Audit Committee Insights | June 2022

What’s old is new again. Rising interest rates, inflation, and a cooling housing market. But for financial reporting, there are always many new developments. Read on to stay informed on relevant developments for audit committee members.

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The CAQ Response on the SEC’s Proposed Climate-Related Disclosures

The CAQ in a comment letter to the Securities and Exchange Commission (SEC) voiced support for requiring certain registrants to subject Scope 1 and Scope 2 greenhouse gas (GHG) emissions disclosures to attestation as this will enhance the reliability and quality of these disclosures.

“For years, the CAQ has recognized the value of company-prepared climate information for investors and the role public company auditors can play,” said Julie Bell Lindsay, Chief Executive Officer of the CAQ. “Research shows that assurance over climate-reporting when performed by a public company auditor offers increased investor protection compared with other assurers.”

The reliability of ESG reporting is just one critical issue to aid investors in evaluating climate information; comparability also proves essential to investor trust and confidence. In its response to the SEC’s proposal, the CAQ expressed its support for a globally accepted ESG reporting system that is built from existing standards and frameworks.

The CAQ also identified a few noteworthy challenges and solutions for the current proposal, including:

• Organizational boundaries for GHG emissions disclosures: Many companies voluntarily report climate-related information using different boundaries from the SEC’s proposal. As a result, companies may encounter reporting challenges and burdens as they move toward reporting under a different boundary.
• GHG emissions methodology: Specifying in the final rule that a widely used framework, such as the GHG Protocol, should be used will help support GHG emissions disclosures being more comparable from company to company and limit companies from opting to use bespoke methods.
• Regulation S-X proposed amendments: The proposed financial statement metrics requirements as written will not achieve the intended objectives and will result in various practical implementation challenges. The SEC should consider alternatives to help focus companies on preparing more meaningful, cost-effective climate-related disclosures that are comparable from company to company.

Additionally, the CAQ provided an alternative phased in approach by both disclosure area and registrant type to provide registrants with more time to prepare for aspects of the disclosure areas.

“Despite the challenges we identified, the SEC’s climate proposal is an important step forward to provide investors, public companies and other capital market stakeholders with clarity around information that is increasingly being used to make investment decisions,” said Lindsay. “We look forward to continued dialogue with the SEC and other stakeholders as this rule is finalized.

Excluding SPACs, Restatements Down 10% in 2021

According to an Audit Analytics report, 2021 Financial Restatements, A Twenty-One-Year Review, SPACs drove rise in restatements in 2021. Excluding SPACs, the total number of restatements declined by 10%. The number of unique companies that disclosed a restatement declined by 15%.

• In response to SEC guidance on accounting for warrants and redeemable shares, many SPACs had to restate financials, contributing to 77% of restatements.
• Debt and equity became top cited accounting issues. Revenue recognition had been the top issue in each of the past 3 years. But debt and equity accounting was 2021’s top issue, both including and excluding SPAC restatements.
• There were more material restatements in 2021. 62% of restatements were reissuance restatements, the biggest proportion since 2005. Excluding SPAC restatements, 24% of 2021 restatements were reissuances, a 3 percentage point increase from 2020.

The decline in restatements during the previous decade has been due, in part, to both improved reporting and a decline in SEC registrants. Improved reporting resulted in the percentage of companies that disclosed a restatement during 2020 reaching a low of just 4.8%. And the number of SEC registrants that filed an annual or quarterly financial report with the SEC declined from more than 10,000 unique companies during 2010 to just 7,300 unique companies during 2020. The popularity of SPACs increased the number of SEC registrants during 2021, climbing to over 8,000. Due to the influx of new SPAC SEC registrants, 2021’s SPAC-centered restatements increased the percentage of unique companies that disclosed a restatement to 12.7%, slightly trailing the 13.6% high point observed during 2006.

What caused the SPAC restatements? Accounting for redeemable shares and warrant liabilities drove restatements of many SPACs.

What’s the bottom line for audit committees? In general, SPACs notwithstanding, it’s good news. Financial reporting and audit quality continue to be high. However, attention to financial reporting matters by audit committees is critical. The list of Top 10 restatement issues is a good reminder of complex and subjective accounting areas.

It’s Never Too Early to Think About Enhancing Audit Committee Disclosures in Your Proxy

While the proxy season may seem to have just ended, it’s the perfect time to consider enhancements for next year. The narrative and disclosures are fresh in your mind. Were there enhancements you wanted to make but decided to push to next year in an effort of continuous improvement? It’s not too early to spearhead those improvements. In partnership with Audit Analytics, the CAQ has published annually examples of best in class audit committee disclosures. See our latest publication, 2021 Audit Committee Transparency Barometer, for such examples. Here are 3 reasons to increase disclosures as derived from Julie Bell Lindsay’s NACD’s blog post:

1. Disclosures are positively correlated with audit quality.

A 2021 study found that disclosure around the audit partner selection process is positively associated with audit quality. Specifically, the study found the following:

• Increased audit committee involvement resulted in the selection of rigorous audit partners.
• Audit committees that disclosed their involvement tended to be more engaged in the selection process.

