Federal Register, Volume 77 Issue 246 (Friday, December 21, 2012)

[Federal Register Volume 77, Number 246 (Friday, December 21, 2012)]
[Notices]
[Pages 75689-75695]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-30739]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-68453; File No. PCAOB-2012-01]

Public Company Accounting Oversight Board; Order Granting
Approval of Proposed Rules on Auditing Standard No. 16, Communications
With Audit Committees, and Related and Transitional Amendments to PCAOB
Standards

December 17, 2012.

I. Introduction

On August 28, 2012, the Public Company Accounting Oversight Board
(the ``Board'' or the ``PCAOB'') filed with the Securities and Exchange
Commission (the ``Commission''), pursuant to Section 107(b) \1\ of the
Sarbanes-Oxley Act of 2002 (the ``Sarbanes-Oxley Act'') and Section
19(b) \2\ of the Securities Exchange Act of 1934 (the ``Exchange
Act''), proposed rules to adopt PCAOB Auditing Standard No. 16,
``Communications with Audit Committees,'' and related and transitional
amendments to PCAOB standards (collectively, the ``Proposed Rules'').
The Proposed Rules were published for comment in the Federal Register
on September 17, 2012.\3\ At the time the notice was issued, the
Commission designated a longer period to act on the Proposed Rules,
until December 17, 2012.\4\ The Commission received five comment
letters in response to the notice.\5\ On November 9, 2012, the PCAOB
submitted a letter addressing certain comments received by the
Commission.\6\ This order approves the Proposed Rules.
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\1\ 15 U.S.C. 7217(b).
\2\ 15 U.S.C. 78s(b).
\3\ See Release No. 34-67804 (September 10, 2012), 77 FR 57408
(September 17, 2012).
\4\ Ibid.
\5\ See letters to the Commission from Howard B. Levy, Principal
and Director, Technical Services, Piercy Bowler Taylor & Kern, dated
September 28, 2012 (``Piercy Letter''); Robert L. Leclerc, Chairman,
Quest Rare Minerals Ltd., dated September 30, 2012 (``Quest
Letter''); Tom Quaadman, Vice President, Center for Capital Markets
Competitiveness, U.S. Chamber of Commerce, dated October 5, 2012
(``Chamber Letter''); Deloitte & Touche LLP, dated October 5, 2012
(``Deloitte Letter''); and Cindy M. Fornelli, Executive Director of
the Center for Audit Quality, dated October 9, 2012 (``CAQ
Letter'').
\6\ See letter to the Commission from the PCAOB, dated November
9, 2012.
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II. Description of the Proposed Rules

Auditing Standard No. 16 will supersede PCAOB interim auditing
standard AU section 380, ``Communication with Audit Committees'' (``AU
sec. 380''), and interim auditing standard AU section 310,
``Appointment of the Independent Auditor'' (``AU sec. 310''). Auditing
Standard No. 16 retains or enhances existing audit committee
communication requirements, incorporates SEC auditor communication
requirements set forth in Rule 2-07 of Regulation S-X,\7\ provides a
definition of the term `audit committee' for issuers and non-issuers,
and adds new communication requirements that are generally linked to
performance requirements set forth in other PCAOB auditing standards.
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\7\ 17 CFR 210.2-07.
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Auditing Standard No. 16 requires the auditor to establish an
understanding of the terms of the audit engagement with the audit
committee. This requirement aligns the auditing standard with the
provision of the Exchange Act, as amended by the Sarbanes-Oxley Act,
that requires the audit committee of listed companies to be responsible
for the appointment of the external auditor.\8\ Additionally, Auditing
Standard No. 16 requires the auditor to record the terms of the
engagement in an engagement letter and to have the engagement letter
executed by the appropriate party or parties on behalf of the company
and determine that the audit committee has acknowledged and agreed to
the terms.
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\8\ See Section 10A(m) of the Exchange Act, as added by Section
301 of the Sarbanes-Oxley Act.
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Auditing Standard No. 16 requires the communications with the audit
committee to occur before the issuance

