|Oct. 11, 2011
|Lewis H. Ferguson, Board Member
|PCAOB Open Board Meeting
I support the issuance of this release aimed at improving the transparency of audits and the specific positions taken by the Board in this release. The release contains three proposed amendments to PCAOB auditing standards and to PCAOB Form 2:
The Requirement to Identify the Audit Engagement Partner in the Audit Report
Investor representatives on the PCAOB's Investor Advisory Group and Standing Advisory Group have advocated consistently and forcefully for greater transparency concerning the work of auditors of public companies. These investor representatives generally believe that the independent audit is useful in insuring the fair presentation of financial reporting and that the auditors of public companies have a unique window into the affairs, particularly financial affairs, of the companies they audit. They have also made clear their view that investors would find useful more knowledge about what auditors do in the audit, who has actually had supervisory responsibility for the audit and what areas of concern the auditor has focused on.
With respect to disclosure of the identity of the audit engagement partner, proponents of disclosure have argued that such disclosure would increase the transparency of the audit process as well as the accountability of the audit engagement partner with respect to the audit, which together could improve audit quality. Skeptics have argued that identification of an individual auditor is actually misleading, especially on a large audit, because such audits are inevitably collective efforts requiring many different resources from the audit firm. Moreover, they have argued that audit committees have responsibility for hiring auditors, and have a large and often determinative role in the selection of the audit engagement partners on their audits, and that any disclosures about the nature of the audit and identity of the engagement partner should be focused on the audit committee since they represent the interests of investors. Skeptics of this proposal have also made a second argument, that identifying a specific individual in the audit report, even if that individual does not sign the audit report, would likely increase the liability of the individual in potential private civil litigation under the federal securities laws relating to the audit.
As to the first argument raised by the skeptics, while it is true that any complex audit of a large enterprise involves a number of people in addition to the audit engagement partner, including staff accountants, managers, concurring partners, national office personnel and sometimes outside experts, the relationship between the audit engagement partner and the client, including its audit committee, board of directors and senior management, is unique. The audit engagement partner is the firm's primary interface with the audit committee, board of directors and company financial management, often, in very large companies, dealing with members of these groups on an almost daily basis. Moreover, the audit committee often has a significant voice in the choice of the audit engagement partner and certainly scrutinizes the audit firm's recommendation for a successor when it comes time, under the audit partner rotation rules of the Sarbanes-Oxley Act, for the current audit engagement partner to rotate off the engagement. As such, the relationship between the audit engagement partner and the client is qualitatively different from the relationship that any other member of the audit team has with the client and it is not surprising that investors are interested in the identity of the audit engagement partner.
Arguments that information about the identity of the audit engagement partner would somehow mislead investors are also unpersuasive. Most equity securities in public companies today are held by substantial, institutional investors whether pension funds, mutual funds or others. These are sophisticated investors, are generally familiar with the work of auditors and the nature of public company audits generally and are not likely to be confused by knowing the identity of the audit engagement partner.
A more serious objection to the Board's proposal arises if, indeed, it can be shown to increase the liability of the audit engagement partner, particularly in civil liability. In its Final Report in 2008, the Advisory Committee on the Auditing Profession ("ACAP") to the U.S. Department of the Treasury, the committee recommended that the PCAOB undertake a standard setting initiative to study mandating the engagement partner's signature on the audit report, stating that the committee believed that such a requirement would increase transparency and accountability. The committee cautioned, however, that any such signature requirement "should not impose on any signing partner any duties, obligations or liability that are greater than the duties, obligations and liability imposed on such person as a member of an auditing firm." While the ACAP recommendation is merely advisory, the Board takes it seriously and has no desire to change the present landscape of auditors' liability, particularly in ways that would increase it. The Board has attempted to limit that possibility by not requiring that the engagement partner actually individually sign the audit report. Instead, the release requires that the audit engagement partner be identified by name in the body of the auditor's report. The U.S. Supreme Court's recent decision in Janus Capital Group, Inc. v. First Derivative Traders, 131 S.Ct. 2296 (2011) held that the maker of a statement for purposes of the federal securities laws is the "person or entity with ultimate authority over the statement, including its content and how to communicate it." The implications of this decision in many areas, including audit reports, is not yet clear and must await further judicial developments based on the ruling. My own view, however, is that it seems unlikely that the mere identification of the audit engagement partner in the body of an audit report will be deemed to be a "statement" by the audit engagement partner for purposes of the federal securities laws making him or her primarily responsible for all of the contents of the report. This seems especially likely, given that the form of the audit report must conform to auditing standards set by the PCAOB, and while the audit engagement partner may have an influence on that report, he or she does not unilaterally control its form or its issuance. Given these facts, my hope is that by not requiring an individual signature to the report individual liability will not be increased. The Board invites comments on this issue.
