DATE: Dec. 4, 2013
SPEAKER: James R. Doty, Chairman
EVENT: PCAOB Open Board Meeting
LOCATION: Washington, DC
The proposal before the Board today would require audit firms to disclose the name of the engagement partner as well as the names of other firms and other persons that participated in the audit.
The disclosure would require no new work by the auditor. Yet as with previous accountability reforms like it — such as Sarbanes-Oxley's requirement that CEOs and CFOs personally certify their company's financial statements and internal controls — it holds the promise of improving audit quality by sharpening the mind and reminding auditors of their responsibility to the public.
The capital markets know that audit quality is not all equal, and they are willing to pay more for reliable audits, in the form of reduced financing costs for companies that obtain such audits. The corollary is also true: markets demand a premium cost of capital from companies that present an audit report that is perceived to be less reliable.
This proposal is a way to use the motivating power of our markets to incentivize higher quality audits. But to do so, the markets need information.
If the public knew about partner history, and the relative extent of involvement of other firms that have their own records of good or poor auditing, the market could react by appropriately pricing the cost of capital. This makes intuitive sense, but studies also show that disclosure of the name of the audit engagement partner has made a difference in foreign markets.
Our inspections of audits are instructive as well. Based on more than ten years of experience, PCAOB inspections have revealed that, even within a single firm, and notwithstanding firm-wide or network-wide quality control systems, the quality of individual audit engagement vary.
There are numerous factors required to achieve a high quality audit, but the role of the engagement partner in promoting quality, or allowing it to be compromised, is of singular importance to the ultimate reliability of the audit.
So too, inspections have found that auditors face and make important choices about how to organize multi-national audits. There's no way for an investor to tell today how much of an audit was performed by firms other than the signing firm. In the case, say, of a large financial institution with major operations in two or more financial centers, a significant portion of the audit may be performed by other firms.
In some cases, the undisclosed auditor has been inspected by the PCAOB, in which case the public inspection report may give the public a sense of the quality of that firm. In other cases, the PCAOB may not be able to inspect the firm, such as in China or a handful of countries in Europe, in which case investors may justifiability want to factor those risks into their conclusions about the reliability of the audit report.
Transparency about the partner and firms involved should incentivize the audit firm to organize the audit team conscientiously to give audit committees and investors comfort that it is reliable.
I am grateful for the comments we received on the first proposal. I also thank the SEC staff for their assistance and close consultation in this effort. The comments have helped us shape the new proposal, in particular to refine and focus our analysis on engagement partner identification and to make the form of the disclosure of other firms that participated in an audit simpler and clearer.
Commenters have also allowed us to think even more deeply about the relative benefits of requiring the engagement partner's signature, as many jurisdictions do, versus merely requiring disclosure of the engagement partner's name.
Requiring a signature could increase the engagement partner's liability exposure. A perceived risk of liability is not necessarily bad, and indeed may contribute to a sense of responsibility. Disclosure of a name, however, should not increase fraud liability for the engagement partner.
To me, upon reflection, the comments confirm that disclosure of the name is sufficient to achieve enhanced accountability and to allow investors to judge the engagement partner's record. I continue to think the compromise reflected in choosing the disclosure alternative is modest and appropriate.
I also believe it is right to provide the disclosure in the audit report itself. The audit report goes straight to investors, as does the request to vote to ratify appointment of auditors, so why shouldn't the attendant disclosure?
I look forward to a new round of public comment. There is a robust record on this proposal. The questions accompanying the reproposal are intended to encourage commenters to think deeply about both their own views as well as opposing views expressed in earlier comments, and to engage constructively.