Good Afternoon,
I am honored to be here today at this important conference. I
thank all of you for your interest in advancing and improving
financial reporting and auditing, as evidenced by your participation
in this conference today.
I am the newest Board Member, appointed in February of this year,
and I've been on the job for almost 9 weeks now (not that I am
counting). In January 2011, three new members were appointed to the
Board, Lew Ferguson, Jay Hanson, and our Chairman, Jim Doty. With 4
of the 5 Board members being relatively new, we are often referred
to as the "new Board." Of course, Steve Harris continues as our
senior statesman, having been on the Board since 2008.
Today, I will provide my impressions and observations from my
first nine weeks on the job, as well as an update on the current
activities of this very busy, "new Board."
Before I go further, however, I must tell you that the views I
express today are my personal views and do not necessarily reflect
the views of the Board, any other Board member, or the staff of the
PCAOB.
Reliability, Role, and Relevance of the Audit
Auditors have been given an important role in the capital markets
— to provide assurance to investors, owners, lenders and others that
the audited company's financial statements and related disclosures
fairly present the institution's financial results in conformity
with applicable accounting and disclosure standards and rules.
Clearly, reliable financial statements play a key role in the
financial markets, which are integral to the success and well-being
of American households and businesses, the U.S. economy, and
participants and stakeholders from around the world. The securities
markets provide a reliable funding mechanism for American — and,
increasingly, foreign — businesses. More than half of American
households invest their savings in securities to provide for
retirement, education, and other goals. Our economy is resilient,
even in the face of the recent financial crisis, in part because
millions of savers continue to be willing to invest in business
enterprises to fuel growth, growth that results in more workers,
more savings and more investment. This cycle promotes economic
wealth, but it relies on the system of accurate financial
disclosures by public companies to the investors who entrust capital
to them.
As we approach the 10th anniversary of the Sarbanes-Oxley Act and
9 years of PCAOB operations, we seem to be, once again, in a period
of re-examination of the role, relevance, and reliability of
financial audits in protecting investors and the public interest.
Many of the topics currently being debated have been debated over
the decades—auditor independence, the role of audit committees,
professional skepticism and objectivity, audit quality, and the
auditor's report, among others. One possible line of response to
reevaluating these issues is "we decided decades ago on this," or
"this has worked fine for the last 70 years." Even if these are some
of the "same old topics" that have been debated for decades, we can
also look to the many corporate failures and financial crises that
have occurred over the decades and recognize the importance of
ongoing re-examination and adjustments in the auditing model. First
of all, auditing is very difficult and filled with competing
tensions, and we can and should continue to learn from years of
experience. Secondly, rapid changes in the financial markets,
globalization, technology, and how business is conducted continue to
drastically impact financial reporting and auditing.
Often, we are inspired to re-examine financial reporting and
auditing in reaction to a crisis. In a way, we may be reacting to
the financial crisis and serious economic situation over the past
several years. But the current efforts are occurring in a measured
and forward-looking manner, in addition to looking back to examine
the impact of the Sarbanes-Oxley Act and PCAOB's accomplishments to
date. Also, the profession and its oversight bodies have new
information, including a large body of PCAOB inspection results and
recent academic research that shed light on auditor processes,
behavior, and judgments.
Role of the PCAOB
As you know, the Sarbanes-Oxley Act of 2002 established the PCAOB
to oversee the audits of the financial statements of public
companies. In July 2010, the Dodd-Frank Act amended the
Sarbanes-Oxley Act and, among other things, vested the PCAOB with
the authority to oversee audits of broker-dealers. The statutory
mission of the PCAOB is to oversee the audits of public companies in
order to protect the interests of investors and further the public
interest in the preparation of informative, accurate, and
independent audit reports. The PCAOB is also charged with overseeing
the audits of broker-dealer compliance reports under federal
securities laws to promote investor protection.
The PCAOB has four main responsibilities under the Act:
- register public accounting firms that audit public companies
or broker-dealers;
- establish auditing and other professional standards;
- conduct and report on regular inspections of registered public
accounting firms that audit public companies or broker-dealers;
and
- conduct investigations and disciplinary proceedings in cases
where auditors may have violated certain provisions of the
Sarbanes-Oxley Act of 2002, the rules of the PCAOB and the
Securities and Exchange Commission, and other laws, rules, and
professional standards governing the audits of public companies,
brokers, and dealers.
Currently, approximately 2,400 firms are registered with the
Board. Of those, approximately 516 are firms that reported auditing
broker-dealers but no issuers. In addition, the 2,400 total
registered firms include approximately 815 firms that reported
issuing no audit reports for issuers or broker-dealers, but have
nonetheless chosen to register with the PCAOB.
