As 2013 dawns, spare a moment to consider the additional responsibilities being piled on the shoulders of audit and compensation committees by the Securities and Exchange Commission and its cohorts. Needless to say, in-house counsel will shoulder much of the burden.

As activist shareholders demand a say on pay, compensation committees will face fresh regulatory pressure to intensify their scrutiny of the people who advise them to ensure they are completely independent and not subject to conflicts of interest.

But the burden on audit committees may be worse, made heavier by the baggage left over from the mudslinging between Hewlett-Packard Company and the former management of its 2011 acquisition, Autonomy Corp. plc., which HP accused of “accounting improprieties and disclosure failures” that forced HP to take an $8.8 billion impairment charge in the fourth quarter of 2012. Autonomy’s former managers immediately denied the charge, citing the army of legal, accounting, and financial talent that HP hired to perform due diligence over the deal.

Whether a new auditing standard that requires auditors to probe an audit committee’s knowledge of its accounting policies and any unusual transactions could have made a difference in the HP case is uncertain.

But that is what the Public Company Accounting Oversight Board has put in place as part of an effort to create “robust” communications between both groups that also encourages audit committees to dig into the quality of their auditors by investigating how they performed in inspections by regulators.

The PCAOB has no authority over audit committees. So it took a roundabout route to stimulate their activity, requiring auditors to pose questions to the audit committee through Auditing Standard No. 16, Communications with Audit Committees, adopted in August 2012 following two years of hearings and comment.

If approved by the SEC, which has oversight of the PCAOB, it will apply to audits of public companies—including emerging growth companies under the JOBS Act—for fiscal periods after December 15. It was adopted in August by the PCAOB following two years of hearings and comment, and builds on the Sarbanes-Oxley Act, which gave audit committees a stronger role in overseeing the work of external auditors.

“The standard moves the auditor’s communication with the audit committee away from compliance checklists, and decisively in the direction of meaningful, effective interchange,” says PCAOB chairman James R. Doty.

The auditor’s report will now have to spell out findings on the company’s accounting policies, the quality of its financial reporting, and any accounting or auditing issues about which it has concerns. The auditor must ask the audit committee whether it is aware of any violations or possible violations of laws or regulations, as well as any other matters relevant to the audit. These inquiries may relate to material misstatement and fraud risks, and to issues the auditor might not have had to disclose before, such as information about unusual transactions, says Paul M. Rodel, a partner in Debevoise & Plimpton’s securities group.

Finally, the auditor must give the audit committee an evaluation of the company’s audit strategy and identify any risks the auditor discovers, as well as its view of the company as a going concern.

Requiring the auditor to ask the audit committee about possible violations of law should raise a red flag for general counsel, says Thomas W. White, partner and general counsel of Wilmer Cutler Pickering Hale and Dorr, and cochair of the American Bar Association’s audit response committee. “The issue for the GC is making sure that while the audit committee appropriately responds to this question, it does so in a way that does not imperil the company’s attorney-client privilege,” White says. “The committee should be careful to speak to the facts, and not about any legal advice it has received on the matter.”

How much extra work will the new standard require? Rodel says it does not impose new performance requirements on the audit committee or the external auditors other than greater communication back and forth, and should not significantly affect costs.

On the other hand, Raina Rose Tagle, head of risk advisory and internal audit services with Baker Tilly Virchow Krause says the GC can facilitate the committee’s work by preparing members for potential questions and for issues they traditionally do not explore, such as “significant unusual transactions” and “critical accounting estimates” that make assumptions about future events.

Separately, the PCAOB is also nudging audit committees to delve into the results of PCAOB inspections of deficiencies in audit firms’ reporting quality.

The PCAOB has suggested four questions audit committees ask their auditors about the inspections:

  • Did the PCAOB select the company’s own audit for inspection?
  • Did the PCAOB find similar deficiencies in other audits conducted by the auditor?
  • How did the audit firm respond to the PCAOB findings?
  • What topics are included in Part II findings—concerning defects in the auditor’s quality controls—and what changes is the firm making to address any quality control issues?

Any efforts by the auditor to sugarcoat its responses or give boilerplate answers—”it was a documentation problem” or “there was a difference in professional judgment”—should be shot down, the PCAOB advised.

Compensation committees and boards face a different set of challenges. Effective for the 2013 proxy season, they will have to comply with a new SEC rule intended to ensure the independence of compensation committee members and their consultants and advisers, and prevent conflicts of interest. Both the New York Stock Exchange and Nasdaq have proposed rules—similar but not identical—to comply with the SEC’s new rule, itself mandated by the Dodd-Frank Act.

Companies that don’t meet these standards will not be able to continue trading on the exchanges.

Fortunately, according to James Barrall, global cochair of Latham & Watkins’s benefits and compensation practice, most U.S. companies already have strict independence standards for their compensation committees and will have to make few changes. However, companies listed on Nasdaq, which have not been required to have separate compensation committees, will now have to do so, he notes.

Companies also will have to disclose in their proxy statements whether the compensation committee hired a compensation consultant, whether any conflict of interest existed, and if so, how it was addressed.

The SEC rule does not define “conflict of interest” but it sets out six criteria which committees can use at a minimum in deciding if a compensation consultant or adviser is subject to a conflict. Most are fairly obvious, such as whether any financial, personal, or business ties exist between a consultant to the compensation committee and the company.

The rule also requires a new “independence assessment” of compensation consultants or advisers hired by the compensation committee. In addition to meeting the six criteria described above, the stock exchanges may include additional factors. However, the SEC has not set out specific thresholds for when independence is compromised. “There are no bright lines. It is all based on facts and circumstances,” Barrall notes.

The SEC rule specifies that in-house lawyers are not subject to this independence assessment. However, the independence of outside legal counsel or other persons who provide advice to the compensation committee will have to be assessed.

The SEC’s rules go live on January 1. NYSE rules will go into effect July 1, while some of Nasdaq’s will go into effect immediately and others over a two-year period.

Meanwhile, says Barrall, there’s plenty for companies to do to get ready, including designing independence assessment standards, determining who is affected, reviewing sources of compensation, and amending compensation committee charters.

It looks like a busy year lies ahead.