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US changes might prompt unwanted company disclosures, auditors fear

Investors in the U.S. could soon get a more in-depth look at auditors' thoughts on public companies, but accounting firms are worried the new requirements could force them to reveal sensitive information about their clients.

Proposed rule changes, set to be largely phased in by June 30, 2019, will require the publication of so-called "critical audit matters," or CAMS, including the perceived risk that a company is misstating its accounts, as well as the nature and timing of significant unusual transactions. But big auditors have raised concerns in comment letters about the danger of revealing previously undisclosed information, and some industry participants have even suggested accountants might be tempted to shroud any revelations in boilerplate language rather than cause trouble.

"I'm afraid that [critical audit matters] aren't going to be as informative as people would like because I do think there will be a fear about saying something we're not supposed to say," said Dave Niles, a partner at DHG Financial Services, who audits smaller banks.

The fact that the same topics will tend to re-occur as CAMs, such as the determination of allowances for loan and lease losses, the fair value of financial instruments, business combinations and income tax accounting, will only assist auditors if they wish to use standardized language to conceal rather than reveal, Niles said.

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In a comment letter to the Public Company Accounting Oversight Board, which proposed and passed the measures on to the Securities and Exchange Commission, PricewaterhouseCoopers said the wording of CAM rules might force auditors to reveal their opinions about whether a company's accounts are honest or not without being certain, potentially exposing accountants to legal liability if they turn out to be wrong. "We believe action is necessary to address the potential for increased and unwarranted litigation risk," PwC said.

Legal liability

The Center for Capital Markets Competitiveness at the U.S. Chamber of Commerce came out strongly against the proposal, and argued that the SEC should exempt auditors from any legal liability if they are shown to have performed their job correctly and in good faith.

"If approved, the Proposed Standard will contribute to disclosure ineffectiveness and overload, degrading the ability of the SEC to promote efficiency, competition and capital formation without a demonstration of the benefits of the proposal," it said in its comment letter.

Both the Public Company Accounting Oversight Board and the SEC declined to comment on the proposals, which would also require auditors to disclose their tenure of engagement, as well as provide a statement of independence and include the phrase "whether due to error or fraud" in a description of their responsibilities in a company's Form 10-K annual report. Some of the changes, which will bring U.S. reporting standards in line with others around the world, including those of the U.K. and the European Union, are due to go into effect for reports issued after Dec. 15, 2017.

Representatives of the SEC's chief accountant office said in a September conference that they were looking through comments and feedback about the CAM proposal, which were due by mid-August. The staff echoed comments from the Public Company Accounting Oversight Board that neither group expects auditors to provide original information unless it was necessary to describe the auditing matter, with the expectation that such a scenario would be rare.

But at least one CAM is likely to crop up in most audit reports, according to industry primers.

This means that discussing critical audit matters with company boards could become contentious, said Markus Veith, a partner in financial services at Grant Thornton. Auditors may argue a matter is critical while board members could push back that it is not, he said.

Niles also feared that deciding on what is a CAM could become a key source of disagreement between auditors and their clients.

"That's the million-dollar question right there," he said.

Despite such concerns, the SEC's investor advocate, Rick Fleming, supported the CAM proposal in an August 2016 comment letter, calling it a way for investors to form a "multifaceted" understanding of a company. Disclosures could highlight key financial reporting issues, inform investors during proxy voting or facilitate "a more focused and richer" dialogue between a company and its investors.

"If a critical audit matter is important enough to merit a conversation between the auditor and the audit committee, investors may determine that it could also merit discussion in their conversations with management," he wrote.