[[Page 75690]]

of the audit report. The standard requires auditors to communicate,
among other matters, the following to audit committees:
Certain matters regarding the company's accounting
policies, practices, and estimates (consistent with Rule 2-07 of
Regulation S-X);
The auditor's evaluation of the quality of the company's
financial reporting;
Information related to significant unusual transactions,
including the business rationale for such transactions;
An overview of the overall audit strategy, including
timing of the audit, significant risks the auditor identified, and
significant changes to the planned audit strategy or identified risks;
Information about the nature and extent of specialized
skill or knowledge needed in the audit, the extent of the planned use
of internal auditors, company personnel or other third parties, and
other independent public accounting firms, or other persons not
employed by the auditor that are involved in the audit;
Difficult or contentious matters for which the auditor
consulted outside the engagement team;
The auditor's evaluation of going concern;
Expected departures from the auditor's standard report;
and
Other matters arising from the audit that are significant
to the oversight of the company's financial reporting process,
including complaints or concerns regarding accounting or auditing
matters that have come to the auditor's attention during the audit.
Auditing Standard No. 16 retains from AU sec. 380 the option for
auditors to communicate to audit committees either orally or in
writing, unless otherwise specified in the standard. The auditor is
required to document the communications in the work papers, regardless
of whether the communications take place orally or in writing.
As part of the Proposed Rules, the Board adopted conforming
amendments to several PCAOB standards, including PCAOB interim auditing
standard AU sec. 722, ``Interim Financial Information.'' In addition to
the conforming amendments, the Board adopted transitional amendments to
AU sec. 380 so that audit committee communications would continue to be
required in audits of all SEC-registered broker-dealers in the event
PCAOB standards become applicable to broker-dealer audits prior to the
effective date of Auditing Standard No. 16.
The PCAOB has proposed application of its Proposed Rules to audits
of all issuers, including audits of emerging growth companies
(``EGCs''),\9\ and the Proposed Rules also would apply to audits of
SEC-registered brokers and dealers if the Commission subsequently
determines to make PCAOB standards applicable to such audits.\10\ The
Proposed Rules would be effective for audits of financial statements
with fiscal years beginning on or after December 15, 2012. The
transitional amendments to AU sec. 380 would be effective for the
periods that PCAOB standards become applicable to audits of SEC-
registered brokers and dealers, as designated by the Commission, if the
effective date of the application of PCAOB standards occurs prior to
the effective date of Auditing Standard No. 16.
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\9\ The term ``emerging growth company'' is defined in Section
3(a)(80) of the Exchange Act.
\10\ The Commission proposed requiring application of PCAOB
standards to audits for brokers and dealers in Release No. 34-64676
(June 15, 2011).
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III. Comment Letters and the PCAOB's Responses

As noted above, the Commission received five comment letters
concerning the Proposed Rules. Two commenters expressed unqualified
support for the Proposed Rules, and cited a link between Auditing
Standard No. 16 and investor protection.\11\ One of these commenters
expressed its view that the matters Auditing Standard No. 16 requires
auditors to communicate to audit committees are commensurate with, and
supportive of, the important role audit committees have in serving the
interests of investors through oversight of financial reporting and the
audit process.\12\ The other commenter cited its belief that adoption
of Auditing Standard No. 16 is in the public interest and contributes
to investor protection because it establishes requirements that enhance
the relevance, timeliness, and quality of communications between
auditors and audit committees.\13\
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\11\ See CAQ Letter and Deloitte Letter.
\12\ See Deloitte Letter.
\13\ See CAQ Letter.
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One of these commenters also expressed unqualified support for the
application of the proposed rules to audits of EGCs and stated its
belief that investors in public companies of all sizes are entitled to
the same level of protection, including the protection provided by
improved communications between auditors and audit committees.\14\ This
commenter also cited the following points in support of its view:
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\14\ See CAQ Letter.
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Auditing Standard No. 16 will foster improved financial
reporting. The commenter believes improved financial reporting reduces
information asymmetry and should increase the efficiency of capital
allocation, thereby fostering capital formation. The commenter also
believes this may be particularly important for EGCs, which may need to
access the capital markets more regularly than more established
companies.
Bifurcation of the requirements would be confusing as to
the level of investor protection an investor is receiving. The
commenter believes that applying Auditing Standard No. 16 to audits of
EGCs would avoid bifurcation of the rules applied to the preparation
and audit of public company financial statements. The commenter also
believes that having different sets of rules for different categories
of public companies makes it more difficult for investors to know what
rules governed the preparation and audit of a given set of financial
statements.
Three commenters raised questions and concerns about the Proposed
Rules and their proposed application. These matters relate to: (1)
Application of the Proposed Rules to audits of foreign private issuers
(``FPIs''); \15\ (2) application of Auditing Standard No. 16 to audits
of broker-dealers; (3) the role of management in communicating matters
to the audit committee that are also the subject of Auditing Standard
No. 16; (4) the specificity of the requirements in Auditing Standard
No. 16; (5) potential regulatory conflicts; (6) convergence of auditing
standards; and (7) the PCAOB's analysis supporting its proposal that
the Proposed Rules apply to audits of EGCs (the ``PCAOB's EGC
analysis'').
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\15\ The term ``foreign private issuer'' is defined in Exchange
Act Rule 3b-4(c) [17 CFR 240.3b-4(c)]. A foreign private issuer
means any foreign issuer other than a foreign government except an
issuer that meets the following conditions: (1) More than 50 percent
of the issuer's outstanding voting securities are directly or
indirectly held of record by residents of the United States; and (2)
any of the following: (i) the majority of the executive officers or
directors are United States citizens or residents; (ii) more than 50
percent of the assets of the issuer are located in the United
States; or (iii) the business of the issuer is administered
principally in the United States.
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1. Audits of FPIs

