Audit committees of U.S. publicly listed companies have had greater disclosure responsibilities since the U.S. Sarbanes–Oxley Act of 2002 took effect. Both the U.S. Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB) have established and enforced audit and disclosure guidelines, including rules for what audit committees must disclose to the public. But those required disclosures are limited in scope.
Recently, some audit committees have begun providing voluntary disclosure to improve transparency and give further insight into the committee’s composition, activities, and decision-making processes. Voluntary disclosure provides additional context to mandatory SEC disclosures. Some audit committees may be disclosing more in hopes that it will discourage the SEC from expanding disclosure requirements. Moreover, shareholders and other stakeholders can benefit from more information about how audit firms are selected, compensated, and evaluated.
In light of this development, internal auditors need to understand which audit committee disclosures are required and become familiar with the voluntary disclosure trend. By engaging with the board and audit committee, internal audit can help shape opinions around which voluntary disclosures may benefit the organization and key stakeholders. Moreover, it can give the board a better understanding of disclosure trends.
The SEC has largely defined audit committee disclosure requirements since 1999. Historically, these requirements have been limited to descriptive information and select process assertions, which continued after the passage of Sarbanes–Oxley. Currently, SEC Regulation S-K, Item 407, requires the audit committee to:
- State whether the audit committee has a charter, and if so, provide appropriate disclosure.
- If the board deems an audit committee member is not independent, disclose the nature of the relationship that makes that individual not independent and the reasons for the board’s determination.
- Disclose whether the audit committee has reviewed and discussed the audited financial statements with management.
- Indicate whether the audit committee has discussed with independent auditors matters required in AU section 380 of the PCAOB’s “Communication With Audit Committees.”
- Include that the audit committee has received a letter from the independent accountant, including written disclosures pertaining to accountant independence (per PCAOB regulations).
- Based on the appropriate review and discussions, provide a statement recommending that the audited financial statements be placed in the company’s 10-K or annual report.
- Disclose member independence, including proof that at least one member is a financial expert.
- Provide the names of each audit committee member or those acting in the role of the audit committee.
In 2015, the SEC issued a concept release on possible revisions to audit committee disclosures, but the SEC has yet to change its requirements. In a July 2017 address at the Economic Club of New York, current SEC Chairman Jay Clayton stated that several SEC initiatives are underway to improve disclosures to investors.
Internal auditors should evaluate whether management has adequate governance to ensure required audit committee disclosures are appropriately identified and made. Creating a disclosure matrix that contains categories of SEC required disclosures can ensure all SEC mandatory items are included in the audit committee’s proxy disclosures.
In addition to adhering to the required disclosures, audit committees often voluntarily communicate additional information to their stakeholders. A variety of organizations have advocated for greater disclosure in recent years. In his response to the SEC’s Audit Committee Disclosure concept release in 2015, IIA President and CEO Richard Chambers noted that increased disclosure could support internal audit’s stature, independence, and resources. It also could build trust with investors and other external users of financial information.
Deloitte’s July 2018 On the Board’s Agenda report notes that Standard & Poor’s (S&P) 100 proxies “help to provide transparency into audit committee oversight activities.” Also, a 2017 Deloitte report stated that “transparency into the audit committee’s oversight activities and performance can provide investors with a better understanding of both the audit committee’s performance and the audit process.”
In addition to transparency, EY’s 2018 Report to Shareholders notes that although investors say they are confident in publicly listed companies’ financial reporting, some are evaluating company-auditor relationships. Earlier, the firm’s Audit Committee Reporting to Shareholders 2017 pointed out that stakeholders are looking closely at the board and audit committee’s role in “supporting high-quality financial reporting.”
Two separate publications from EY and the Center for Audit Quality (CAQ) highlight many potential benefits to a company in providing voluntary disclosure:
- Increased transparency with key stakeholders.
- Alignment of all stakeholder expectations, resulting in reduced conflict.
- Trusting relationships among stakeholders.
- Increased investor confidence in the board.
- Increased investor confidence in financial earnings quality.
- Increased investor confidence in the presence of corporate policies.
- Ability to assess top management’s decisions and behaviors.
- Improved insight and assessment of the audit committee’s decision-making process.
Internal auditors can educate the audit committee on voluntary disclosure trends — both overall and within their industry — and the potential benefits to the organization. They can add a voluntary category to their disclosure matrix to list potential voluntary disclosures for their organization to consider. To compile that list, they should consult current disclosure studies and research what S&P 500 companies and other organizations in their industry are reporting. Based on such findings, internal auditors can assist management and the board with recommendations on the extent and type of voluntary audit committee disclosures that their organization should make.
The CAQ’s 2018 Audit Committee Transparency Barometer report provides insight into what companies are voluntarily disclosing beyond the SEC requirements. The barometer provides five-year trend data for four categories of “enhanced disclosure” for each S&P 500, mid-cap, and small-cap company:
- Audit firm selection/ratification.
- Audit firm compensation.
- Audit firm evaluation
- and supervision.
- Audit engagement partner selection.
The sampling frame used in the CAQ’s report was the S&P Composite 1,500 proxy statements of companies in these indices at the end of the filing period. “Voluntary Disclosures Rising” below reveals an upward trend in nearly all analyzed voluntary disclosures between 2014 and 2018. This increase may be driven by two factors.
First, these areas provide insight into how diligently an audit committee is assessing the audit firm’s independence. The SEC cites this responsibility as one of the most important duties of an audit committee.
A second factor may be a response to recent PCAOB Staff Inspection Briefs that have expressed ongoing concerns with audit firm independence. In December 2018, the PCAOB’s Inspections Outlook for 2019 listed independence among its key areas of focus for inspections in 2019 and beyond. The board’s August 2017 Staff Inspection Brief noted that some firms’ systems of quality control did not provide enough assurance that their personnel understood and complied with independence requirements. Among the deficiencies were impermissible nonaudit services and instances where external auditors performed such services without the audit committee’s preapproval.
Similarly, a 2018 proxy review by the Deloitte Center for Board Effectiveness found disclosures related to auditor independence increased 10 percent across a sample of S&P 100 companies that reported by May 31, 2018. Given these two factors, audit committees may be increasing voluntary disclosure to provide further assurance that they are taking appropriate action to ensure audit firm independence.
With more audit committees opting to provide voluntary disclosures, internal auditors can provide valuable insights on the topic to their audit committee. Practitioners should periodically monitor the audit committee disclosures among the organization’s competitors and any further action that the SEC may take on its 2015 concept release. Additionally, internal auditors should monitor annual publications from the CAQ, PCAOB Staff inspection briefs, and related applicable documents to both understand disclosure trends and provide necessary attention to them. Finally, internal auditors should inform clients that investors are evaluating the relationship between companies and audit firms. One way to communicate about this topic to investors is through voluntary disclosure.