SEC Approves PCAOB Risk Assessment Standards and Deflects General Attack on PCAOB Standard-Setting

The SEC has approved the PCAOB’s risk assessment standards, effective for audits of fiscal years beginning on or after December 15, 2010. The risk assessment standards are designed to benefit investors by enhancing the effectiveness of the auditor’s assessment of and response to the risks of material misstatement in an audit. In approving the standards, the SEC emphasized that assessing and responding to risks underlies the entire audit process. Release No. 34-63606.

The new risk assessment standards replace interim standards in large part written twenty to thirty years ago and grandfathered by the Board when it began operations. Key changes made to the standards include an increased emphasis on fraud risks and disclosure, the inclusion of multi-location audit requirements, an alignment of the standards with AS No. 5 on internal controls, and inclusion of a concept of materiality more specifically grounded to that used in the federal securities laws.

The Commission received two comment letters: one from Deloitte & Touche, LLP and one from the Center for Capital Markets Competitiveness of the U.S. Chamber of Commerce, both of which expressed concern with the PCAOB’s general approach to standard-setting. Specifically, both commenters noted as concerns the Board’s divergence from IAASB standards, the prescriptive nature of the Board’s standards, and the lack of a codification of PCAOB standards.

The SEC noted that the PCAOB did consider IAASB audit standards when adopting its risk assessment standards. The Commission appreciates that in order to be consistent with the federal securities laws, and the PCAOB’s own statutory mandate, the Board’s standards may have to reasonably differ from IAASB standards.

Regarding the concern over prescriptiveness, the SEC recognizes that the Board endeavors to strike a proper balance in auditing standards between providing minimum requirements and allowing auditors to apply judgment in determining the nature and extent of audit procedures given the particular circumstances of an individual audit engagement. PCAOB standards recognize that the auditor uses judgment in planning and performing audit procedures and evaluating the evidence obtained from those procedures. At the same time, overly broad standards without an appropriate balance of necessary requirements could lead to a level of discretion that may limit the effectiveness of audits. While approving the balance that the PCAOB’s struck in the risk assessment standards, the SEC encouraged the Board to monitor implementation and evaluate the input received during the development of future standards to continue to strive to achieve an optimal balance.

Regarding codification of the auditing standards, the Commission noted that the Board
recently added this project to its strategic plan and amended its performance measure on standard-setting activities to reflect this new initiative.

Dutch Corporate Governance Monitor Says Supreme Court Ruling on Shareholder-Board Relations Calmed the Waters

A Netherlands Supreme Court ruling that a company’s management board can determine corporate strategy without involving the shareholders in advance of the decisions, and that the supervisory board is not obliged to mediate in disputes between the management board and shareholders, has calmed and clarified the vexing relationships between boards and shareholders. This was the view of the Dutch Corporate Governance Monitoring Committee on the landmark ASM International N.V. (ASMI) opinion rendered by the Court last year.

The committee also said that the supervisory board must have the freedom to decide from case to case whether direct contact with the shareholders and/or mediation between shareholders and the management board is desirable. But the committee also pointed out that the Supreme Court emphasized in its ruling that the management board is obliged to respect the rights of shareholders to obtain information during the general meeting of shareholders.

Although the debate on certain aspects of the Court’s ruling is still in progress, the Monitoring Committee expects the ruling to calm and clarify the vexed subject of the mutual relationships between the various organs of listed companies. The Committee also observed that these relationships could become unclear again as a result of pending legislation to compel shareholders with a stake of 3 per cent or more to indicate whether they object to the strategy of the company.

Approximately 75 per cent of the shares in the largest Dutch companies are held by foreign investors. In the view of the committee, the enactment of the legislation will probably usher in an era where shareholders will indicate that they do not agree with the corporate strategy in order to keep open all their options for future discussions with the management board. Consequently, a substantial proportion of the major shareholders may indicate solely for legal reasons that they do not support the company’s strategy, although this is often not the case in practice.

NASAA Opposes Additional Exams for Advisory Personnel

The North American Securities Administrators Association (NASAA) has urged the SEC not to spend the agency's limited resources on developing additional qualification examinations for investment adviser personnel. In a comment letter to the SEC's Acting Director Division of Investment Management, Jennifer McHugh, on December 13, 2010, NASAA opposed a FINRA proposal concerning the development and implementation by the SEC of an investment adviser personnel qualification program. In NASAA's view, the existing competency examinations developed by NASAA remain a vital tool in assessing the qualifications of individuals who are seeking registration as investment adviser representatives. NASAA also believes that FINRA's current continuing education program for registered representatives of broker-dealers is inapplicable to investment advisers.

NASAA observed that state regulators developed the existing Series 65 and 66 examinations in consultation with representatives from the investment adviser industry and experts in the development of qualification examinations. Moreover, NASAA has continued to revise the examinations with the involvement of both practitioners and compliance personnel to ensure that the examinations reflect the current needs of the industry. As a result, NASAA believes that current testing standards are both rigorous and comprehensive in scope. For example, NASAA noted that the existing Series 65 examination covers nearly all of the items that FINRA believes should be included on an investment adviser qualification examination, while also including others not listed by FINRA, such as tax considerations, retirement plans, and state registration issues.

Although acknowledging the need for a continuing education program for registered representatives, given the highly prescriptive nature of regulating the business practices of the broker-dealer industry, NASAA believes that the necessity of such a requirement should be carefully studied before it is determined whether it is appropriate for investment adviser representatives in light of their fiduciary duty. NASAA reminded the SEC that the regulation of investment adviser personnel is a principles-based structure, one centered on the requirement that an investment adviser act in the best interest of its client. The regulation of registered representatives, on the other hand, is modeled on a lesser standard supplemented by rules. Accordingly, NASAA believes that the current continuing education program applicable to registered representatives could not serve as a model for investment adviser representatives.