One commenter requested clarification as to whether or not the
Proposed Rules would apply to audits of issuers that are FPIs.\16\ The
commenter stated that it was not seeking relief, solely clarity. In
response to the commenter's request, the Commission notes that under
the Sarbanes-Oxley Act, the PCAOB's auditing and other professional
standards apply to audits of

[[Page 75691]]

issuers.\17\ There is no exception for issuers that are FPIs, and the
PCAOB did not propose to create an exclusion. Accordingly, the Proposed
Rules, consistent with other auditing standards adopted by the PCAOB,
will apply to audits of FPIs.
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\16\ See Quest Letter.
\17\ See Sections 101(c)(2) and 103(a)(1) of the Sarbanes-Oxley
Act.
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2. Audits of Broker-Dealers

One commenter requested more clarity about to whom the required
Auditing Standard No. 16 audit committee communications should be made
in situations when a broker-dealer does not have a board of directors
or audit committee.\18\ The commenter also recommended that the PCAOB
make clear that the required communications should not be made to a
chief financial officer or similar officer, but rather a chief
executive officer. The commenter raised similar comments in connection
with the PCAOB's own solicitation for comments on the Proposed Rules.
The PCAOB revised Auditing Standard No. 16 in response to this comment,
which was also raised by other commenters. The PCAOB revised the
definition of audit committee with respect to non-issuers such that, if
a non-issuer broker-dealer did not have a board of directors or audit
committee, the required communications would be directed to the
person(s) identified by the auditor as responsible for overseeing the
accounting and financial reporting processes of the company.
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\18\ See Chamber Letter.
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However, the definition was not revised to exclude from the
definition of audit committee those persons with oversight
responsibility who also have management responsibilities for the
preparation of the financial statements of the company. In its adopting
release, the PCAOB stated that for non-issuers with no existing audit
committee or board of directors (or equivalent body), the auditor would
be expected to identify senior persons at the company who have
decision-making authority and responsibility to oversee the accounting
and financial reporting processes of the company and audits of the
financial statements, and to make the required communications to those
persons.\19\ The PCAOB provided examples and stated that if all persons
identified by the auditor as having responsibility for oversight of the
company's accounting and financial reporting processes and audits also
have management responsibilities for the preparation of the financial
statements, then the auditor could also make the communications
specified in the standard to other individuals at the company (e.g.,
the chief executive officer or others in charge of the company's
operations and performance, who may benefit from the communications).
The Commission does not find the PCAOB's response to be unreasonable.
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\19\ See PCAOB Release No. 2012-004 (August 15, 2012), pg. A4-3.
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The commenter also requested that the PCAOB clarify to whom audit
committee communications should be made when a broker-dealer is a
subsidiary of an entity that has an audit committee.\20\ The PCAOB
addressed this comment in its adopting release as well. In that
release, the PCAOB observed that some commenters suggested that the
standard should clarify to whom the auditor should communicate when the
company is a subsidiary of another entity. The PCAOB stated that
Auditing Standard No. 16 does not require communication outside the
governance structure of the audited entity because the standard
designates the appropriate party to receive the auditor communications
within the audited entity.\21\ The PCAOB also stated that if directed
by the audit client, or if the auditor otherwise deems it appropriate,
the auditor could also communicate to a parent company audit committee
or equivalent body. The Commission does not find the PCAOB's response
to be unreasonable.
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\20\ See Chamber Letter.
\21\ See PCAOB Release No. 202-004 (August 15, 2012), pg. A4-4.
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3. The Role of Management in Communicating Matters to the Audit
Committee

