Broc Romanek is Editor of CorporateAffairs.tv, TheCorporateCounsel.net, CompensationStandards.com & DealLawyers.com. He also serves as Editor for these print newsletters: Deal Lawyers; Compensation Standards & the Corporate Governance Advisor. He is Commissioner of TheCorporateCounsel.net's "Blue Justice League" & curator of its "Deal Cube Museum."
Here is something I blogged yesterday in CompensationStandards.com’s “The Advisors’ Blog“:
Mark Poerio of Paul Hastings reports: Last week, the application of Delaware law principles has led courts in Colorado (Janus Capital), North Carolina (Dex One), and California (Hewlett-Packard) to dismiss shareholder challenges based on alleged disconnects between pay and performance, failed say-on-pay votes, and alleged waste through payment of $53 million of severance. In each case, the underlying complaints failed to excuse a pre-suit demand because none of the allegations created a reasonable doubt that the questioned transaction was entitled to protection under the business judgment rule.
Corp Fin Updates Financial Reporting Manual (Again)
Yesterday, Corp Fin indicated that it has updated its Financial Reporting Manual for a JOBS Act note and clarification of guidance related to proxy statement requirements for the disposal of a business, auditor association with amounts from inception, the application of PCAOB auditor requirements in a reverse merger, reporting requirements in a reverse acquisition with a non-shell company, and other changes.
Can the SEC Eliminate the Prohibition on General Solicitation Retroactively?
Keith Bishop continues to blog provocatively – the latest being this gem about whether the SEC can give its upcoming rulemaking on general solicitation retroactive effect…
Meanwhile, state regulators are not too happy about the SEC’s proposal, as noted in this article…
Part of being the highest profile company in the land means that more attention is paid to what you do. From a compliance standpoint, Apple hasn’t always embraced that attention. For example, the fact that their announcements might move markets (eg. Steve Jobs health) – or even perhaps what they say about their financial performance during product announcements – as illustrated by this recent blog by Gus Schmidt of Gunster entitled “Did Apple violate Regulation FD at its iPhone 5 release conference?“.
In addition, as this blog notes, Apple recently received a shareholder proposal asking the company to publish a report explaining how its board is overseeing privacy and data security risks. Note that one thrust of this proposal is about personal information privacy. That can encompass issues such as what personal information is collected by apps, where it is stored, how it is used and shared, and how user consent is obtained.
The SEC’s cybersecurity disclosure guidance from last year did not mention the word privacy, although federal and state privacy laws can be implicated in the context of a data breach involving personal information (what the SEC described as a cyber incident). In light of the recent legislative focus on privacy and data security topics, and increased media focus on Big Data and companies’ privacy practices, the SEC might conclude that shareholder proposals related to information privacy risks or cyber security risks raise significant policy issues and therefore are not excludable under Rule 14a-8(i)(7) for the reasons discussed in Staff Legal Bulletin No. 14E. In the coming proxy season, more companies may see shareholder proposals focused on cyber security and privacy risks. So, now is a good time for their management and boards to focus on their risk management in those areas. Thanks to Jim Brashear of Zix Corp. for his insight!
Now Effective: Higher Filing Fees at the SEC
Don’t forget that fees to register securities at the SEC went up effective October 1st. Here is my blog about the rate increase from last month…
I’m bummed the baseball team here – the Washington Nationals – let the Teddy mascot win the daily race against his fellow Presidential mascots during yesterday’s game. Having him consistently lose was starting to become a national “thing” – and that’s great branding. No more. But I have “Natitude” for the coming playoffs…
How to Transition Existing Draft Registration Statements to Edgar
Yesterday, Corp Fin posted this sample letter that it has sent to companies whose draft registration statements are under review so they can transition them to the new Edgar process – using Form DRS – explained in this blog.
