Thursday, January 26, 2012

Corporate Secretaries Oppose PCAOB Suggestions of AD&A and Auditor Assurance Outside Financial Statements

The possible revisions to standards on the reports of outside auditors on company financial statements suggested by a PCAOB concept release would fundamentally change the role of the auditor from an independent analyst to an original source of information for investors, said the Society of Corporate Secretaries and Governance Professionals. In a comment letter to the PCAOB, the Society said that the net effect of many of the suggestions in the concept release would make the auditor a guarantor of the accuracy and completeness of the financial statements and, indeed, of the company’s historical results of operations and financial condition.

While the PCAOB would retain the outside auditor’s pass/fail opinion on a company’s financial statements, the Society believes that the pass/fail approach would be vitiated by the alternatives set out in the release. Depending on the nature and extent of the auditor’s comments in the proposed Auditor’s Discussion and Analysis (AD&A), and in any required assurance on disclosures outside the financial statements, the audit would yield the equivalent of high pass, medium pass, low pass, and similar grades, which would add complexity and uncertainty for investors that does not exist with the current pass/fail system.

The Society strongly disagrees with requiring an AD&A because it would be counterproductive to the PCAOB’s goal of providing greater transparency to investors and would substitute the auditor’s judgment for management’s judgment, which could ultimately undermine the auditor’s independence and management’s responsibility for the financial statements and related disclosures. Management is ultimately responsible for the preparation of the financial statements and related disclosures and is in the best position to understand its business and discuss its financial results. If an auditor were required to provide its own analysis of critical audit risks and close calls, reasoned the Society, the auditor would essentially be taking ownership of the financial statements.

Moreover, providing more detailed disclosure by the auditor of the matters considered and underlying considerations with regard to an issuer’s financial statements would not meet the PCAOB’s stated objectives of increasing transparency and making financial statements more relevant to users, noted the Society, rather it would likely increase confusion and the length of disclosure documents without a corresponding benefit. In addition, the nature and process of review and approval of the AD&A would greatly increase the difficulty of meeting tight time frames for filings under the securities laws, particularly filings of large, accelerated filers whose financial statements are generally complex.

According to the Society, even if the AD&A does not become boilerplate, which is a fear, the lack of consistency and comparability among different issuers’ AD&As would cause confusion. In the Society’s view, to add a discussion on difficult and contentious issues, particularly including close calls on the application of complex accounting standards, would create an unproductive situation where there are two potentially competing views on accounting matters.

The Society also disfavors the proposed assurance on items outside of the financial statements. While auditors are familiar with the figures and disclosure upon which the MD&A, earning releases, and non-GAAP measures are based, the cost of requiring an auditor opinion on MD&A or these other disclosures would provide relatively little benefit compared to the cost. Auditors already routinely comment on these matters and issuers routinely take such comments into account, noted the Society, and their responsibilities include consideration of whether such information is materially inconsistent with the financial statements.

Thus, the scope and nature of these other disclosures is unlikely to materially change as a result of requiring a more formal assurance on the part of auditors, reasoned the Society, but would only increase the cost. The illustration of a possible attestation in the release appears to suggest that such an attestation would have to contain a legal opinion that the MD&A satisfies SEC regulations, as well as assurance or comfort regarding the amounts and numbers contained therein. The Society cautioned that these requirements would be well beyond the scope of auditors’ duties and would require an auditor to develop expertise in areas not currently associated with auditing responsibility.