One commenter repeated concerns expressed in letters to the PCAOB
during the PCAOB's proposal stages that Auditing Standard No. 16
appears to shift inappropriately from management to auditors the
primary responsibility to communicate to audit committees about matters
of the selection and identification of significant and critical
accounting policies, estimates and significant unusual
transactions.\22\ The commenter acknowledged that the PCAOB revised
Auditing Standard No. 16 in response to this comment, and observed that
Auditing Standard No. 16 is not intended to change the requirements of
Rule 2-07 of Regulation S-X. However, the commenter believes the
Commission should give consideration to its concerns and make
``appropriate revisions'' to Rule 2-07 to preserve what the commenter
believes is the proper balance among the responsibilities of
management, audit committees and auditors.
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\22\ See Piercy Letter.
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The Commission has previously considered views similar to those
expressed by the commenter. Exchange Act Section 10A(k), as added by
Section 204 of the Sarbanes-Oxley Act, directed the Commission to issue
rules requiring timely reporting of specific information by auditors to
audit committees. In response to this directive, in 2002, the
Commission proposed amending Regulation S-X to require each public
accounting firm registered with the Board that audits an issuer's
financial statements to report, prior to the filing of such report with
the Commission, to the issuer or registered investment company's audit
committee: \23\
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\23\ See Release No. 33-8154 (December 2, 2002).
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(1) All critical accounting policies and practices used by the
issuer or registered investment company;
(2) All alternative accounting treatments of financial information
within generally accepted accounting principles that have been
discussed with management, including the ramifications of the use of
such alternative treatments and disclosures and the treatment preferred
by the accounting firm; and
(3) Other material written communications between the accounting
firm and management of the issuer or registered investment company.
In response to this proposal, some commenters expressed a view that
these communications should be the responsibility of management alone,
while others expressed a view that both the accountant and management
should share the responsibility for informing the audit committee about
such matters. In adopting Rule 2-07, the Commission stated that
``[w]hile we understand that management has the primary responsibility
for the information contained in the financial statements, since the
accounting firm is retained by the audit committee, we share the view
reflected in Section 205 [sic] of the Sarbanes-Oxley Act and current
auditing standards, that the accounting firm has a responsibility to
communicate certain information to the audit committee.'' \24\ The
Commission still holds this view and believes that the communications
required by Auditing Standard No. 16 in this regard are appropriate.
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\24\ See Release No. 33-8183 (March 27, 2003).
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Further, the Commission believes that additional changes made by
the PCAOB in response to this concern are appropriate and balanced. In
its adopting release, the PCAOB observed

[[Page 75692]]

that in many companies, management might communicate matters involving
management's preparation of the company's financial statements and that
in many companies, management might communicate these matters or take
the lead on communicating these matters to the audit committee. The
PCAOB also observed that it does not have the authority to require
management to communicate to the audit committee, and that certain
communications are mandated by federal securities laws and Commission
rules. Because of these factors, Auditing Standard No. 16 clearly
recognizes and acknowledges that management might communicate to the
audit committee certain matters related to the company's financial
statements; and in such circumstances, the auditor does not need to
communicate those matters at the same level of detail as management, as
long as certain conditions are met, as specified in the standard.

4. Level of Specificity of Requirements in Auditing Standard No. 16

One commenter observed that Auditing Standard No. 16 is
``prescriptive'' in that it contains specific mandatory communication
requirements.\25\
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\25\ See Chamber Letter.
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The PCAOB addressed this comment in its letter to the Commission.
In that letter, the PCAOB stated that its standards, including Auditing
Standard No. 16, reflect the fact that a company's size and complexity
can affect the risks of material misstatement and that the Proposed
Rules are designed to allow auditors to tailor the required
communications to the size and level of complexity of a company's
operations, accounting practices, and audit issues.
The Commission addressed a similar comment in 2010 in connection
with its consideration of rules proposed by the PCAOB to establish new
risk assessment standards.\26\ The Commission recognizes that there
should be an appropriate balance in auditing standards between
providing necessary minimum requirements and allowing auditors to apply
judgment in determining the nature and extent of audit procedures given
the particular circumstances of an individual engagement. The
Commission believes that all PCAOB standards should reflect an
appropriate balance of requirements and judgments that enables auditors
to perform high quality and effective audits and believes the PCAOB's
approach in Auditing Standard No. 16 reflects a reasonable balance in
this respect.
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\26\ See Release No. 34-63606 (December 23, 2010).
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5. Potential Regulatory Conflicts

