Statement on the Commission’s Consideration of the Public Company Accounting Oversight Board’s Proposed 2016 Budget and Accounting Support Fee

Commissioner Kara M. Stein

March 14, 2016

I want to extend my thanks to the team in the Office of the Chief Accountant that works every day with the Public Company Accounting Oversight Board (“PCAOB”) to protect investors, including Jim Schnurr, Brian Croteau, Kevin Stout, Mark Jacoby, Khalid Shah, and Matt Hodder, and to the team in our Office of Financial Management, Ken Johnson, Caryn Kauffman, Richard Taylor, Nicole Puccio, Crystal Willis, and Yolanda Dews.

I also want to extend my thanks to Chairman James Doty for appearing here today and to the members and staff of the PCAOB for their hard work throughout the budget process. In addition, I want to acknowledge the other members of the Board that are with us today, Steve Harris, Lew Ferguson, and Jeanette Franzel. Your work is vital to ensuring the integrity and fairness of our capital markets through strong oversight of public company and broker-dealer auditors.

Over a decade ago, a series of sensational accounting scandals exposed severe weaknesses in our accounting and financial reporting system. Ultimately, a number of large companies collapsed after revelations about their fictitious accounting. This raised concerns about the public’s confidence in financial reporting, in the capital markets, and particularly, regarding the role of the public’s gatekeepers, the auditors. Nine months after Enron’s financial misdeeds were first reported, and weeks after the WorldCom scandal became public, Congress passed the Sarbanes-Oxley Act of 2002.[1]

The Sarbanes-Oxley Act, among other things, created a new organization called the Public Company Accounting Oversight Board (PCAOB). The PCAOB was created to provide external, and independent, oversight of the auditors of U.S. public companies. When establishing the PCAOB, Congress vested the Commission with the authority to both review and approve the PCAOB’s rules, standards, and budget. [2]

We are here this morning to fulfill the Commission’s statutory duty to review and consider the PCAOB’s 2016 budget, and the related fees that will fund its operations. Today’s meeting brings the public into the oversight process, which is important for both the Commission and the PCAOB’s accountability to the American people.

To be sure, the PCAOB and the audit profession have both come a long way since the enactment of the Sarbanes-Oxley Act. Audit quality has improved. The PCAOB’s inspections have led to audit firms making significant improvements to their quality controls. The PCAOB’s inspection reports are now being used by audit committees to engage in discussions with their auditors about audit quality. In addition, these public reports can be used by the accounting profession as a whole to identify potential issues and prevent quality control problems within their own firms.

However, progress in how the audit gets communicated to the public remains elusive. The only communication to investors, market participants, and regulators about all of the hard work that goes into an audit is a one-page standardized audit report that has changed little over the last 80 years. Other countries are experimenting with modernizing the standardized audit report. They are finding that additional transparency in the audit is extremely valuable for investors.[3] I’m looking forward to hearing about the progress that the PCAOB is making in its review of the current audit reporting model and improvements about how the audit is communicated.

Further, with the PCAOB firmly established in its roles in standard-setting, inspections, and enforcement, now is a good time to ask questions about the future of both auditing and the audit profession. Is the investor getting the information that he or she needs? How can we make the audit more effective?

It appears that more and more companies are prioritizing information outside of the financial statements in their communications with investors and other market participants. Some are emphasizing non-GAAP performance measures and other metrics, either through press releases or in management’s discussion and analysis. Others are highlighting changes in the number of new customers, new subscribers, or same-store sales, or even “normalized” earnings.

In addition, many companies may be making customized adjustments to their GAAP financial measures. Some in the industry have termed this trend as “earnings before bad stuff.” Recent articles report a growing difference between companies’ advertised financial measures and what they earned under generally accepted accounting principles.[4] A recent news article reported that companies in the S&P 500 had advertised earnings that were 25% higher than their earnings as reported under generally accepted accounting principles. [5]

Are these supplemental measures and metrics driving investment decisions? They might be. Recently, a company disclosed an error about its previously advertised measure concerning growth in new customers. In response to an announcement that its growth from new customers was overstated, its stock price declined by seven percent.[6] It appears that investors, in this case, were relying on this metric. This is a trend that we all need to focus on.

Clearly, the financial reporting model is evolving to accommodate the reporting of other measures and metrics that may be informative to investors. As the financial reporting model is evolving, how is it affecting the auditor’s role? How is the auditor’s role evolving?

Finally, never before has the assurance profession been as transformed as it has been by the integration of technology, data, and analytics. How is the auditing profession innovating? How is the PCAOB monitoring, and responding, to this rapid change in the industry? How is the PCAOB considering revisions to its auditing standards to encourage appropriate innovation, while ensuring outstanding audit quality and investor protection?

I look forward to hearing from Chair Doty on the current state of the PCAOB and how it is thinking about these challenging issues.

Thank you.