Disclosure, vs. Signature
My two cents (see disclaimer posted on the right side of this blog): I believe it is significant and intentional that the PCAOB’s press release announcing tomorrow’s meeting uses the words ‘disclosure’ and ‘disclose’ rather than the previously common vernacular of engagement partner “signature.”
The latter term ties back to the Final Report and recommendations published in 2008 by the U.S. Treasury Advisory Committee on the Auditing Profession (ACAP), (see recommendation 6, Subcommittee on Firm Structure and Finances) which recommended that regulators, the auditing profession, and other bodies, as applicable: “Urge the PCAOB to undertake a standard-setting initiative to consider mandating the engagement partner’s signature on the auditor’s report), and to the PCAOB’s 2009 Concept Release issued for public comment, entitled, “Concept Release on Requiring the Engagement Partner to Sign the Audit.”
ACAP described the potential benefits from such a requirement as “increase[ing] transparency and accountability.” :
As also recognized by ACAP, one of the most contentious issues surrounding a potential engagement partner signature requirement was whether the value-added by such a signature would offset any potential additional legal liability to that partner.
Additionally, concerns have been voiced in ACAP and at prior discussions of the PCAOB Standing Advisory Group about any unintended consequences other potential reputational risks arising from the association of one partner’s name (instead of the firm’s name generically, as is the case today) with one particular audit, vis-à-vis other audits headed up by that particular partner, as well as potential client’s consideration of taking on that particular partner and his/her firm, based on particular audits for which that partner signed off.
Some questioned the impact this could have on auditor’s behavior as well, not only in the desired direction of ‘accountability’ but on the flipside, potentially causing the opposite effect, in which some questioned whether putting their name on the line associated with ‘good’ and ‘bad’ audits could potentially cause an auditor to hesitate to cause a negative consequence to a client, since his/her name would be publicly attached to that particular client, and in turn impact other clients, the investing public, and regulator’s views about that partners’ other audit clients.
Safe Harbor: Necessary? Provided?
Concern about legal liability in particular may be the driving force behind why a call for ‘engagement partner signature,’ floated a few years ago in its Concept Release, is now at the proposal stage but appears targeted at engagement partner ‘disclosure’ rather than signature. I assume that the presumed benefits anyone is looking for from a signature requirement would be satisfied by a disclosure (rather than signature) requirement.
At a 2009 PCAOB Standing Advisory Group Meeting, SAG member Jeff Mahoney, General Counsel of the Council of Institutional Investors (also a member of ACAP), noted that footnote 87 (in the section pertaining to the Subcommittee on Firm Structure and Finances) in ACAP’s Final Report (numbered page VII: 20 of that report) spoke of the belief that the same kind of “Safe Harbor” available to the audit committee ‘financial expert” by the Securities and Exchange Commission in the SEC’s Final Rule requiring disclosure of the name of the audit committee ‘financial expert, could form the model for a safe harbor for a safe harbor for audit firm engagement partners under any requirement to disclose them by name. (See the safe harbor in the SEC’s Final Rule.: Disclosure Required by Sections 406 and 407 of the Sarbanes-Oxley Act of 2002, Release No. 33-8817)
Here is what the relevant sentence in ACAPs report said, which includes footnote 87:
The Committee notes the signature requirement should not impose on any signing partner any duties, obligations or liability that are greater than the duties, obligations and liability imposed on such person as a member of an auditing firm.”
87 This language is similar to safe harbor language the SEC promulgated in its rulemaking pursuant to Sarbanes-Oxley’s Section 407 for audit committee financial experts. See SEC, Final Rule: Disclosure Required by Sections 406 and 407 of the Sarbanes-Oxley Act of 2002, Release No. 33-8177 (Jan. 23, 2003).
