Beginning in 2017, accounting firms participating in audits of issuers will be required to make additional disclosures, according to new rules released by the Public Company Accounting Oversight Board (PCAOB) this month. Rules 3210 and 3211 will require public accounting firms to file Form AP for each issuer audit, which discloses both the name of the engagement partner and the level of participation of any other accounting firm that participated in the audit. This information will be available in a searchable database on the PCAOB’s website. According to the PCAOB, the new rules promote “transparency about the partner and firms involved” in issuer audits and will “provide more specific data points in the mix of information that can be used when evaluating audit quality and hence credibility of financial reporting.” See PCAOB, Release No. 2015-008, Improving the Transparency of Audits: Rules to Require Disclosure of Certain Audit Participants On a New PCAOB Form and Related Amendments to Auditing Standards 15 (Dec. 15, 2015); News Release, PCAOB, PCAOB Adopts Rules Requiring Disclosure of the Engagement Partner and Other Accounting Firms Participating in an Audit (Dec. 15, 2015).
The new rules require public accounting firms to disclose for each issuer audit a Form AP that provides two types of information previously not made publicly available:
1. the name of the engagement partner, and
2. the participation in an audit of any “other accounting firms” (defined as any registered public accounting firm other than the firm filing the Form AP or any other person or entity that opines on the compliance of any entity’s financial statements within an applicable financial reporting framework)
With respect to “other accounting firms,” the rules require varying amounts of information depending on the degree to which the other firms participated in the audit. For any other accounting firm participating in five percent or more of an audit’s total hours, the responsible firm must disclose the name, city, state, and/or country of the other accounting firm, and the percentage of total hours attributable to that firm. For other accounting firms contributing participation of less than five percent of an audit’s total hours, the responsible firm must only disclose the total number of those other accounting firms and the aggregate percentage of total audit hours contributed by those other accounting firms.
Deadlines for filing the new Form AP are triggered by the date an auditor’s report is first included in a document filed with the Securities Exchange Commission. Typically, an accounting firm will have 35 days before the Form AP disclosures must be filed. In the case of initial public offerings, disclosures must be made within 10 days after the auditor’s report is first included in a document filed with the SEC.
Disclosure of the names of individual engagement partners will become effective for auditor’s reports issued on or after January 31, 2017, or three months after SEC approval of the final rules, whichever is later, and disclosure of other accounting firms will apply to auditor’s reports issued on or after June 30, 2017.
As the PCAOB noted in its rulemaking release, during the six-year development of the PCAOB’s new rules, some commenters raised concerns that requiring disclosure of the names of engagement partners would subject engagement partners to increased liability under the federal securities laws.
For example, section 11 of the Securities Act imposes liability on participants in a securities offering, including accountants, who are named as having prepared or certified any part of a registration statement or a report used in connection with the registration statement. During the PCAOB’s rulemaking, some questioned whether requiring disclosure of the names of engagement partners would increase those individuals’ liability under section 11. The PCAOB believes that it addressed this concern by requiring disclosure in a separate form that is not automatically incorporated by reference in an auditor’s report, and thus not incorporated by reference into a registration statement. See PCAOB, Release No. 2015-008, at 31. Whether this separation limits liability, however, remains to be seen.
Moreover, the PCAOB’s rulemaking release recognizes that “commenters expressed mixed views on the potential for liability under Exchange Act Section 10(b),” the act’s anti-fraud provision, and Rule 10b-5 promulgated thereunder. The PCAOB’s rulemaking release acknowledges that “the ultimate resolution of Section 10(b) liability is outside of [the PCAOB’s] control.” In addition to risks of liability under the federal securities laws, there may be an increased likelihood of the named engagement partner or disclosed “other accounting firms” to be added as defendants in the context of accounting negligence actions.
Accordingly, attorneys advising public accounting firms and individual engagement partners should be aware of the potential issues that may arise as a result of the PCAOB’s new required disclosures. In particular, public accounting firms (and the attorneys advising them) should ensure their clients understand the requirements of the new rules and begin to put in place robust compliance procedures to meet those requirements, including procedures designed to enhance information flow with other participating accounting firms.
Keywords: professional services liability litigation, PCAOB, Form AP, accounting firm disclosures
— James W. Thomas Jr., Arthur Luk, and Lindsay Vance Smith, Arnold & Porter LLP, Washington, D.C.