PCAOB annually inspects firms that audit over 100 issuers, while
firms that issue 100 or fewer audit reports each year are subject to
inspection every three years. PCAOB does not inspect firms that do
not perform audit work for issuers. In addition, PCAOB is currently
conducting an interim inspection program for auditors of
broker-dealers, and will use information from this interim program
to guide its decisions about a permanent program, including whether
to differentiate among classes of brokers and dealers in terms of
inspection schedules, and possible exemptions from inspections.
During 2011, PCAOB inspected 10 firms that audited more than 100
issuers. As part of those inspections, PCAOB inspectors examined
portions of more than 340 audits. Also during 2011, PCAOB inspected
203 firms in the 3-year category, examining portions of more than
485 audits by those firms. Finally, in the interim inspection
program for broker-dealer auditors, PCAOB inspected 8 audit firms in
2011, covering portions of 19 audits of broker-dealers.
Since it began its inspections operations, the PCAOB has
conducted over 1800 inspections and reviewed over 7800
audits. PCAOB inspection reports issued to the firms after
their inspections identify deficiencies in the firms' audit work as
well as weaknesses or deficiencies in the firms' quality control
policies and procedures. Certain portions of the inspection reports
— those dealing with particularly significant audit deficiencies
identified by inspectors — are made publicly available. With respect
to any problems found by the Board in the firm's quality control
systems, firms are given twelve months to remediate those issues or
face publication of the portion of the inspection report describing
those issues.
Remediation is a very important part of the process. It is
through these actions that firms propose to correct their quality
control deficiencies in order to drive improvements in auditing. We
have seen most firms take their responsibilities for remedial
efforts and improvements seriously.
In addition to our activities in connection with registering and
inspecting firms, the Board is responsible for setting auditing
standards for the audits of public companies and brokers and
dealers. I will talk in a few minutes about some of our priorities
in this area.
Finally, the PCAOB also has an active Division of Enforcement and
Investigations. To date, the PCAOB has taken 49 disciplinary
proceedings against 39 registered accounting firms and 52 persons
associated with registered firms. The sanctions have included
censures, fines, suspensions or bars from being associated with a
registered firm, and revocations of firm registrations. To date, the
Board has revoked the registration of 25 firms, barred 41
individuals, and suspended 5 individuals and 1 firm's registration.
In my short time with the Board, I have put the registration,
inspection, standards, and enforcement roles that I have just
described into a "bucket" that I think of as the Board's "ordinary
business operations." The workload associated with carrying out the
Board's "ordinary business" is heavy and varied, and is integral to
fulfilling the Board's mission and statutory responsibilities. The
information and knowledge we gain from our operations also provides
input for the Board's priorities and consideration of longer-term
initiatives in order to promote independent and high quality audits
that protect investors and further the public interest.
PCAOB Priorities and Initiatives
PCAOB is in a unique position given the knowledge and information
gained through the inspection program to identify trends and risks
in the auditing profession. PCAOB staff and the Board also work
one-on-one with firm personnel and firm leadership in discussing
issues impacting audits, including effective audit practices and
responses and ways to enhance audit quality in light of current
pressures and risks. The Board also issues practice alerts, summary
reports, research notes, interpretative releases and other
communications in order to also communicate these issues broadly.
Finally, PCAOB uses input from its inspections, task forces, the
Academic community, and other stakeholders in developing its
standards setting agenda.
I mentioned earlier the category of the PCAOB workload that I
think of as "ordinary business operations." I think of our other
work as being in the category of "leadership in protecting investors
and the public interest" by being a driving force for change when
needed, to ensure independent and high quality audits. In this
category, we have several layers:
- Drive change in the profession to correct gaps in auditing
practice under the current audit model in order to achieve needed
improvements in the near term.
- Determine what types of changes are needed in the audit
model—including auditing standards, as well as the business model
used by the firms in implementing those standards—in order to help
ensure reliable audits and investor protection in the future.
- Determine through ongoing monitoring whether, at any time,
immediate actions are needed to mitigate unusual, emerging risks
to financial audits from a variety of factors, including rapid
changes and increasing complexity in business operations and
financial markets, evolving technology, the global business
environment, and other factors.
Improvements Needed in Current Audit Practices
Regarding the current gaps in practice, PCAOB inspections
continue to find serious audit deficiencies on a regular basis. In
fact, our inspection reports issued during 2011 related to the 2010
inspection cycle, including reports on inspections of some of the
largest firms, show a significant and concerning increase in
inspection findings.
Such deficiencies include cases where auditors issue clean
opinions even though:
- the audit work is incomplete or not properly conducted;
- financial statement information is contradicted by other
available evidence; and/or
- audit conclusions on material issues are based on management's
views without independent verification.
