Auditor Rotation and the Impediments to Private Ordering (Part 4)

Moreover, the staff has gone further than banning proposals that seek to require rotation.  Even proposals that call for reports on auditor independence have been allowed to be excluded.  In connection with Dell, shareholders submitted a proposal asking management to create a report on auditor independence.  Specifically, the proposal requested: 

Therefore, Be It Resolved: That the shareholders of Dell Inc. request that its Board Audit Committee prepare and disclose to Company shareholders an annual Audit Firm Independence Report that provides the following:

1. Information concerning the tenure of the Company's audit firm if such information is not already provided, as well as the aggregate fees paid by the Company to the audit firm over the period of its engagement; 2. Information as to whether the Board's Audit Committee has a policy or practice of periodically considering audit firm rotation or seeking competitive bids from other public accounting firms for the audit engagement, and if not, why; 3. Information regarding the mandated practice of lead audit partner rotation that addresses the specifics of the process used to select the new lead partner, including the respective roles of the audit firm, the Board's Audit Committee, and Company management; 4. Information as to whether the Board's Audit Committee has a policy or practice of assessing the risk that may be posed to the Company by the long-tenured relationship of the audit firm with the Company; 5. Information regarding any training programs for audit committee members relating to auditor independence, objectivity, and professional skepticism; and  6. Information regarding additional policies or practices, other than those mandated by law and previously disclosed, that have been adopted by the Board's Audit Committee to protect the independence of the Company's audit firm.

Dell (May 3, 2012).  The staff again allowed for exclusion, again because the proposal intruded into the ordinary business of the corporation.  As the staff reasoned:

There appears to be some basis for your view that Dell may exclude the proposal under rule 14a-8(i)(7), as relating to Dell's ordinary business operations. In this regard, we note that while the proposal addresses the issue of auditor independence, it also requests information about the company's policies or practices of periodically considering audit firm rotation, seekig competitive bids from other public accounting firms for audit engagement, and assessing the risks that may be posed to the company by the long-tenured relationship of the audit firm with the company. Proposals concernng the selection of independent auditors or, more generally, management of the independent auditor's engagement, are generally excludable under rule 14a-8(i)(7).  Accordingly, we will not recommend enforcement action to the Commission if Dell omits the proposal from its proxy materials in reliance on rule 14a-8(i)(7).

The analysis was repeated in letters to Xilnx, McKesson, Computer Sciences Corporation, and CA, Inc.

In addition to the questionable analysis about the application of the ordinary business exclusion (and non-application of the public policy exception), these proposals raise another more critical issue.  The truth is that most companies submit the auditor to shareholders for approval.  This is discussed in see Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.

But the disclosure companies must give when submitting the matter to shareholders provide no meaningful basis for shareholders to determine the quality of the services provided.  For the most part, companies only have to disclose fees, dividing them into audit and non-audit services. Specifically, Item 9 of Schedule 14A does not require any meaningful qualitative disclosure. 

It does require disclosure of audit related fees, tax fees, and all other fees.  But this information is out of date and not particularly useful in the shareholder voting process.  These categories were developed prior to SOX when shareholders needed to know the relationship between audit and non-audit fees.  In SOX, however, Congress largely prohibited auditors from performing most non-audit services, rendering the disclosure for the most part irrelevant.

Thus, these proposals are designed to fill a gap left by the SEC's disclosure regime.  They seek to ensure that shareholders when approving auditors have available meaningful information on the qualitative aspects of the relationship.