A member recently sent me the following: Recently, there has been a marked increase in the number of public offerings of preferred stocks and many of those securities are listed. We understand that NYSE Staff has applied a heightened level of scrutiny to the provisions of these preferred issuances, in particular those relating to voting rights of the preferred stockholders. Consequently, it seems timely to share some perspectives gleaned from recent transactions reviewed by the NYSE Staff.
It may be worth noting as an initial matter that the requirements discussed below are not applicable to trust preferred securities, which are not listed under the preferred stock listing requirements set forth in Section 703.05 of the Listed Company Manual. Trust preferred securities are listed under Section 703.19 (“Other Securities”) and are analyzed by the Exchange as structured products rather than as preferred stocks.
The applicable rules are found in Section 313(C) of the Listed Company Manual. The provisions that have generated comments from the NYSE Staff typically relate to the voting rights of preferred stockholders when the issuer proposes to amend the terms of the preferred stock in a manner that would “materially affect” the rights of the holders of the preferred stock.
The threshold question is what constitutes an amendment that ” materially affect[s]” the rights of the preferred stockholders? The NYSE Staff has made it clear that this voting requirement is triggered only in the event of a material adverse effect on the rights of the preferred stockholders and that, generally, these would be changes that relate to the economic rights pertaining to the preferred stock (such as its dividend rate, its liquidation preference, or the creation of a senior issue) or the voting rights of the preferred stock. However, this is not necessarily an exclusive list and you should consult with NYSE Staff if there is any question as to whether a proposed amendment requires a vote.
The area which has generated most confusion, and has led to the NYSE Staff requesting changes to transaction documents, relates to who gets to vote in the event of a material change. Section 313(C) provides as follows:
– Approval by the holders of at least two-thirds of the outstanding shares of a preferred stock should be required for adoption of any charter or by-law amendment that would materially affect existing terms of the preferred stock.
– If all series of a class of preferred stock are not equally affected by the proposed changes, there should be a two-thirds approval of the class and a two-thirds approval of the series that will have a diminished status.
The NYSE Staff has indicated that the above provisions should be understood as follows:
– For matters which affect multiple classes or series of preferred stock, the first bullet above requires that at a minimum the terms of the listed preferred must provide that the listed preferred has the right to vote along with all other outstanding classes or series of preferred stock (either listed or unlisted) that have voting rights and are similarly affected by the proposed action. The proposal must be approved by the votes of two-thirds of all such classes or series considered in the aggregate.
– The second bullet requires that the listed preferred must have the right to vote separately on any proposal which affects the listed preferred in some respect that is more negative than its effect on other classes or series, with a required vote for approval of two-thirds of the listed preferred. If the negative effect is on the listed preferred alone, then the holders of the listed preferred must have the right to vote as a separate class; if it affects multiple classes or series (either listed or unlisted) in the same way, then it is appropriate for all of the affected classes or series to vote together. While it is not explicitly stated in the rule text, the voting requirements of the first bullet can also always be met by providing for a separate vote of the listed preferred, as this is more protective of the holders than a vote in which they share the right to approve the proposal with other classes or series of preferred.
More Fallout in ISS-Proxy Solicitor Leak Case
Back in April, the New York Post revealed the persons involved in a scandal involving the leaking of confidential shareholder votes for money. Now, Reuters reports that ISS has received a Wells notice from the SEC related to a whistleblower complaint made against an employee. Here is MSCI’s related Form 8-K.
Baldness Is Powerful: Yeah, Baby!
In honor of this WSJ article about how baldness can be an advantage in the business world, below is the second pic in my series of bald men in the corporate world (here is the first pic), featuring Pfizer’s Bob Lamm and Alliance Advisor’s Reid Pearson with me at the recent Southeastern Chapter meeting of the Society of Corporate Secretaries:
For the many of you that have registered for our Conferences coming up in less than one week, we have posted the Course Materials (attendees received a special ID/PW yesterday via email that will enable you to access them; but copies will be available in New Orleans). The Course Materials are better than ever before – with over 40 sets of talking points comprising 160 pages of practical guidance. We don’t serve typical conference fare (ie. voluminous memos and rule releases); our conference materials consist of practical bullets and examples. Our expert speakers certainly have gone the extra mile this year!
