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SEC Approves Auditing Standard No. 16 as Applicable to EGCs

Posted in IPO On-Ramp

On December 17, 2012, the SEC issued an order granting approval of the Public Company Accounting Oversight Board’s Auditing Standard No. 16, “Communications with Audit Committees,” and related and transitional amendments to PCAOB.  Auditing Standard No. 16 will replace the temporary auditing standard regarding auditor communications with the audit committee that the PCAOB adopted shortly after it was formed. The new auditing standard will be effective for audits of financial statements with fiscal years beginning on or after December 15, 2012.

The approval of Auditing Standard No. 16 represents the first time that the SEC has used its authority under the JOBS Act to determine if a new auditing standard will apply to audits of emerging growth companies (“EGCs”). Section 103(a)(3)(C) of the Sarbanes-Oxley Act, as amended by Section 104 of the JOBS 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.

After considering all of those factors, the SEC found that applying Auditing Standard No. 16 to audits of EGCs is necessary or appropriate in the public interest.  In making this determination, the SEC considered the PCAOB’s EGC analysis, which included 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 communication requirements; and (4) characteristics of EGCs and economic considerations.  Only one commenter, the U.S. Chamber of Commerce, commented on the EGC analysis, and the SEC specifically responded to the points made in that comment letter.  The Chamber raised concerns about the PCAOB’s EGC analysis, focusing in particular on the substance and form of the PCAOB’s EGC analysis and whether it was sufficient to form a basis for the SEC’s EGC determination

In determining that Auditing Standard No. 16 should apply to EGCs, the SEC noted that the EGC determination does not require the Commission to overcome a “presumption” that a PCAOB proposed rule should not apply to audits of EGCs. Rather, the statute sets forth a predicate finding that the SEC must make, after considering specified factors, in order for the rule to be approved.