Clearly improvements are needed in current audit process under
current standards. In that regard, the PCAOB staff and Board Members
devote considerable attention and time to working with firms to
evaluate systemic root causes within a firm's structure, operations,
processes or other areas that detract from audit quality or cause
deficiencies. When the Board issues inspection reports, the portion
of the report containing findings about deficiencies in a firm's
system of quality control, referred to as "part 2" of the report,
are subject to statutory restriction on public disclosure. The firm
has 12 months from the issuance of the inspection report to address
the issues to the Board's satisfaction. The PCAOB staff and Board
also spend considerable time evaluating firm's remediation plans and
actions. If a firm does not satisfactorily address any of the
quality control criticisms within 12 months, the portion of the
report discussing the particular criticism(s) is made publicly
available.
PCAOB Standards-Setting Activities
The Board uses information that it learns in its inspections and
from other sources to evaluate the need for changes in auditing
standards. In developing new standards, the PCAOB also seeks advice
from a wide variety of interested stakeholders on ways to improve
audits. The Board's standards activities are informed by meetings
and dialogue with investors, auditors, representatives of public
companies, members of the academic community, and through its
Standing Advisory Group. The Board also holds roundtable discussions
and other public meetings to deepen its dialogue with commenters and
other interested parties. The Board works closely with the SEC on
the development of standards and monitors the work of accounting
standard setters, such as the Financial Accounting Standards Board,
for developments that may affect auditing.
The Board currently has a full agenda for seeking views on ideas
and specific proposals impacting auditing and related professional
practice standards through concept releases, proposed standards, and
potential future projects.
Concept Releases
The Board is currently evaluating comments and feedback on two
concept releases, one dealing with the auditor's reporting model and
another with auditor independence and mandatory firm rotation. These
concept releases did not propose new auditing standards. Rather,
they sought the public's views on particular matters so that the
Board can better evaluate the need for future standard-setting.
- Auditor's Reporting Model — On June 21, 2011,
the Board issued a concept release to seek public comment on
potential changes to the auditor's reporting model. Such potential
changes could include a supplement to the auditor's report in
which the auditor would be required to provide additional
information about the audit and the auditor's view of the
company's financial statements (an "Auditor's Discussion and
Analysis"); required and expanded use of emphasis paragraphs in
the auditor's report; auditor reporting on other information
outside the financial statements; and clarification of certain
language in the auditor's report. The concept release was preceded
by several discussions with the PCAOB's advisory groups, and
extensive outreach by PCAOB staff in 2010 and early 2011. In
addition, the Board solicited further comment at a roundtable on
Sept. 15, 2011. The deadline for comments on the concept release
was Sept. 30, 2011. Staff is currently preparing a proposed
standard.
- Auditor Independence and Audit Firm Rotation —
As a result of PCAOB inspections, the experience of other
audit regulators and concerns expressed by investors, the Board
issued a concept release Aug. 16, 2011, seeking public comment on
a variety of possible approaches to improving auditor
independence, objectivity and professional skepticism. As part of
that concept release, the Board sought comment on whether a
rotation requirement would risk significant cost and disruption
and how mandatory rotation would serve the Board's goals of
protecting investors and enhancing audit quality. The Board also
sought comment on whether other measures could meaningfully
enhance auditor independence. The deadline for comments was Dec.
14, 2011. The Board held a public meeting to obtain further
comment on the concept release on March 21 and 22, for which the
comment period was reopened. Future such public meetings are
planned.
Proposed standards
The Board is currently evaluating comments on several proposed
standards and seeking comment on one proposal.
- Audits of SEC-Registered Brokers and Dealers —
The Dodd-Frank Act gave the PCAOB the authority to oversee
auditors of SEC-registered brokers and dealers, including
authority to set standards and rules for audits of brokers and
dealers. On July 12, 2011, the Board proposed standards dealing
with (1) examination engagements for compliance reports, (2)
review engagements of exemption reports, and (3) auditing
supplemental information. The deadline for comments on the
proposed PCAOB standards was Sept. 12, 2011. Further action on the
Board's proposals is dependent on the SEC's adoption of the
proposed amendments to its Exchange Act 17a-5 rule.
- Audit Transparency — On Oct. 11, 2011, the Board
proposed amendments to its standards that would improve the
transparency of public company audits by requiring that audit
reports disclose the name of the engagement partner as well as the
names of other independent public accounting firms and other
persons that took part in the audit. The amendments would also
require registered public accounting firms to disclose the name of
the engagement partner for each audit listed on the firms' annual
reports filed with the PCAOB. The deadline for comments on the
proposed amendments was Jan. 9, 2012.
- Communications with Audit Committees — On Dec.