For those seeking CLE credit, here’s a list of states in which credit is available for watching the Conferences live in New Orleans and by video webcast. And for those attending by watching video online, you can test your access now.
Act Now: As happens so often, there is now a mad rush for folks to register for these Conferences that begin next Monday, October 8th. With an aggregate of over 50 panels (including the “20th Annual NASPP Conference”), if these Conferences don’t help get you prepared for the upcoming proxy season, nothing will. You can either register for the three days of the “20th Annual NASPP Conference” (in New Orleans) – or the two days of the “7th Annual Proxy Disclosure Conference” & “Say-on-Pay Workshop: 9th Annual Executive Compensation Conference” (in New Orleans or by video webcast, or a combination of both). Register Now.
NYSE Amends Its Compensation Committee Proposal From Last Week
Here’s news from Kyoko Takahashi Lin and Ning Chiu in this Davis Polk blog:
The NYSE has published an updated rule filing submitted to the SEC on the recent proposed listing standards related to compensation committees. The rule filing notes that “Amendment No. 1 corrects a single error in the rule text in Exhibit 5 as originally filed. The error was in Section 303A.00 under the heading ‘Transition Periods for Compensation Committee Requirements.'”
To be clear, listed companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new director independence standards with respect to compensation committees. Other proposed changes, including those related to compensation committee advisers, will become operative on July 1, 2013.
Transcript: “Hot Topics for Smaller Company Legal Depts”
We have posted the transcript for our recent webcast: “Hot Topics for Smaller Company Legal Depts.”
On Friday, Corp Fin posted 13 more FAQs related to the JOBS Act – Questions 42-54 – some of which relate to the confidential submission process that moves over to Edgar today, as I blogged about last week…
Recently, on “The Mentor Blog,” I included an audio clip from a recent earnings call that went awry when someone accidentally blurted out some profanity in what may have been a cross-call (I have since deleted the audio clip in case the person’s name could be made out). Many members responded with their own stories or analysis including:
– In my many years here, I have only had one interruption which was caused by an inexperienced operator – to wit, the operator inadvertently connected her “management line” into the call so that while my CEO was speaking the operator and an IR person came over the line discussing the volume on the call. No harm done and almost immediately corrected, but I think the most common way it can happen is for either the operator or the inside IR person to accidentally hit that button (I suggest that perhaps it would best if they labeled it with giant “Dr. Evil” lettering, “DO NOT PUSH” or something similar).
– While this has never happened to me or any former client, I have heard narratively of management teams not remembering to “turn off” their mikes following the end of the call so that extraneous commentary is accidentally added to the recording. As politicians and newscasters know, don’t make jokes or add commentary while “on set” regardless of whether or not you believe that you aren’t being recorded.
– On one of our first calls after going public a while back, our CFO kicked the speaker connection under the table and we were dropped. The conference call service did a great job of asking people to hang on the line and we called back in. He got a lot of grief internally for a while (we told him to sit away from the speaker connection, etc.). As far as the listeners knew, it was just a glitch in the system (we were probably off for 2 minutes or so).
– We’ve only had one in 11 years due a power failure on our end. Being in the Northeast, we do sometimes get more concerned during the winter.
– I wonder how many people are recording the “prepared remarks” in advance for playback and then only fielding questions “live.” We’ve contemplated it but are never done far enough in advance to pull it off. Plus, we don’t have enough quality recording equipment in house to make it work. With that said, with an iPhone, I’m sure it would sound 100x better than a high quality recording from 2002.
– In my experience, I would say that it’s because the telephone/web conference coordinators and the investor relations personnel who are literally physically running the meeting are fairly skilled about running the call itself, handling the question sequencing and maintaining muting and other similar functionality (and reminding others of this too).
