Thank you for inviting me to this symposium. It is an honor and a
pleasure to be here. The Public Company Accounting Oversight Board
is engaged in several endeavors that I hope will be of interest to
Some would say that any Texan lucky enough to escape the Beltway
and find himself in Dallas on a day the Rangers contend for the ALCS
must be insane to go back to Washington. After all, the town made it
through OU weekend, which some still consider the supreme threat to
domestic tranquility. Why leave now?
On the other hand, as an audience of lawyers, you may be
thinking, "This guy is fascinated by auditing? The wonder
is that he is registering a pulse!"
Yes, I am riveted by auditing, by the challenges auditing faces
in a rapidly transforming global economy, and by the fundamental
role auditing has played, and I believe will play, in the global
The rules and reference points for auditors are changing. I want
to try to explain to you how my new commitment, the PCAOB, fits into
that picture, and how it may intersect with the legal judgments you
make on behalf of your firms and clients.
The PCAOB's mission is to protect the investing public's interest
in informative, accurate and reliable audit reports for public
companies, and since the Dodd-Frank amendments, brokers and dealers
too. As corporate counsel, you too play an important role in
protecting the investing public. I hope this information about the
PCAOB's work will be useful to your own, and that it will help you
find ways in your companies and at your clients to foster an
appropriate culture for supporting reliable independent audits.
I will start by providing some background on the PCAOB's work,
and then turn to focus on international matters. And finally I will
touch on our current policy and legislative initiatives. Before I go
further, though, I must say that the views I express are my own and
should not be attributed to the PCAOB as a whole or any other
members or staff.
I. Overview of the PCAOB's Work
When I left law practice earlier this year, many of my law
colleagues knew little about what I was going to do. They asked me
if it would be a part-time job. (No!) They asked me if I was going
back to government service. (No.) The PCAOB was indeed established
by Congress, but as a non-profit. It has a full-time board, or shall
I say over-time? The other night I was at the office at 9:00 and
noticed three of five board members were also working late. (The
other two were starting their day, in Asia, for meetings with
foreign audit regulators.)
For those of you who, like my law partners, aren't as familiar
with the work of the PCAOB, let me give you a brief overview. Prior
to the creation of the PCAOB, public company auditors were subject
to oversight by their professional association and to peer reviews
conducted by other auditing firms.
After the revelation of the numerous high profile scandals
earlier this decade that we all remember, the Sarbanes-Oxley Act of
2002 profoundly changed the environment in which public company
auditors operate by providing for ongoing accountability to the
PCAOB, for the benefit of investors. The Board exercises that
oversight through four basic functions.
First, to establish the foundation for PCAOB oversight, the Act
requires the PCAOB to maintain a registration system for auditors of
securities issuers, as that term is defined in the Act, as well as
(under the Dodd-Frank amendments) auditors of broker-dealers. No
accounting firm may prepare, or substantially contribute to, an
audit report for a public company that files financial statements
with the SEC, or for a broker-dealer, without first registering with
There are currently 2,411 accounting firms registered with the
Board. This includes 907 non-U.S. firms and 507 firms that are
registered only because they have broker-dealer audit clients.
Registered firms must file annual and other reports that provide the
Board and the public with updated information about the firm and its
Contrary to what some believe, mere registration with the PCAOB
does not reflect an examination of the firm's audit quality, which
does not happen until we inspect the firm's audits. If a firm plays
by the rules, it may easily register, and easily withdraw, if its
business plans change and it hasn't violated the rules in the
That leads to our second basic function — inspection of firms and
their public company audits. The PCAOB's inspection program is the
core of its oversight of registered firms' public company audit
work. The PCAOB's inspection staff accounts for approximately 400 of
our 700 staff.
Since 2003, the PCAOB has conducted more than 1,700 inspections
of firms' quality controls and reviewed aspects of more than 7,500
public company audits.
As required by the Act, the PCAOB conducts annual inspections of
each of the firms that regularly audit the financial statements of
more than 100 public companies. In 2011, the PCAOB will have
inspected ten such firms in the course of the year.
Each firm that regularly audit the financial statements of 100 or
fewer public companies must be inspected at least once every three
years. The PCAOB plans to inspect approximately 211 such firms in
2011, including 44 non-U.S. firms located in 16 foreign
After completion of the inspections field work, PCAOB inspectors
engage in a dialogue with firms, through written comments, and in
certain cases, in-person meetings, about audit deficiencies they
have identified. The PCAOB then issues a report after each
inspection. The inspection report is not a complete report card on
the firm's entire audit practice, but rather focuses on areas where
inspectors found audit deficiencies.
The public portion of an inspection report describes matters that
inspectors have identified as significant audit deficiencies.
Counsel to corporate boards that engage auditors should understand
what this means. These findings, presented in what we call Part I of
the report, generally involve situations in which PCAOB inspectors
believe that the auditor failed to obtain sufficient evidence to
support the audit opinion or failed to identify a material departure
from generally accepted accounting principles.
Consistent with restrictions in the Sarbanes-Oxley Act, the PCAOB
does not publicly disclose the identity of the companies that are
the subject of audits discussed in an inspection report.
Nevertheless, you may find the general discussion of audit
challenges useful if you're involved in counseling an audit
committee or board.
Inspection reports also include discussion of any criticisms of
or potential defects in a firm's system of quality control in Part
II of its inspection reports. This portion of the report is
non-public. The Act affords inspected firms one year within which to
remediate Board criticisms or potential defects concerning firm
quality controls. If the Board is not satisfied with a firm's
remediation efforts, the portion of the report containing the
discussion of the quality control deficiencies becomes public.
