The SEC's approval of the new PCAOB auditing standards for risk related to material misstatements creates a bridge between compensation committees and the company's auditors. Chairs of compensation committee should expect to see auditors crossing that bridge with lots of questions, beginning next year.
In the newly revised PCAOB Auditing Standard No. 12 on Identifying and Assessing Risks of Material Misstatement, there is increased focus on financial relationships and transactions with executive officers. In addition to reading employment contracts and proxy disclosures, the auditor is facing several new requirements related to executive officer compensation that will impact compensation committees, including:
- A specific requirement to inquire of the compensation committee chair regarding "the structuring of the company's compensation for executive officers."
- Needing to obtain an understanding of executive compensation,
including at least two specific matters under the control of the
compensation committee:
- Changes or adjustments to incentive compensation arrangements, and
- Special bonuses.
Since the focus is on risk assessment, the auditors may go beyond the executive officers. If the compensation committee is involved in, for example, the incentive plan for all officers, the auditor could also ask about the structure of those incentives.
The revised standards apply to audits of financial statements for fiscal years beginning on or after December 15, 2014, including reviews of interim financial information within these fiscal years.
We expect that companies will want to prepare their compensation committee chairs for these auditor meetings. This ongoing auditor interaction may also be added to the duties of the compensation committee in its charter at the next revision.
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