– Could the process be spoofed? I.e., could I dial in and register as if I were an analyst known to the company? I suppose so, but if two callers registered as the same person, that would obviously raise suspicions.
– Jim Brashear noted: “The reason you don’t see more disruptions is that companies only allow questions and comments from credible, known analysts and investors. They don’t take random calls from just anyone. My companies have allowed anyone to dial in and listen to earnings calls, but if someone wants to be able to ask a question or make a comment they have to register their name and organization. When the caller presses the button to be added to the queue for asking a question, we can see in the conference room their name and organization in a list of everyone that was added to the queue. We can choose to prioritize or ignore the names, as we choose. ”
Transcript: “JOBS Act Update: Where Are We Now”
We have posted the transcript of the popular webcast: “JOBS Act Update: Where Are We Now.”
Instead of “Just Vote No” Campaign – “Just Stay Home” and Don’t Vote…
With elections on everyone’s mind, I thought it was appropriate to point out this interesting blog from Keith Bishop from a few months back about the use of a strategy to prevent quorum from being reached rather than just voting no against a board…
1. “Product” Determination: A key element in Step 1 in the conflict minerals disclosure process requires issuers to determine whether it manufactures or contracts to manufactures products. Is it clear what a product is? For instance, what product is a cable television company selling? The entertainment or the set top box leased to customers? How about an airline? Use of seat?
2. Examples of Product Manufacturing: There has been a number of interesting fact patterns regarding whether a company is manufacturing a product. For instance, does a company that assembles products, such as a computer systems integrator that sets up a network with off-the-shelf components, “manufacture” a product?
3. Degree of Influence for “Contract to Manufacture”: There have also been a number of questions regarding when a company has the degree of influence necessary to trigger the “contract to manufacture” provision in the rule. For instance, if a manufacturer sets performance requirements for the components it buys that will naturally require certain materials to be used in the product, is that enough? And what if you sell a product that includes your intellectual property, such as a Mickey Mouse doll that includes a voice recording supplied by the company?
4. Tricky “Functionality” Conclusions: Is it possible to conclude that the packaging used for a product is not “necessary to the functionality or production” of the product? For instance, are the cans used for soft drinks necessary to the functionality of the drink? How about the tin boxes that certain cookies are delivered in?
5. Various Approaches to Preparation: What steps should companies take now to prepare for reporting on 2013? Should they send letters to suppliers now? If so, will they need to resend letters next year? And what should companies be asking suppliers to disclose to the company? Does the answer to this question depend on the conflict mineral involved?
6. Differences in Approach By Industry: What is the approach to preparation in particular industries? Includes discussion of electrical, gold industries.
7. Changes to Sourcing Policies: The SEC’s adopting release for the new rules states that “[a]n issuer’s policies with respect to sourcing of conflict minerals will generally form a part of the issuer’s reasonable country origin inquiry.” Are companies changing sourcing policies to assist with compliance with the new rules? For instance, are companies restricting sourcing from the covered countries? Or, if a company sources from a covered country should it only source from large mining companies, as opposed to artisanal mining sources?
8. Whether Audit is Required (and How): Have companies started to consider what auditor they will use, if an audit is required? The SEC made it clear that a company’s existing financial statement auditor can be used, but is that a good or bad idea? Are there auditor independence considerations?
9. Disclosure Issues: Is there any part of the required disclosures in the Form SD that will be most problematic for companies to make? And what happens if an issuer does not file its Form SD? Or if it files the Form SD late? Does it impact Form S-3 eligibility?
10. Possibility of Lawsuit to Stay Rules: What’s the possibility that a lawsuit will be filed that will block the effectiveness of the new rules? If so, how will that process work?