Other factors make it seem unlikely that the Board's decision would increase auditor liability in a practical sense. Individual audit partners have long been subject to potential disciplinary action by the Securities and Exchange Commission and, since enactment of the Sarbanes-Oxley Act, by the PCAOB for a variety of reasons, and a requirement to identify the audit engagement partner in the audit report is unlikely to increase the scope of that potential liability. In private civil litigation involving auditors as defendants, individuals participating in the audit are commonly identified early on in the discovery phase of such litigation and are served with interrogatories, subject to depositions and called to testify today. The absence of the audit engagement partner's signature or identity in the audit report does not render such persons invisible in or immune to private civil litigation. Individual members of the audit team, including the audit engagement partner, are rarely named as individual defendants in such suits, not because their identity is unknown or because legal theories of potential individual liability are absent, but because they are usually not perceived as having substantial assets to satisfy any judgment. A requirement to identify the audit engagement partner in the audit report is unlikely to change this situation. Even if such persons were to be named as defendants in litigation, they can also be indemnified by their employers, as officers and directors of issuers already commonly are today.
Whether naming an individual audit engagement partner in the audit report would make auditors act more carefully and improve audit quality seems to be a closer question. Auditors, particularly in large firms, are subject to oversight and rigorous periodic quality reviews. As a practical matter, in larger accounting firms, a failed audit or major error in the audit of a significant client, particularly a public company, can be career ending for the audit engagement partner in charge of the audit. As a result, there are substantial checks and balances and professional pressures that encourage auditors to do high quality work already in place. It is not clear whether disclosure of the audit engagement partner's name would materially increase the already existing pressures to perform high quality audit work. On the other hand, the provisions of Sections 302 and 906 of the Sarbanes-Oxley Act requiring principal executive officers and chief financial officers of U.S. public companies to certify to the accuracy of financial reports filed with the SEC appear to have increased the level of care and focus that such individuals exercise in overseeing financial reporting with respect to which they must provide certification. The analogy clearly is not perfect; the Board is proposing a disclosure requirement while the Sarbanes-Oxley Act provisions involve certifications with penalties for failures to comply. Nonetheless, there are similarities in that specific individuals are identified publicly as having responsibility for certain functions and common human experience suggests that when an individual is publicly identified with a particularly activity, that identification usually leads to a higher degree of care and focus.
In light of all of these factors, it seems that the arguments in favor of publicly identifying the audit engagement partner in the audit report outweigh the risks and potential costs of doing so. The Board invites comment on this proposal and urges commentators to bring forward any other factors or evidence that we may have failed to consider.
Disclosure of the identity of the audit engagement partner in PCAOB Annual Reports on Form 2.
The arguments in favor of disclosing the identity of the audit engagement partner in the Annual Report on Form 2 filed by accounting firms with the PCAOB are essentially similar to those described above. There is, however, an additional argument for providing such information in the Form 2. The Form 2 will provide a unique source of such information in an aggregated form. This will permit investors to see all of the public issuer audits for which the particular audit partner is or, over time, has been responsible. Many investors may find this information, not currently publicly available, useful.
Disclosure of other audit firms and individuals who participated in the audit or who the primary auditor supervised or for whose work the primary auditor assumes responsibility.
Audits today, particularly of large public companies having global operations often involve work done by a number of different audit firms, usually affiliates of the primary auditor and members of its network of firms but sometimes by independent firms and sometimes by independent experts. Investor representatives have indicated to the PCAOB that they would find it informative to have more information about which firms are actually performing work in the audit. Such information would also make publicly available information showing where parts of an audit are conducted by audit firms located in jurisdictions where the PCAOB cannot yet conduct inspections. Skeptics of this proposal contend that such information might be misleading since the primary auditor is ultimately responsible for signing the audit report and assuring the quality of all of the audit work that underlies the report whether they actually supervise or assume responsibility for the work. These persons contend that naming other participants in the audit might actually lead readers of the auditor's report to misunderstand the respective roles of various participants in the audit. To the extent that such complaints have validity, they can be ameliorated by additional disclosure that explains the role and responsibility of the various firms or individuals that participated in the audit and explains the ultimate responsibility of the audit firm that actually signs the report.
The Board invites comment on this proposal including comment on the extent to which details of off-shoring of audit work performed by the auditor should be disclosed and what the nature of any such disclosure should be.
Finally, this proposal represents the excellent and dedicated work of the Board's staff including the Office of the Chief Auditor and the Office of the General Counsel. The Board also received thoughtful comments from the staff of the Securities and Exchange Commission. My thanks to all of them.
 U.S. Department of the Treasury, Final report of the Advisory Committee on the Auditing Profession to the U.S. Department of the Treasury, VII: 19, VII:20 (2008).