One commenter voiced concerns that the Proposed Rules may go
outside of the scope of the PCAOB's jurisdiction over the audit and
infringe upon the corporate governance responsibilities of the
Commission or under applicable state law in overseeing the audit
committee.\27\ This commenter asked that the Commission review the
Proposed Rules ``with an eye towards eliminating any potential
regulatory conflict.'' In considering the Proposed Rules, the
Commission does not believe the Proposed Rules create any potential
regulatory conflicts. In its adopting release, the PCAOB recognized the
scope and limits of its jurisdiction. In one place, the PCAOB states
that its definition of audit committee is not intended to conflict with
or affect any requirements, or the application of any requirements,
under federal law, state law, foreign law, or an entity's governing
documents regarding the establishment, approval, or ratification of
board of directors or audit committees, or the delegation of
responsibilities of such a committee or board; \28\ and in another
place, the Board recognized that it does not have the authority to
require management to communicate to the audit committee.\29\
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\27\ See Chamber Letter.
\28\ See PCAOB Release No. 202-004 (August 15, 2012), pg. A4-2.
\29\ See PCAOB Release No. 202-004 (August 15, 2012), pg. 4.
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6. Convergence of Auditing Standards

One commenter expressed support for the notion of working to
achieve one set of global high quality auditing standards through the
convergence of PCAOB auditing standards with those of the International
Auditing and Assurance Standards Board (``IAASB'') and the Auditing
Standards Board of the American Institute of Certified Public
Accountants (``ASB'') and observed that the Proposed Rules do not
adequately identify and explain the rationale for differences between
the Proposed Rules and the relevant standards of the IAASB and ASB.\30\
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\30\ See Chamber Letter.
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The PCAOB has received similar comments in the past, and has
observed that:

[B]ecause the Board's standards must be consistent with the
Board's statutory mandate, differences will continue to exist
between the Board's standards and the standards of the IAASB and
ASB, e.g., when the Board decides to retain an existing requirement
in PCAOB standards that is not included in IAASB or ASB standards.
Also, certain differences are often necessary for the Board's
standards to be consistent with relevant provisions of the federal
securities laws or other existing standards or rules of the
Board.\31\
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\31\ See PCAOB Release No. 2010-004, August 5, 2010, pp. A10-
91--A10-92 (internal footnotes omitted).

The Commission also addressed a similar comment in connection with
its consideration of the rules proposed by the PCAOB to establish new
risk assessment standards.\32\ As noted then, the Commission encourages
the Board's efforts to consider standards issued by the IAASB and the
ASB, and appreciates the reasons why it is reasonable to expect that
the Board's standards may appropriately differ from such standards. In
this regard, we take note of the efforts the PCAOB has taken in
developing the Proposed Rules to consider the work of other standard
setters.
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\32\ See supra note 26.
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7. The PCAOB's EGC Request and the Commission's EGC Determination

Section 103(a)(3)(C) of the Sarbanes-Oxley Act provides that any
additional rules adopted by the PCAOB subsequent to April 5, 2012 do
not apply to the audits of EGCs, unless the Commission determines that
the application of such additional requirements is necessary or
appropriate in the public interest, after considering the protection of
investors and whether the action will promote efficiency, competition,
and capital formation.\33\ Having considered those factors, and as
explained further below, the Commission finds that applying the
Proposed Rules to audits of EGCs is necessary or appropriate in the
public interest.
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\33\ Section 103(a)(3)(C) of the Sarbanes-Oxley Act, as amended
by Section 104 of the Jumpstart Our Business Startups Act (the
``JOBS Act'').
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The PCAOB adopted Auditing Standard No. 16 on August 15, 2012 for
application to audits of all issuers, including EGCs; and the PCAOB
requested that the Commission make the determination required by
Section 103(a)(3)(C) such that Auditing Standard No. 16 would apply to
audits of EGCs. To assist the Commission in making its determination,
the PCAOB prepared and submitted to the Commission its own EGC
analysis. The PCAOB's EGC analysis includes discussions of: (1) The
background of and reasons for the new standard; (2) the PCAOB's
approach to developing the new standard, including consideration of
alternatives; (3) key changes and improvements from existing audit
committee