JOBS Act: Draft Registration Statements To Be Filed on EDGAR Starting Monday
Yesterday, the SEC announced that draft registration statements can be filed on Edgar starting Monday, October 1st using submission form types DRS and DRS/A. This is a significant logistical development for those emerging growth companies and foreign private issuers that qualify for a confidential SEC Staff review. These companies can choose to continue to use the SEC’s secure email system for an unspecified period of transition time rather than use Edgar. The SEC will announce later when use of Edgar for draft registration statements will be mandatory.
Yesterday, the SEC posted this 32-page guide – mainly consisting of screen shots – on how to file draft registration statements on Edgar.
Hot Off the Press! Nasdaq’s Compensation Committee Proposal
Yesterday, I blogged about the NYSE proposal – 58 pages – implementing the Rule 10C-1 requirements for compensation committees was posted. Then later in the day, I updated the blog to note that Nasdaq’s proposal – 97 pages – was posted yesterday morning. Folks have 21 days to comment once the proposals are published in the Federal Register. We’ll be posting the inevitable slew of memos in CompensationStandards.com’s “Compensation Committees” Practice Area.
What You Need to Do Now: These soon-to-be-adopted new rules will be a hot topic during our “7th Annual Proxy Disclosure Conference”” (and the combined “Say-on-Pay Workshop”) coming up in just over a week – October 8-9th in New Orleans and via Live Nationwide Video Webcast. If you haven’t been to our Conferences before, give it a try – particularly this year when New Orleans needs the tourism dollars. Here are the agendas for the combined conferences. Register Now.
Late yesterday, the NYSE proposal – 58 pages – implementing the Rule 10C-1 requirements for compensation committees was posted. Then Nasdaq’s proposal – 97 pages – was posted this morning. We’ll be posting the inevitable slew of memos in CompensationStandards.com’s “Compensation Committees” Practice Area (Mark Borges already has blogged about it).
What You Need to Do Now: These soon-to-be-adopted new rules will be a hot topic during our “7th Annual Proxy Disclosure Conference”” (and the combined “Say-on-Pay Workshop”) coming up in just over a week – October 8-9th in New Orleans and via Live Nationwide Video Webcast. If you haven’t been to our Conferences before, give it a try – particularly this year when New Orleans needs the tourism dollars. Here are the agendas for the combined conferences. Register Now.
Survey: Employees Use Internal Channels for Reporting Misconduct
Here’s news from this blog by Davis Polk’s Ning Chiu:
Amidst concerns that the SEC whistleblower rules will encourage employees to bypass internal protocols and take allegations of misconduct directly to the Commission, a survey by the nonprofit organization, the Ethics Resource Center, found that only one out of six employees ever reported misconduct to regulators or other outside channels, and 84% of those individuals said that they took this step only after trying to work through their companies’ own procedures. Just 2% of employees surveyed initiated reporting outside of their companies and never informed their employers.
“Inside the Mind of a Whistleblower” is a recent supplement to a 2011 survey that received over 4,000 responses. For companies that want to promote an ethical culture, it may be discouraging to learn that more than 1 out of 3 employees who have observed misconduct indicated that they never made it known. The strongest motivation for reporting misconduct comes from whether the individual believed corrective action would be taken, and not surprisingly, the main reason employees failed to inform anyone was the belief that nothing would change as a result of their efforts. Fear of retaliation, and the employee’s own sense of financial security (those whose earnings recently increased are more likely to report), were other factors that affected the likelihood of revealing perceived misconduct.
63% of those asked stated that the ability to make anonymous reports was a positive factor. However, a vast majority of employees sacrificed this benefit and instead first reached out to their supervisors, and another quarter initially turned to higher management. People who tend to report misconduct want problems to be fixed, and are not influenced by rewards, or bounties, offered to whistleblowers, but monetary gain does make a difference to certain employees who would otherwise not be inclined to make a report.
