Image Credit: Christophe Vorlet
By Jason Zweig | Aug. 18, 2017 12:36 pm ET
With luck, it may soon become a little harder for companies to keep investors in the dark.
The Securities and Exchange Commission is considering whether to adopt a rule proposed by the Public Company Accounting Oversight Board that would require companies’ annual reports to include information about some of the most important issues raised by accountants in the annual audit.
Similar rules are already in force in the United Kingdom and Europe and other parts of the world; all told, 124 countries have adopted or are adopting those standards, says Matt Waldron, technical director at the International Auditing and Assurance Standards Board, a global accounting organization based in New York.
Should the U.S. join them?
Corporate audits have long been conducted in a kind of twilight. An independent accounting firm confidentially pores over a company’s books and records and other aspects of the business, and then gives a terse thumbs-up or thumbs-down in the company’s annual report.
A thumbs-up states that the accounting firm obtained “reasonable assurance” that the financial statements are “free of material misstatement” and represent the company’s condition “fairly.” A thumbs-down casts doubt on whether the company can “continue as a going concern.”
That’s it. These certifications — a handful of paragraphs typically indistinguishable from one company to another — offer no further information for investors.
The new rules would make auditors describe any significant issues they raised with the audit committee of the company’s board of directors. The auditors will have to explain any “challenging, subjective or complex” judgments.
Auditors in other countries are already disclosing the areas where they have challenged management’s assumptions and where estimates are conservative or optimistic.
So companies whose shares trade both overseas and in the U.S. may have the same auditor but two drastically different reporting formats.
The 2016 U.S. annual report for Aegon N.V., the Dutch insurer and asset manager, has a cookie-cutter communiqué of less than 650 words; the international version is more than seven times as long and delves into the potential risks of specific assets and transactions. (Both were prepared by the Amsterdam affiliate of PricewaterhouseCoopers.)
After years of negotiating, the biggest accounting firms have been generally supportive of the new rules in their recent comments on the rule.
Some companies have argued that the rule could prompt their audit firm to disclose sensitive information about them that could be exploited by competitors. “I find that argument bizarre,” says Linda de Beer, an accountant and corporate director in South Africa who helped develop the international standards. “All investors are asking auditors for is, ‘We want to see a little of the detail, through your eyes, of what you drove deeper on.’ That doesn’t involve giving away any competitive edge.”
Would accountants be sued more often if they spelled out the reasoning behind their analysis? Lynn Turner, a former chief accountant at the SEC, thinks the opposite: “The obligation to come clean on critical items in the report means that auditors will have more ability to push back on management.”
That won’t prevent notorious frauds like Enron or WorldCom, but it might make them at least slightly less likely.
In surveys by the CFA Institute, a nonprofit group of financial analysts, investors have consistently supported the concept of adding more detail to the auditor’s report. The existing format is “antiquated,” says Kurt Schacht, a managing director there. “Shareholders ought to get more information considering that they pay for these opinions.”
A spokeswoman for the PCAOB declined to comment, citing the board’s policy not to discuss rules while the SEC is soliciting input from the public. The SEC also declined to comment.
Through Friday, you can express your own opinion on the rule at sec.gov/rules/pcaob.htm; the SEC is likely to move on it by the end of October.
When future Supreme Court Justice Louis Brandeis wrote, in 1913, that “sunlight is said to be the best of disinfectants,” he couldn’t have known how long it would take to part the clouds.
Companies listed on the New York Stock Exchange weren’t required to have their financial statements audited by independent auditors until 1933. In 1939, the SEC’s chief accountant argued that the auditor’s report should itemize “any permissible exceptions or limitations” in a company’s financial statements, along with any “unusual and significant features of the audit” — exactly in the spirit of the rule the SEC is only now considering.
A 1963 study by the SEC found that more than a quarter of all companies whose stocks traded over-the-counter “did not disseminate any financial information to shareholders at all,” and 23% of their reports weren’t even certified by the auditors.
Under the proposed rule, annual reports, already bulky, will get even fatter. But it will provide valuable information for investors, and it’s a welcome step on the long, slow path toward more transparency.
Source: The Wall Street Journal, http://on.wsj.com/2wgXvlx
For further reading:
Definitions of ANNUAL REPORT, AUDITOR, DISCLOSURE in The Devil’s Financial Dictionary