[[Page 75693]]

communication requirements; and (4) characteristics of EGCs and
economic considerations.
In developing its analysis, the PCAOB compiled data available from
entities voluntarily identifying themselves as EGCs in SEC filings.
Based on data available to the PCAOB, the Board observed that one key
difference between EGCs and other entities appears to be the length of
time an EGC has been subject to the reporting requirements under the
Exchange Act.\34\ The Board also observed that the enhanced audit
committee communication requirements of Auditing Standard No. 16 may be
of particular benefit to EGCs given that: (1) Some EGCs are companies
that are relatively new to the SEC reporting process, and may have new
audit committee members that may be less familiar with SEC reporting
requirements and have relatively more questions regarding how to
present their financial statements for SEC reporting purposes; and (2)
some EGCs may also be considering, for the first time, initial choices
in their accounting policies and practices that could have implications
for their financial reporting.\35\
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\34\ See 77 FR 57448.
\35\ See 77 FR. 57447.
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The PCAOB's EGC analysis was included in the Commission's public
notice soliciting comment on the Proposed Rules. Based on the analysis
submitted, the comments received, and the PCAOB's response, we believe
the information in the record is sufficient for us to make the EGC
determination in relation to this standard. Specifically, the PCAOB's
EGC analysis discussed its approach to developing the new standard and
its consideration of alternatives, as well as the characteristics of
EGCs and economic considerations. The Commission also takes note, in
particular, of the PCAOB's overall approach to Auditing Standard No.
16, which was designed to: (1) Scale the required communications to the
size and complexity of the company being audited; (2) maintain
flexibility (e.g., with respect to auditors communicating orally or in
writing); (3) minimize duplicative or redundant communications to the
audit committee from the auditor and management; (4) focus the
communications on the accounting matters that are significant to the
auditor and the audit committee; and (5) reduce auditors' search costs
(i.e., the costs associated with researching the federal securities
laws' and auditing standards' various communication requirements) by
providing a list of other PCAOB standards and rules that contain audit
committee communication requirements in one place. Moreover, the
auditor's requirements under the new standard are focused on
communicating the results of audit procedures that the auditor is
already required to perform.
One commenter raised concerns about the PCAOB's EGC analysis.\36\
This commenter did not assert that any specific aspect of Auditing
Standard No. 16 should not apply to audits of EGCs. Rather, the
commenter raised several concerns about the substance and form of the
PCAOB's EGC analysis and whether it was sufficient to form a basis for
the Commission's EGC determination. We discuss each of this commenter's
main points, and set forth our responses, separately below.
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\36\ See Chamber Letter.

First, the commenter states that because the JOBS Act
provides an automatic exemption for EGC audits from any future PCAOB
rules, there is a special burden on the Commission to determine that
benefits outweigh costs in order to reverse a clear Congressional
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directive in favor of an exemption.

As noted above, Section 103(a)(3)(C) of the Sarbanes-Oxley Act
contains very specific provisions concerning the application of PCAOB
rules to audits of EGCs. The statutory text of Section 103(a)(3)(C)
demonstrates that where Congress intended to provide EGCs with an
absolute exemption from future PCAOB rules, it did so explicitly (e.g.,
that any future PCAOB rules on mandatory audit firm rotation or an
auditor discussion and analysis shall not apply to EGCs audits). By
contrast, with respect to other future PCAOB rules, Congress indicated
that new requirements may apply to EGCs, but that for them to apply,
the Commission needs to make a determination that such application is
``necessary or appropriate in the public interest, after considering
the protection of investors, and whether the action will promote
efficiency, competition, and capital formation.'' This determination is
separate from the existing finding needed to approve a PCAOB proposed
rule change under Section 107 of the Sarbanes-Oxley Act that the
proposed rule is consistent with the requirements of the Sarbanes-Oxley
Act and the securities laws, or is necessary or appropriate in the
public interest or for the protection of investors.\37\
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\37\ See Section 107(b)(3) of the Sarbanes-Oxley Act. As
discussed below, the Commission makes both findings. The Commission
makes each finding on its own merits and does not consider either
one dependent on the other.
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Just as the Section 107 finding does not require the Commission to
overcome a ``presumption'' that a proposed PCAOB rule should be
disapproved, the Section 103 EGC determination does not require the
Commission to overcome a ``presumption'' that a PCAOB proposed rule
should not apply to audits of EGCs. Rather, in both instances, the
statute sets forth a predicate finding that the Commission must make,
after considering specified factors, in order for the rule to be
approved (section 107(b)(2)) or for it to apply to EGC audits (Section
103(a)(3)(C)).
The statutory text of Section 103(a)(3)(C) requires the Commission
to consider the protection of investors and whether the action will
promote efficiency, competition, and capital formation as part of its
affirmative determination that the application of such additional
requirements is necessary or appropriate in the public interest.
Plainly this involves considering the economic effects of the Proposed
Rules as they relate to efficiency, competition and capital formation.

