Audit committees historically have played a vital role in our capital markets' investor protection framework. Charged with oversight over the company's financial reporting processes and its external audit, the audit committee represents the interests of investors in ensuring that financial statements are accurate, complete and informative. The Sarbanes-Oxley Act enhanced the scope and effectiveness of the oversight role played by the audit committee, including by requiring increased expertise among audit committee members in financial reporting matters and through stricter independence requirements. As a result of these and other reforms, it has been my experience that audit committees today are much more equipped to provide rigorous oversight over external auditors than a decade ago.
Nevertheless, we have heard, through our formal outreach and in more informal encounters, that audit committees are looking to us for additional support, to help them better achieve their important objectives. I believe that it is important for the Board to consider the needs of audit committees. This includes the potential effect on audit committees of the regulatory actions under consideration in our standard setting projects, such as those relating to the auditor's reporting model, auditor independence and audit transparency. We are also currently considering whether we could provide audit committees with some additional guidance regarding our inspections process and reporting framework.
Perhaps most importantly, we understand from our discussions with audit committee members and others that one key to effective oversight of the auditor is access to important information relevant to the financial reporting activities of the company and the work of the auditor. Today, by re-proposing a standard, Communication with Audit Committees, we attempt to satisfy this need. The proposed standard is intended to enhance the relevance and quality of the communications between the auditor and the audit committee. It retains many of the existing requirements of the legacy requirements in AU sec. 380 but also establishes communication requirements for certain additional categories of information. These include, for example, requirements to communicate:
- An overview of the overall audit strategy and identified risks;
- Information about other independent public accounting firms or persons that are involved in the audit;
- The basis for the principal auditor's determination that he or she can serve as principal auditor;
- Difficult or contentious matters resulting in consultations outside the engagement team;
- Significant unusual transactions;
- The auditor's evaluation of going concern;
- Complaints or concerns that came to the auditor's attention; and
- Other matters that are significant to the oversight of the company's financial reporting process.
I believe that the proposed requirements for auditor communications will better enable audit committees to perform their oversight responsibilities. At the same time, the standard is intended to avoid the information overload and excessive costs that could result if auditors are required to communicate too much information that is not relevant to the audit committee's monitoring and oversight role. I look forward to receiving comments from auditors, audit committees, preparers, investors and others about whether we have achieved an appropriate balance.
I would also like to point out that regardless of the requirements of the proposed standard, nothing would prevent audit committees from requesting more information from auditors if deemed appropriate in light of the relevant circumstances. Likewise, nothing prevents auditors from volunteering information above and beyond that required by today's proposed standard.
For example, some commenters responding to the original proposed standard were hoping that the Board would require auditors to discuss their assessment of the company's "tone at the top." The Board was careful to tie its communications requirements in the proposed standard to existing requirements for audit procedures in order to avoid increasing the substantive audit work that must be performed through the communication standard. As a result, the proposed standard addresses the "tone at the top" issue only insofar as AS 5 includes audit performance requirements to evaluate management in connection with the control environment. Audit committees are free, however, to expand on these discussions with their auditors by asking for additional information about management's philosophies and priorities, in order to develop a more comprehensive picture of the company's tone at the top.
Some commenters also suggested that the Board retain the originally proposed requirement that auditors discuss with the audit committee the quality, clarity and completeness of the company's financial statements and related disclosures. As described in the release, the standard we are proposing today omits this requirement, stating only that the auditor must communicate the results of the auditor's evaluation of whether the presentation of the financial statement and related disclosures are in conformity with the applicable financial reporting framework. Nevertheless, the standard does not prevent auditors from communicating, or audit committees from asking their auditors to communicate, the auditor's view about the quality, clarity and completeness of the financial statements and disclosures. Doing so may be particularly appropriate in connection with the audits of companies with complex financial transactions or investments and significant use of fair value measurements and management estimates.
The proposed standard also does not impose a specific timeline for the various communications. Rather, recognizing that audits vary in complexity and duration, it requires only that the communications be made in a timely manner and before issuance of the audit report, and it notes that the appropriate timing of communications may depend on the significance of the matter to be communicated and the necessary follow-up actions required. However, audit committees always have the discretion to request auditor communications in connection with certain specific audit milestones where appropriate. They also may want to reinforce the standard's objective by encouraging auditors to communicate important matters early enough during the audit to allow sufficient time for such matters to be considered fully by the audit committee and for any necessary consultation or supplemental audit procedures.
Finally, I would like to point out that one of the stated objectives of the standard is for the auditor to obtain from the audit committee information relevant to the audit. In other words, while the standard is focused primarily on requiring the auditor to provide certain types of information to the audit committee, the standard also is intended to foster an effective, comprehensive, two-way dialog between auditor and audit committee. This, I believe, can best be achieved if both sides are actively engaged in a face-to-face, give-and-take dialog, providing information, listening to the other side, and probing for more detail where appropriate. Written communications alone are unlikely to achieve this goal.
This proposed standard is not the "end all" of communications requirements. There are many existing standards that already require communications from the auditor to the audit committee, and those are not repeated here. The list of the sources of these requirements is included in Appendix B to the proposed standard. In addition, as other projects on our agenda are finalized, including standards addressing Going Concern and Related Parties, we may include further communication requirements as enhanced performance requirements are adopted.
In closing, I would like to add my appreciation to that already expressed by my fellow Board members for the hard work on this project by members of the Office of the Chief Auditor and the Office of General Counsel. I appreciate your patience with the many questions and comments I provided, and I commend you for your grace under pressure. I would also like to thank the staff of the SEC who took time to provide input, as well as all of the individuals and organizations who provided their thoughtful comments on the original proposed standard. Please keep them coming.