Accurate, transparent, and reliable financial statements are the backbone of our capital market. It is incredibly important to choose the right audit partner to lead and manage the audit. Increasing disclosures around the audit committee’s involvement in the audit partner selection process can contribute to high-quality audits.

 2. Investors are increasingly using disclosures to make investment decisions.

Investors depend on the information they receive from public company management to make investment decisions. One area that investors are increasingly interested in is cybersecurity—and for good reason. According to PwC’s 2022 Global Economic Crime and Fraud Survey, across organizations of all sizes, cybercrime poses the biggest threat, followed by customer fraud and asset misappropriation.

Even before the pandemic, public companies were increasing—and disclosing—their use of cybersecurity technologies. Our Transparency Barometer report found that the most dramatic voluntary audit committee disclosure increase continues to relate to responsibility for cyber-risk oversight, growing from 11 percent to 46 percent of S&P 500 companies disclosing this between 2016 and 2021.

This is a positive step toward increasing investor trust. Public companies and their audit committees should consider what other information outside of financial statements are of high interest to investors, such as environmental, social, and governance issues.

 3. Transparency can dispel criticism.

From time to time, critics argue that audit committees don’t exercise enough oversight and that they are ceremonial in nature. Disclosures are a powerful tool for audit committees to increase transparency on the many important activities they perform on behalf of investors.

While public companies have made great strides in increasing their disclosures, there are opportunities for improvement, including as they relate to the following:

• Fee negotiation. This does not mean simply stating the audit committee’s responsibility to compensate the external auditor but also providing insight into how fees were negotiated. Were they negotiated with audit quality in mind?
• Explanation for changes in audit fees. Specific reasons for changes in the fees paid to the external auditor can increase transparency and help stakeholders understand the correlation between fees and efficiency and quality.
• Significant areas addressed. What areas did the audit committee focus on and spend time addressing? The answer to this can demonstrate the seriousness with which audit committees take their oversight role and gatekeeper function.

ICYMI: CAQ Public Policy and Technical Alert (PPTA), May 2022

Each month, the PPTA highlights and examines the regulatory, standard-setting, legislative, and broader financial reporting developments impacting the public company audit profession. The CAQ’s May Alert included these featured articles.

• Sample letter to companies regarding disclosures pertaining to Russia’s invasion of Ukraine and related supply chain issues
  Companies may have disclosure obligations under the federal securities laws related to the direct or indirect impact that Russia’s invasion of Ukraine and the international response have had or may have on their business. To satisfy these obligations, the SEC’s Division of Corporation Finance believes that companies should provide detailed disclosure, to the extent material or otherwise required regarding direct or indirect exposure to Russia, Belarus, or Ukraine. The division has issued a sample letter.
• SEC proposes to enhance disclosures by certain investment advisers and investment companies about environmental, social, and governance (ESG) investment practices
  The SEC proposed amendments to rules and reporting forms to promote consistent, comparable, and reliable information for investors concerning funds and advisers incorporation of ESG factors. The proposed changes would apply to certain registered investment advisers, advisers exempt from registration, registered investment companies, and business development companies. The proposed amendments seek to categorize certain types of ESG strategies broadly and require funds and advisers to provide more specific disclosures in fund prospectuses, annual reports, and adviser brochures based on the ESG strategies they pursue. The proposal would require certain ESG reporting on Forms N-CEN and ADV Part 1A.

Important Legal Ruling in June (Not That One)

As reported by The New York Times, Ohio State University has received a trademark for one of the most common words in the English language, one that the school’s supporters often forcefully emphasize when uttering its name: “The.” While athletes from other schools may simply say they went to Michigan or Penn State, a Buckeye rarely cuts corners: “The Ohio State University,” they’ll say, usually adding a dramatic pause after stressing the “the.”

According to the NYT article, the trademark, issued by the U.S. Patent and Trademark Office on June 21, 2022, won’t unleash heavy-handed lawyers in search of anyone using the word “the” — its protections are limited to a narrow set of circumstances that people are unlikely to cross unless they are selling knockoff Ohio State merchandise. But it gives the university some protection against unlicensed sellers, and adds to the school’s efforts to link itself to the very common word.

On a completely unrelated note, the CAQ’s CEO Julie Bell Lindsay is a graduate of The Ohio State University.

Questions and comments about Audit Committee Insights can be addressed to Vanessa Teitelbaum, Senior Director, Professional Practice (vteitelbaum@thecaq.org). This newsletter is intended as general information and should not be relied upon as being definitive or all-inclusive. The CAQ encourages readers to refer to applicable rules, standards, guidance, and other resources in their entirety. All entities should carefully evaluate which requirements apply to their respective organizations. Check out the CAQ’s Audit Committee Resource Webpage for more information.