The organization’s 2012 survey was limited to 2,100 employees at Fortune 500 companies and shows similar findings, as only 1% of respondents said that they initially reported misconduct outside of their companies. Employees at larger companies seemed to be more cognizant of possible wrongdoing, as over half of the Fortune 500 employees said they had observed misconduct in the past year, compared to 45% of employees across a larger group of U.S. companies.
Most of these employees initially approached their supervisors or higher management, with 11% contacting a hotline. However, 17% of employees then made a second report outside of their companies, generally because they were disappointed with the responses.
While the surveys were conducted after the SEC adopted its whistleblower rules, their usefulness in predicting whether employees will approach the SEC directly as permitted under those rules is limited by the broad nature of the misconduct discussed by the respondents, involving primarily workplace environment issues rather than financial reporting, and the lack of clarity surrounding when these actions were discovered and subsequently reported.
Study: Political Contribution Disclosures at S&P 200
Here are some stats from the Center for Political Accountability – in conjunction with the Zicklin Center for Business Ethics Research – from their latest political contribution disclosure study for the S&P 200:
– Almost 60% disclose at least some information about political spending. This includes 47% that make some disclosure of their direct political spending and another 11% that say their policy is not to engage in such political spending.
– 40% are opening up about their payments to trade associations, often a conduit for secret political spending. 36% make some disclosure of their payments to trade associations, while 5% said they ask trade associations not to use their payments for political purposes.
– Even in a climate of increased hidden spending, 75 out of 88 large companies that were studied for two years in a row get improved scores for disclosure of political spending and for accountability.
– The 2012 Index identifies these top leaders for disclosure and accountability: Merck, with an overall score of 97 out of 100; Microsoft, overall score of 94; Aflac, 93; Gilead, 92; and Exelon and Time Warner, Inc., 88 each.
– Companies showing the greatest improvement from 2011 to 2012 are Costco, receiving a score of 85, up from 3 last year; Disney receiving a score of 67, up from 12; and Capital One, which improved its overall score from 20 to 63.
Over the past 18 months, I have spoken at least a dozen times to groups about how social media impacts the securities laws, corporate governance – and your career. In our “Social Media” Practice Area, I have posted “The Twitter Handbook: Overcoming Your Fears” which I drafted as a common sense “nuts & bolts” guide that walks you through the process of signing up for Twitter, learning how to use it and understanding how to navigate Twitter etiquette and the rules of the road. I drafted it to help those of you out there that are scared of the unknown and might not be the most tech savvy. It’s only five pages long. Feel free to email me any questions you might have on any of the basics, etc.
Here’s something unusual that the FTC is doing: “FTC in Three.” Answering 3 questions via social media (Twitter & Facebook) each week. Anyone can submit questions via these social media vehicles – then the FTC chooses three of them and answers them in a video. I guess it shows the agency is hip and cool and williing to answer questions…
Don’t Tweet: “Board meeting. Good numbers=Happy Board”
This WSJ article entitled “Facebook and Twitter Postings Cost CFO His Job” will make the day for many lawyers that I have spoken in front of – the ones who want a hat to hang their hat when they try to convince a CEO client that they shouldn’t be on Twitter. In my opinion, those lawyers are the next generation of lawyers that follow those from 25 years ago that warned clients not to use email because of the things that might be said in writing. I wonder if lawyers were advising clients a hundred years ago not to use telephones?
My point is not that everyone should be on Twitter – in fact, it’s far from that. It’s that I dislike the kneejerk reaction of those that tell clients not to do something technological just because they don’t understand it. The fear of the unknown. Far too many lawyers have not spent more than a handful of minutes trying to understand Twitter – or social media in general for that matter – so I’m not convinced they are qualified to give an educated opinion on the topic.