Second, the commenter believes the PCAOB's EGC analysis
is ``devoid of any semblance of an analysis of the cost of
compliance with the rule for all issuers or for EGCs,'' and asserts
that the PCAOB, in its EGC analysis, cited a belief that Auditing
Standard No. 16 would be less costly for EGCs.

The PCAOB did provide information regarding potential costs of the
proposed rules to issuers, including EGCs. The PCAOB's analysis
included qualitative factors that would affect such costs (e.g., nature
or complexity of the issuer). As noted above, the PCAOB also provided
an analysis of the characteristics of EGCs, including data on the
number of issuers that have voluntarily disclosed their EGC status
after enactment of the JOBS Act. In its analysis, the PCAOB noted that
EGCs vary widely in size, and noted that one key difference between
EGCs and other entities appears to be the length of time an EGC has
been subject to the reporting requirements under the Exchange Act. In
this regard, the PCAOB further described how this difference may in
fact relate to the ability of the Proposed Rules to promote efficiency
and capital formation for EGCs over other issuers.
Notwithstanding the commenter's assertion that the PCAOB believes
the application of Auditing Standard No. 16 would be less costly for
EGCs, no such statement is expressed in the PCAOB's EGC analysis.
Rather, the PCAOB's EGC analysis reflects the Board's view that a
company's size and complexity can affect the risks of material
misstatement, and therefore, auditing challenges and audit strategies
(matters that impact the

[[Page 75694]]

amount of time and effort put into an audit). This point was reiterated
in the PCAOB's letter to the Commission. In that letter, the PCAOB also
provided examples of how communications required by Auditing Standard
No. 16 could be tailored to the audit of a less complex company, which
could have an impact on the overall cost of the audit and could help to
avoid unnecessary costs.
Section 103(a)(3)(C) does not require the Commission to conclude
that a proposed PCAOB rule would be ``less costly'' for EGC audits than
for other issuer audits in order to find that applying the rule to EGC
audits would be necessary or appropriate in the public interest. The
relative impact on EGCs vis a vis other issuers could be a factor to
consider in whether the application of the proposed rules to EGC audits
is necessary or appropriate in the public interest, after considering
the protection of investors and whether the action will promote
efficiency, competition, and capital formation. However, nothing in the
statutory text indicates that the Commission's public interest finding
hinges on whether, on a categorical basis, the requirements of a given
PCAOB rule would be less costly for EGCs.

Third, the commenter disputes the relevance of existing
audit committee communication requirements under PCAOB interim
auditing standard AU sec. 380 to a discussion of the application of
Auditing Standard No. 16 to audits of EGCs.

The Commission does not view the PCAOB's discussion of the Proposed
Rules in relation to the existing standards as inconsistent with the
proper analysis of an EGC determination. Rather, establishing a
baseline for conducting an analysis of economic effects of a proposed
regulatory action is an appropriate regulatory practice. Also, it is
important to consider that currently, all issuers, including EGCs, are
subject to the existing audit committee communication requirements of
AU secs. 310 and 380 and Rule 2-07 of Regulation S-X. If the Commission
determined that the Proposed Rules should not apply to audits of EGCs,
AU secs. 310 and 380 and Rule 2-07 of Regulation S-X would still apply
to the audits of EGCs.\38\
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\38\ Also, the Commission does not view the PCAOB's highlighting
the existing baseline as the sole justification to carry forward
existing requirements. Rather, throughout the PCAOB's submission
describing the individual requirements of the standard, while the
PCAOB notes whether the particular requirement is new or carried
forward, the PCAOB also explains why it chose to include them
irrespective of whether they already are included in the existing
standards.
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The Commission believes the PCAOB's EGC analysis appropriately
describes the consequences of the Proposed Rules relative to the
baseline. As the PCAOB notes in its submission, the impact of the
Proposed Rules is largely incremental to existing requirements
regarding communications between auditors and audit committees.
Accordingly, this discussion of existing requirements is highly
relevant to considering the impacts on efficiency, competition and
capital formation that would be caused by applying the new standard to
audits of EGCs. The Commission does not believe the Proposed Rules can
be categorized as a major or profound change to the way auditors
communicate with audit committees. In fact, the PCAOB received comments
to this effect during its own due process. For example, one commenter
observed that ``many of the requirements [of the proposed rules] are
already reflected in the best practices of audit firms and public
companies.'' \39\ Another commenter to the PCAOB stated its ``belie[f]
that auditors, in most cases, are already providing meaningful
communications on the financial statement and audit areas that meet the
spirit of the requirements of the Proposed Standard and go beyond what
is currently required by the extant standards.'' \40\
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\39\ See letter from The Society of Corporate Secretaries and
Governance Professionals to the PCAOB (June 1, 2010). This letter
may be viewed at: http://pcaobus.org/Rules/Rulemaking/Docket030/032_SCSGP.pdf.
\40\ See letter from Deloitte & Touche to the PCAOB (May 28,
2010). This letter may be viewed at: http://pcaobus.org/Rules/Rulemaking/Docket030/020_DT.pdf.