20, 2011, the Board reproposed a new auditing standard,
Communications with Audit Committees, and related
amendments. The standard is intended to benefit investors by
establishing requirements that enhance the relevance and quality
of the communications between the auditor and the audit committee.
The deadline for comments was Feb. 29, 2012.
- Auditing Related Party Transactions — On
February 28, 2012, the Board proposed a new standard, Related
Parties, as well as amendments to certain PCAOB auditing
standards to assist auditors in detecting and addressing the audit
risks associated with related parties and other unusual
transactions. The comment period expires May 15, 2012.
Potential future projects
The Board is also considering possible revisions to standards in
the following areas to strengthen and clarify requirements:
- auditors' use of specialists,
- part of the audit performed by other auditors,
- assignment and documentation of firm supervisory
responsibilities,
- fair value measurements,
- going concern,
- confirmation,
- quality control,
- codification of PCAOB standards, and
- subsequent events.
As you can see, the Board is working on an ambitious agenda
including numerous areas of audit practice aimed at strengthening
auditing standards themselves, while improving audit practices and
approaches.
Risk Monitoring, Assessment, and Research
Through the Office of Research and Analysis, the PCAOB also
monitors information obtained from a variety of sources, including
PCAOB inspections, public company financial reporting, price and
volatility information from debt and equity markets, and corporate
governance information in order to identify emerging risks to
financial reporting and auditing. This information is then used by
PCAOB's inspections, standards setting, and enforcement functions.
In addition, information is provided to the public, as appropriate.
On March 15, 2011, PCAOB issued its first public "Research Note"
to provide new data on the growth of reverse merger transactions
involving companies based in China, Hong Kong, and Taiwan. A reverse
merger typically occurs when an operating company merges with a U.S.
shell company that had previously registered its securities on a
U.S. exchange. The Research Note, along with Staff Audit Practice
alerts issued in July 2010 and October 2011, represented an effort
by PCAOB to provide more information to investors and other users of
financial statements about the audit environment for companies from
the China region.
Additionally, the Office of Research and Analysis performs
regular research and analysis to support the various efforts of the
Board while also monitoring risks and identifying emerging issues.
Current Legislative Initiatives
Currently, legislation is pending (HR 3503 and S 1907) that would
amend the Sarbanes-Oxley Act of 2002 to make PCAOB disciplinary
proceedings open to the public.
Under the Sarbanes-Oxley Act as it exists today, the PCAOB's
disciplinary proceedings are nonpublic, unless the Board finds there
is good cause for a hearing to be public and each party consents to
public hearings. PCAOB disciplinary proceedings remain nonpublic
even after a hearing has been completed and adverse findings made by
a disinterested hearing officer, if the auditors and firms opt to
appeal and do not consent to make the proceedings public. The
auditors and audit firms charged with violating applicable laws,
rules or standards have little incentive to consent to public
disclosure of disciplinary proceedings against them, and in fact,
none have ever done so.
Continued litigation postpones — often for several years — public
disclosure that the PCAOB has charged the auditor or firm, the
nature of those charges, and the content of adverse findings. In
addition, unlike the authority the Securities Exchange Act of 1934
provides the SEC in its administrative proceedings, the PCAOB has no
authority, while litigation is pending, to issue temporary
cease-and-desist orders in appropriate cases, to prevent potential
further harm to investors or the public interest.
This situation results in a variety of unfortunate consequences
for investor protection and the public interest. The public is
denied access to important information regarding PCAOB cases and
respondents' alleged misconduct — no matter how serious. As a
result, investors are unaware that companies in which they may have
invested are being audited by accountants who have been charged,
even sanctioned, by the Board, and meanwhile, the audit firm and
associated persons may continue to issue audit reports.
If the SEC were to bring the same case as the PCAOB, alleging the
same violations, against the same auditor, the SEC's charges would
be disclosed at the time the Commission instituted its proceeding.
Any administrative trial would be open to the public. If there were
an appeal to the Commission and an oral argument, the public could
attend. The ability — or inability — of the SEC's staff to prove its
charges would be a matter of public record.
The non-public nature of PCAOB's enforcement proceedings is not
good for investors, for the auditing profession, or for the public
at large.
* * *
The reliability, role, and relevance of financial audits, auditor
independence, and audit quality are enduring themes that we must
regularly monitor and evaluate in order to protect investors and the
public interest in a dynamic, global business environment. This
involves looking beyond the status quo and the current business
cycle. We also need to carefully consider and analyze the potential
costs and benefits of various actions as well as the risks of
unintended consequences.
I am pleased to have the opportunity as a Board member to explore
the broad range of issues impacting the auditing profession as we
seek to make progress to strengthen the reliability and accuracy of
audit reports.