Update on the current board issues: April 2014

Audit committee issues


EU moves further on its path to controversial audit reforms

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On April 14, the Council of Ministers of the European Union ratified the European Directive on Statutory Audits of Annual and Consolidated Accounts and Regulation on Statutory Audit of Public Interest Entities (PIEs or public companies) after they were approved by the European Parliament. Now the legislation has to be signed into law by the presidents of the Council and the Parliament. The Federation of European Accountants (FEE), which represents the accountancy profession in Europe, expects them to be in effect by 2016. Member states will have to implement their own legislation to make the directive effective in their countries.

[For more information on the European Directive and Regulation, read FEE FAQ.]

The regulation places restrictions on independent auditors providing non-audit services to companies, requires mandatory audit firm rotation after 10 years (with the option to extend to 20 years upon a competitive tender after 10 years or to 24 years where joint auditors are to be involved), establishes oversight of auditors and audit firms at the EU level, and creates the Committee of European Audit Oversight Bodies.

The directive amends provisions on independence and objectivity of independent auditors, creates a mechanism for companies to adopt International Auditing Standards on a European level, and contains new requirements for independent auditor reporting to the public and additional internal reporting to public company audit committees.

The regulation contains up to 21-member-state options that each of the 28 member states must elect. For example, member states can elect a mandatory audit firm rotation period shorter than 10 years and can elect not to provide the ability to extend. This will likely lead to a patchwork of rules across the EU, both in the areas of rotation and limits on non-audit services, and has the potential to create confusion and practical challenges for companies, including US-based companies with European subsidiaries and companies with multiple EU public companies.

“While some provisions will strengthen financial reporting and improve corporate governance, the CAQ [Center for Audit Quality] has expressed its concerns that other requirements, particularly severe limits on non-audit services and mandatory audit firm rotation, will undermine the role of independent audit committees acting on behalf of shareholders and reduce choice in the marketplace,” CAQ Executive Director Cindy Fornelli said.

“Looking forward, we are concerned that the implementation of these reforms will generate inconsistencies across jurisdictions, which could affect companies and their auditors in the United States, where the idea of mandatory firm rotation was recently considered and set aside for sound public policy reasons,” she said. “We hope that these new rules can be implemented with the greatest consistency possible across Europe with minimal extra-territorial impacts.”


PwC releases 2014 State of the Internal Audit Profession Study

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The internal audit function needs to show that it can create more value in an increasingly complex and risky business landscape, according to the results of PwC’s 10th annual State of the Internal Audit Profession Study. Given adequate resources, opportunities exist for internal audit to increase its value and its contribution to the business. The study reflects the opinions of more than 1,900 chief audit executives, internal audit managers, senior management, and board members of companies in 24 industries across 37 countries.

Some key findings include:

  • More than half of senior managers said they do not believe internal audit adds significant value to their organization.
  • Nearly 30% of board members believe internal audit adds less than significant value.
  • Only 49% of senior managers and 64% of board members believe internal audit is performing well at delivering on expectations.
  • While many respondents reported their internal audit functions made progress in the past year, performance issues identified in previous years’ research continue and stakeholders have said progress has not been sufficient to keep pace with the changing business environment.

Federal court upholds most of SEC conflict minerals disclosure rule

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The Court of Appeals for the D.C. Circuit decided on April 14 to uphold most of the elements of the SEC’s conflict minerals disclosure rule. The decision comes six weeks before the May 31 conflict minerals filing deadline.

In its opinion, the court affirmed the lower court’s decision upholding the rule, except for one section that requires companies to label whether or not any of their products are “DRC (Democratic Republic of the Congo) conflict free.” The court wrote that requiring companies to do so violated the First Amendment in that it constituted “compelled speech.” [For more information on the court’s decision, read a client memo from Davis Polk.]

The conflict minerals disclosure rule, mandated by the Dodd-Frank Act, requires public companies to disclose whether they use conflict minerals (tantalum, tin, tungsten, and gold) and whether the minerals originated in the DRC or adjoining countries. It responds to concerns that conflict minerals mined in these “covered countries” help finance armed groups that are responsible for violence in the region.

On April 7 the SEC added more questions and answers to its Frequently Asked Questions in order to provide further guidance to companies.

For more information about the original FAQ, which was issued in May 2013, read BoardroomDirect June 2013 (Issues in brief – FAQ further clarifies SEC conflict minerals rule.) 

The nine new questions and answers address the required independent private sector audit of a company’s conflict minerals report and the temporary transition period companies are granted under the rules. Some of the questions relate to whether a CPA must perform the audit, the scope of such an audit, and details of the company’s due diligence and how it should be described in the conflict minerals report.

PwC has released the results of its 2014 Conflict minerals survey, which was taken in February across 15 industries. It found that at the time more than one-quarter of the 700 respondents were still in the early stages of conflict minerals compliance and two-thirds did not require an independent audit. The survey also showed that nearly two-thirds of respondents have full-time employees dedicated to conflict minerals.

[Editor’s note: As of the writing of this newsletter, SEC Commissioners Daniel M. Gallagher and Michael S. Piwowar released a joint statement on the conflict minerals disclosure rule decision in which they say they believe the entirety of the rule should be stayed pending the outcome of the litigation.]