Thank you, Chairman Doty. I support the re-proposed auditing standard and amendments that we are considering this morning. The re-proposal before us today reflects careful consideration of the comments and feedback the Board received on the initial proposal.
I will not state again in this statement why there is a need for Board action in the audit areas being addressed here, namely, related party transactions, significant unusual transactions, and executive officer compensation but I will have a few questions to further buttress the record. By now it is widely recognized that these three audit areas pose higher than normal risk of material misstatement and an increased risk of fraud. In my statement from February 28, 2012, I discuss in some detail why I believe it is appropriate for the Board to act in these areas and why these proposals are important for investor protection.
The comments we received on the original proposal were generally supportive of the Board's action in these areas. Some commenters, however, raised concerns on certain aspects of the initial proposal. I would like to touch on comments we received in one area in particular—executive compensation.
The original proposal would have required the auditor to perform specific procedures to obtain an understanding of the company's financial relationships with its executive officers. To do this, the auditor would have been required to read the employment and compensation contracts of the company's executive officers as well as the proxy statement and other filings with the SEC.
Some commenters supported the above procedures with one commenter stating that these procedures would lead to higher quality audits. Other commenters, however, asserted that such procedures could expand the auditor's role by placing the auditor in a position in which he might potentially influence the design and appropriateness of the company's compensation arrangements with its executives.
The intent of the procedures in the original proposal was not to place the auditor in such a role. Rather, the intent was to enable the auditor to identify and assess risks associated with such arrangements as well as to identify any incentives and pressures on management to commit fraud. Reading and understanding the terms of how the executive officers are compensated can be an important step in identifying and assessing the risks of material misstatements.
I agree with commenters that the auditor should not be involved in assessing the appropriateness of the executive compensation structure of a company. That is something that is best left to the compensation committees or boards of companies. The re-proposal addresses this concern by clarifying that these procedures are part of the auditor's risk assessment procedures and not intended to expand the auditor's role.
Overall, the re-proposal before us strengthens existing audit performance requirements. The re-proposal sets forth new and specific audit procedures that the auditor should perform when examining a company's transaction with its related parties or significant unusual transactions. It is important that auditors give greater attention when auditing such transactions. They should ensure that they understand the business purpose of the transactions and the terms and nature of the transactions. Said another way, under the re-proposal the auditor must do more than just audit management's disclosure of such transactions. By requiring more, the Board is ensuring that the interests of investors are protected.
I want to briefly touch on our rulemaking process and economic considerations and, in that context commend the staff for their thoroughness in addressing the following fundamental issues: (1) What is the problem that needs to be addressed? (2) What is the current baseline and how does it need to be changed? (3) What other alternatives were considered? (4) What are the benefits and costs of the proposed changes? (5) How does the proposed standard benefit investors? and (6) How are they an improvement over existing standards and those by the International Auditing and Assurance Standards Board?
On a final note, the current release is just over 200 pages. I recognize that the release covers three significant areas but I want to encourage all involved to look for ways to streamline future releases.
In closing, I join you, Mr. Chairman, and others in thanking Marty Baumann and his staff, Greg Scates, Brian Degano, and Nick Grillo, and Bob Burns from the General Counsel's Office for their work on the re-proposed standard and amendments before us today. I would also like to thank the staff of the SEC for their helpful input on this project.