And as for this particular CFO, consider this: isn’t the company far better off finding out now that he seems to not know what is appropriate to tell others? If this CFO has so little disregard for what his compliance obligations are, imagine what he was telling others on the golf course! Social media is just like any other avenue of communication – either you have a filter or you don’t. And if you don’t, you shouldn’t be in the kind of job that requires you to have one. See John Palizza’s blog about this case…
Survey: Board Use of Technology
According to a survey conducted by Thomson Reuters Governance, Risk & Compliance, here’s a snapshot of ways that board materials are shared with directors:
– Board packs/books delivered physically by courier – 61%
– Board members print electronic files and carry them – 75%
– Documents sent to board members via personal, non-commercial email addresses – 73%
– Always establish email accounts and use exclusively for board communications – 10%
A new study – entitled “Executive Superstars, Peer Groups and Over-Compensation – Cause, Effect and Solution” – examines flawed peer group methodology, finding that CEO pay has become untethered from both broader organizational wage structure and from economic fundamentals due to the use of peer benchmarking. Funded by the IRRC Institute, Professors Charles Elson and Craig Ferrere of the University of Delaware wrote the study. Here’s a NY Times article about the study from yesterday – and here’s IRRC’s press release.
This new study makes it clear that peer grouping with minimal board discretion is a seriously flawed methodology even when the peer groups are fairly constructed. The authors note their study is the first to document that peer group benchmarking has accidentally become the de facto standard even though it never was designed to determine CEO compensation.
The fact that most CEOs aren’t transferable is something that we have been saying for a long time (eg. this blog). And we also have been warning compensation committees that if they rely heavily on peer groups – and don’t use alternative benchmarking techniques like internal pay equity instead – they can be in trouble in court since so many have warned that pay has skyrocketed over the past two decades due to peer group benchmarking. In other words, it arguably isn’t reasonable to rely on peer group surveys any more (here’s my latest rant on this topic). Will boards and their advisors finally wake up on this issue? They should before the lawsuits come – because then it will be too late…
COSO Issues Draft Update of Internal Controls Framework
Last week, the Committee of Sponsoring Organizations of the Treadway Commission (known as “COSO”) released an exposure draft of its Internal Control over External Financial Reporting (ICEFR): Compendium of Approaches and Examples for comment. This is a big deal as it’s a new look at 20 years worth of internal control guidelines. The final product is expected in early 2013…
Concerns Over PCAOB’s New Auditing Standard 16, Communications with Audit Committees
Good stuff from this blog by Davis Polk’s Richard Sandler and Elizabeth Weinstein:
As we discussed here, the PCAOB recently approved Auditing Standard No. 16, Communications with Audit Committees. While the bulk of the new standard concerns communications that the auditors are required to provide to the audit committee, one notable provision relates to inquiries required to be made of the audit committee by the independent auditor. Under the new standard, auditors are required to inquire whether the audit committee “is aware of matters relevant to the audit, including, but not limited to, violations or possible violations of laws or regulations.” This expands the inquiries of the audit committee required by previous auditing standards, which required the auditor to inquire of the audit committee regarding the matters important to the identification and assessment of risks of material misstatement and fraud risks.
As at least one comment letter on the proposed standard noted, the new standard could jeopardize attorney-client and work product privileges. In its adopting release, the PCAOB acknowledged the criticisms of the comment letter regarding the risk of loss of privileges, but declined to exclude the language. The PCAOB stated that it did not remove the language because “limiting the scope of information that the audit committee might provide to the auditor could severely affect the auditor’s ability to conduct an effective audit…Due to the audit committee’s oversight responsibilities, it is appropriate for the auditor to ask the audit committee for information relevant to the audit, including matters related to violations or possible violations of laws or regulations.” The final standard did exclude language from an interim proposal which would have required the auditor to inquire of the audit committee about matters that “might be” relevant to the audit, somewhat narrowing the scope of inquiry. However, the risk of loss of privileges remains an issue. The PCAOB did not provide guidance to companies regarding mitigating such risk.
If approved by the SEC, Auditing Standard No. 16 will be effective for audits of financial statements for fiscal years beginning on or after December 15, 2012.
