Acting Chief Accountant Stresses Auditor Independence and Audit Committee Oversight
On October 26, SEC Acting Chief Accountant Paul Munter issued a statement urging “all gatekeepers in the financial reporting ecosystem (auditors, management, and their audit committees) to maintain constant vigilance in the faithful implementation of the requirements of [the Sarbanes-Oxley Act (SOX)] by fulfilling their shared responsibilities to continue to produce high quality financial disclosures that are decision-useful to investors and maintain the public trust in our capital markets.” See The Importance of High Quality Independent Audits and Effective Audit Committee Oversight to High Quality Financial Reporting to Investors. Mr. Munter added that “an integral part of the faithful implementation of SOX is for * * * audit committees to take ownership of their oversight responsibilities with respect to the independent auditor.” Further, “[e]ffective oversight by strong, active, knowledgeable and independent audit committees significantly furthers the collective goal of providing high quality, reliable financial information to investors.”
The thrust of the statement is the importance of the assurance provided by an independent audit to the credibility of financial reporting. Mr. Munter states that the “independence of the auditor, in both fact and appearance, is foundational to the credibility of the financial statements” and that “compliance with auditor independence rules is a shared responsibility of the issuer, its audit committee, and the auditor. As to the specifics of the audit committee’s responsibilities for auditor independence, he outlines two things audit committees should do:
Consider the sufficiency of the auditor’s and the issuer’s monitoring processes. This includes monitoring that addresses corporate changes or other events that potentially affect auditor independence. “This is particularly relevant in the current environment as companies seek to access public markets through new and innovative transactions, and audit firms continue to expand business relationships and non-audit services.”
Proactively seek to inform themselves of any potential impact to auditor independence, in fact and appearance, as companies negotiate potential transactions with third parties. “This proactive monitoring requires management, the audit committee, and the independent auditor to each consider the potential effects of the auditor’s existing business and service relationships with other companies on the auditor’s ability to remain independent of the issuer if a contemplated transaction is consummated.”
The Munter statement also includes a broad declaration of the link between audit committee oversight and auditor independence, financial reporting quality, and audit quality:
“An effective audit committee enhances the accountant's independence by, among other things, providing a forum apart from management where the accountants may discuss their concerns. It facilitates communications among the board of directors, management, internal auditors and independent auditors. An effective audit committee also enhances auditor independence from management by exercising its responsibilities in appointing, compensating and overseeing the work of the independent auditors. Because audit committees have financial reporting and audit oversight authority and responsibility, they also are instrumental in setting the tone at the top for the quality of the issuer’s financial reporting to investors. In selecting, retaining, and evaluating the independent auditor, the audit committee always should be focused, in the first instance, on audit quality.” (footnote omitted)
Comment: One likely motive for the issuance of the statement at this time can be found in Mr. Munter’s references to “new and innovative transactions” by which companies access public markets (e.g., SPAC mergers) and to the continued expansion of audit firm “business relationships and non-audit services.” Both of these trends increase the potential for the auditor’s relationship with a third party to create an unanticipated independence challenge for existing audit clients. These independence challenges can in turn become issues for the audit committee.
The statement is quite explicit that auditors, managements, and audit committees all need to be vigilant in identifying independence threats. Having publicly made this point, SEC Chief Accountant’s staff may not be sympathetic when companies find themselves in the position of confronting a potential violation of the Commission’s requirement to file an audit report issued by an independent auditor, if the issue could have been anticipated in advance. Audit committees should take seriously Mr. Munter’s suggestions that they monitor the auditor’s and the company’s processes for identifying independence threats and stay “proactively informed” of events and transactions that could impact the auditor’s independence.