On October 21, 2014, the SEC approved amendments to certain auditing standards that impact small cap companies that maintain GAAP compliant audits and file reports with the SEC under the Securities Exchange Act of 1934 (“Exchange Act”). The SEC Order approved proposed rule changes that had been submitted to by the Public Company Accounting Oversight Board (the “PCAOB”) regarding the auditing standards for related party transactions and the standards regarding significant unusual transactions.
The amended rules apply to all SEC audits including those for broker-dealers and go into effect for the audits for fiscal year ends beginning on or after December 15, 2014.
Related Party Transactions
The SEC has approved new Auditing Standard No. 18 (AU No. 18) setting forth guidance and procedures for auditors to use in identifying and evaluating related party transactions. AU No. 18 is intended to strengthen requirements for identifying, assessing and responding to the risks of material misstatement associated with related party transactions. In particular, AU No. 18 requires an auditor to:
- Perform procedures to obtain an understanding of the company’s relationships and transactions with its related parties including the nature of the relationships and business terms (or lack thereof);
- Evaluate whether the company has properly identified its related parties and relationships and transactions with its related parties. AU No. 18 sets out specific procedures for the auditor to test the accuracy and completeness of its evaluation.
- Perform specific procedures if the auditor determines that a related party or relationship or transaction with a related party previously undisclosed to the auditor exists.
- Perform specific procedures regarding each related party transaction that is either required to be disclosed in the financial statements or determined to be a significant risk.
- Communicate with the company’s audit committee regarding the auditors’ findings and the company’s controls, procedures and accounting processes.
Significant Unusual Transactions
- Auditing Standards Section 316 (Consideration of Fraud in a Financial Statement Audit) (AU Sec. 316) addresses significant unusual transactions. AU 316 requires that if the auditor becomes aware of significant unusual transactions, further inquiry must be made, including taking steps to gain an understanding of the business rationale for the transactions and consider whether the transactions may constitute or conceal a fraud. The amended AU 316 requires an auditor to:
- Perform procedures to identify significant unusual transactions;
- Perform procedures to obtain an understanding of, and evaluate the business purpose (or lack thereof) of, significant unusual transactions;
- Consider certain factors in evaluating whether significant unusual transactions may be concealing fraudulent financial reporting or the misappropriation of assets;
Other Amendments
The PCAOB rule amendments also require that the auditor perform procedures in transactions and areas surrounding related parties or significant unusual transactions, including requiring the auditor to gain an understanding of the company’s financial relationships and transactions with its executive officers. The PCAOB rules are designed to make sure an auditor pays attention to incentives offered to key executives for particular financial results and milestones and the concurrent incentive to engage manipulative practices to achieve these goals. The amendments specifically exclude the auditors’ ability to opine on the appropriateness or reasonableness of executive compensation.
As part of the amendments, management must now provide a written representation to the auditor that there are no side agreements or other written or oral arrangements undisclosed to the auditor.
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The Author
Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
LAnthony@LegalAndCompliance.com
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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