Here is what the SEC’s Final Rule on disclosure of the audit committee financial expert says re: Safe Harbor:
5. Safe Harbor from Liability for Audit Committee Financial ExpertsHowever, I for one wonder if the reference to what an ‘expert’ means, as relating to those experts who ‘certify’ certain information, takes the SEC financial expert safe harbor type language out of the water if applied to a named engagement partner; see e.g. footnote 37 of the above-referenced SEC rule, which states:
Several commenters urged us to clarify that the designation or identification of an audit committee financial expert will not increase or decrease his or her duties, obligations or potential liability as an audit committee member. A few recommended a formal safe harbor from liability for audit committee financial experts. Unlike the provisions of the Act that impose substantive requirements,34 the requirements contemplated by Section 407 are entirely disclosure-based. We find no support in the Sarbanes-Oxley Act or in related legislative history that Congress intended to change the duties, obligations or liability of any audit committee member, including the audit committee financial expert, through this provision.
In the proposing release, we stated that we did not believe that the mere designation of the audit committee financial expert would impose a higher degree of individual responsibility or obligation on that person. Nor did we intend for the designation to decrease the duties and obligations of other audit committee members or the board of directors.
We continue to believe that it would adversely affect the operation of the audit committee and its vital role in our financial reporting and public disclosure system, and systems of corporate governance more generally, if courts were to conclude that the designation and public identification of an audit committee financial expert affected such person's duties, obligations or liability as an audit committee member or board member. We find that it would be adverse to the interests of investors and to the operation of markets and therefore would not be in the public interest, if the designation and identification affected the duties, obligations or liabilities to which any member of the company's audit committee or board is subject. To codify this position, we are including a safe harbor in the new audit committee disclosure item to clarify that:
A person who is determined to be an audit committee financial expert will not be deemed an "expert" for any purpose, including without limitation for purposes of Section 11 of the Securities Act,35 as a result of being designated or identified as an audit committee financial expert pursuant to the new disclosure item;
The designation or identification of a person as an audit committee financial expert pursuant to the new disclosure item does not impose on such person any duties, obligations or liability that are greater than the duties, obligations and liability imposed on such person as a member of the audit committee and board of directors in the absence of such designation or identification; and The designation or identification of a person as an audit committee financial expert pursuant to the new disclosure item does not affect the duties, obligations or liability of any other member of the audit committee or board of directors.36
This safe harbor clarifies that any information in a registration statement reviewed
by the audit committee financial expert is not "expertised" unless such person is acting in the capacity of some other type of traditionally recognized expert.
Similarly, because the audit committee financial expert is not an expert for purposes of Section 11,37 he or she is not subject to a higher level of due diligence with respect to any portion of the registration statement as a result of his or her designation or
identification as an audit committee financial expert.
In adopting this safe harbor, we wish to emphasize that all directors bear significant responsibility. State law generally imposes a fiduciary duty upon directors to protect the interests of a company's shareholders. This duty requires a director to inform
himself or herself of relevant facts and to use a "critical eye" in assessing information prior to acting on a matter.38 Our new rule provides that whether a person is, or is not, an audit committee financial expert does not alter his or her duties, obligations or liabilities. We believe this should be the case under federal and state law.
37 Section 11 of the Securities Act imposes liability for material misstatements and omissions in a registration statement, but provides a defense to liability for those who perform adequate due diligence. The level of due diligence required depends on the position held by a defendant and the type of information at issue. Escott v. BarChris Construction Corp., 283 F. Supp. 643 (S.D.N.Y. 1968). The type of information can be categorized as either "expertised," which means information that is prepared or certified by an expert who is named in the registration statement, or "non-expertised." Similarly, a defendant can be characterized either as an "expert" or a "non-expert."Whether disclosure (vs. signature), potentially paired with some type of Safe Harbor language, will entirely protect the named partner(s) from incurring potential additional legal liability remains to be seen, and it will be interesting to hear the PCAOB board and staff members’ discussion, as well as the discussion in the proposing release, around this point. It will also be interesting to hear the scope of potential disclosure requirements of “other accounting firms and certain other participants that took part in the audit.”
The PCAOB’s open meeting, slated for 9:30 am (ET) Tues. Oct. 11, will be webcast.
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