditor may issue its report without altering the required title: “Report of Independent Registered Public Accounting Firm.” The PCAOB views this as stating a legal requirement, and not a specific assertion of compliance with the applicable PCAOB rule.

Internal Controls: More ICFR Risk Factors in Wake of SEC Enforcement Action

I’ve blogged a few times (here’s the most recent) about the SEC’s enforcement action against a handful of companies that couldn’t get their acts together when it came to addressing material weaknesses in ICFR. Now, this Audit Analytics blog says that some companies with material weakness disclosures extending over multi-year periods are including “Risk Factor” disclosure specifically addressing the risk of SEC enforcement resulting from their inability to resolve those issues.

This excerpt suggests that we’re likely to see more disclosure along these lines as the year progresses:

It appears public companies are taking notice of the SEC’s January statement that merely disclosing ICFR material weakness is not enough. This year we may see more companies disclose ineffective controls, and this is meaningful because of the SEC’s scrutiny.

In conclusion, analysts and investors need to be on guard for more companies disclosing material weakness with ICFR. Further, they need to consider that admission of weak internal controls doesn’t necessarily mean 2018 was the first year the firm had problems. It’s possible historical filings could show years of ineffective ICFR.

Transcript: “How to Handle an SEC Enforcement Inquiry Now”

We have posted the transcript for our recent webcast: “How to Handle an SEC Enforcement Inquiry Now.”

– John Jenkins