
[Federal Register Volume 77, Number 246 (Friday, December 21, 2012)]
[Notices]
[Pages 75689-75695]
From the Federal Register Online via the Government Printing 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