Fourth, the commenter raised a concern that the public
was never afforded an opportunity to comment upon the impact of the
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proposed rules on the audits of EGCs.

Section 103(a)(3)(C) requires the Commission to make the specified
determination. The PCAOB submitted an EGC analysis that assisted the
Commission in its own determination. The PCAOB's analysis was included
in the Commission's notice of the Proposed Rules which provided an
opportunity for the public, including the commenter, to submit comments
on the analysis.\41\ The PCAOB also supplemented the record with
additional information after comments were received. As noted above,
based on the analysis submitted, the comments received, and the PCAOB's
response, we believe the information in the record is sufficient for us
to make the EGC determination.
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\41\ In addition, the commenter acknowledged that the JOBS Act
was signed into law after the PCAOB's second comment period closed.
The PCAOB did not re-expose the Proposed Rules again as part of its
standard-setting process to seek public input on whether application
of the Proposed Rules to EGC audits would be necessary or
appropriate in the public interest, after considering the protection
of investors, and whether the action will promote efficiency,
competition, and capital formation.

Fifth, the commenter believes that the inspection
findings cited in the PCAOB's EGC analysis do not provide any
indication whether any of the audit committee communication failures
involved the audits of EGCs. The commenter also criticizes the
relevance of the PCAOB's citation to four year old research that
indicated that audit committee oversight was having a positive
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impact on the overall quality of audits.

In its EGC analysis, the PCAOB cited its inspection findings as one
input into its decision to bring together in one place audit committee
communication requirements; \42\ and in its letter to the Commission,
the PCAOB reiterated this point. The Commission believes it was
appropriate for the PCAOB to consider its inspection findings in
developing the Proposed Rules.
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\42\ See 77 FR 57441.
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As to the PCAOB's reference in its EGC analysis to research, the
Commission believes it was wholly appropriate for the PCAOB to
highlight the relationship between audit committee communications and
overall audit quality and improved financial reporting, given the
relevance of the quality of financial reporting to considerations of
efficiency and capital formation. It does not appear that the PCAOB was
referencing the research identified by the commenter to justify the
Proposed Rules themselves or was attempting to use research
inconsistently or opportunistically to support its views. Rather, the
PCAOB noted, citing to other research, that improved financial
reporting quality promotes efficiency and capital formation. The PCAOB
explained that the results of one of the studies cited in its EGC
analysis supported its view that audit committee oversight of the
auditor improves audit quality and financial reporting quality. The
PCAOB then went on to discuss additional findings from its outreach and
research that improved interaction between, and information shared,
between the auditor and the audit committee enhances audit committee
oversight and auditor performance.

IV. Conclusion

The Commission has carefully reviewed and considered the Proposed
Rules and the information submitted therewith by the PCAOB, including
the

[[Page 75695]]

PCAOB's EGC analysis, the comment letters received, and the PCAOB's
response. In connection with the PCAOB's filing and the Commission's
review,
A. The Commission finds that the Proposed Rules are consistent with
the requirements of the Sarbanes-Oxley Act and the securities laws and
are necessary or appropriate in the public interest or for the
protection of investors; and
B. Separately, the Commission finds that the application of the
Proposed Rules to EGC audits is necessary or appropriate in the public
interest, after considering the protection of investors and whether the
action will promote efficiency, competition, and capital formation.
It is therefore ordered, pursuant to Section 107 of the Act and
Section 19(b)(2) of the Exchange Act, that the Proposed Rules (File No.
PCAOB-2012-01) be and hereby are approved.

By the Commission.
Elizabeth M. Murphy.
Secretary.
[FR Doc. 2012-30739 Filed 12-20-12; 8:45 am]
BILLING CODE 8011-01-P