A word of advice to counsel who represent firms, or companies
that use firms, that need to remediate quality concerns. The PCAOB
staff are available to work with firms on evaluating remediation
plans, but our help is most effective when the firm engages with us
early in the process. Warn your clients of the perils of "going
dark" on us for much of the remediation year.
Since 2003, PCAOB inspections have identified hundreds of audit
failures, including failures by the largest U.S. and non-U.S. firms.
These findings have led to changes in firm auditing processes, and,
in some cases, more audit work performed after the fact or
corrections of client financial statements.
The PCAOB also conducts investigations and disciplinary
proceedings. The Board has broad authority to impose sanctions on
registered firms and associated persons that have violated
applicable laws and standards.
The PCAOB has publicly announced the resolution of 41 enforcement
proceedings. Sanctions in these proceedings have included
revocations of firms' registrations, bars on individuals' ability to
participate in public company audits, monetary penalties, and
appointment of an independent monitor.
One of the Board's more significant settled disciplinary orders
relates to the PW India audit firms that audited the U.S.-listed,
Indian-domiciled company, Satyam. The Board's order included a $1.5
million penalty for violations of PCAOB rules and standards in
relation to an audit that failed to identity Satyam's billion-dollar
overstatement of assets.
The announced decisions do not, however, reflect the full extent
of PCAOB enforcement activity. Under the Sarbanes-Oxley Act, all
Board investigations and all contested proceedings
(i.e., cases in which the Board files charges and the
respondent elects to litigate, rather than settle) are non-public.
The Board closely coordinates its enforcement efforts with the
SEC. In certain instances, the PCAOB investigates the auditor's
conduct and the SEC focuses its investigation on the public company,
its management, and other parties. In other cases, the SEC's
Division of Enforcement takes responsibility for an auditor
investigation and requests that PCAOB defer to that investigation.
Finally, as I alluded, the PCAOB is responsible for establishing
the auditing and related professional practice standards under which
public company audits are performed.
The PCAOB has an active standard-setting agenda, which it pursues
through extensive outreach in the form of public solicitation of
comment at various stages of a project, public roundtable
discussions, and regular discussions with the PCAOB's Standing
Advisory and Investor Advisory Groups.
The groups are comprised of experts from diverse backgrounds as
investor representatives, financial statement preparers, auditors,
academics. They have also included several securities lawyers.
All of the Board's responsibilities are discharged under the
oversight of the SEC, which among other things appoints PCAOB board
members and approves PCAOB budgets, standards and rules, and hears
appeals of PCAOB disciplinary proceedings.
Chairman Mary Schapiro, the SEC Commissioners, and Chief
Accountant James Kroeker have taken a deep interest in the PCAOB's
development and work. To their credit, they have carefully crafted a
board of diverse and complementary expertise that functions with
collegiality and technical excellence. I am grateful to them for
their support and for the strong working relationship they have
fostered between our organizations.
This is a very high level overview. It would not be complete
without mentioning that one of the jewels in the PCAOB's crown is
right here in Dallas. The PCAOB has a Dallas office that is led by
one of the leaders in the inspection division, John Fiebig.
John also leads the team that inspects one of the four largest
accounting firms. Based in Dallas, he supervises a team that circles
the globe. Our inspectors need not be in Washington to inspect even
the most challenging and complex audits for the largest companies in
I've seen Dallas grow from a Texas financial center to a national
center, and now a global center. The PCAOB staff in Dallas are every
bit a part of the globalization Dallas has seen.
II. Audits Without Borders
Let me tell you about some of the things we've seen in those
global audits. Since we began inspecting, we have observed that the
U.S.-based firms that we oversee — both large and small — are
increasingly engaged in audits with an international component.
Moreover, as I mentioned, the PCAOB has registered a significant
number of non-U.S. firms that audit or wish to participate in audits
of issuers. Many of these non-U.S. firms are affiliated with one or
another of the large U.S. firms through a global network.
These affiliates can be quite large, measured by number of
professionals as well as by market capitalization of audit clients.
Substantial portions of the audits of many of the largest U.S.
companies are performed by such affiliated firms.
You may think of these firms as merely local offices of one of
the large accounting firms. But because of their legal structure,
they are separately registered and subject to their own inspection.
To date, we have conducted 296 inspections of non-U.S. registered
firms located in 36 jurisdictions.
To best protect investors, inspections of cross-border audits
need to be as seamless as the audits are supposed to be. At the
PCAOB, we have seen first hand the benefits of evaluating the
various pieces of audits performed by different registered firms in
Our inspectors often see more than the principal auditor — or
signing firm — does. In many cases principal auditors rely on
high-level reports from affiliated auditors. They don't in every
case review the work papers of the other auditors. When our
inspectors have done so, in many cases they have found problems in
that work and focused the firms involved on the need to address
As has been widely reported, the PCAOB remains unable to inspect
registered firms that perform or participate in U.S. audits but
reside in China or some parts of Europe. I remain hopeful that we
will be able to resolve concerns raised by authorities in these
This is not to say that we haven't made progress: we are recently
back in the U.K.; we have begun inspections in Switzerland; and we
will soon begin inspections in Norway. In each of these inspections,
we will not only review audit work for foreign private issuers, but
we will also look at audit work performed on subsidiaries of U.S.
We also hope to make progress on a joint inspection arrangement
with Chinese authorities, but there the progress is slower.
Unfortunately, the risks to investors are every bit as great. For
example there have been numerous reports of auditors for Chinese and
other emerging-market issuers resigning because of concerns about
Earlier this month, the PCAOB staff issued an Audit Practice
Alert that provided auditors guidance on a number of audit questions
related to risks in emerging markets. The alert is based on observations
from PCAOB inspections and other oversight activities, as well as
other situations that have come to light in recent corporate filings
with the SEC and SEC orders suspending trading in certain emerging
It highlights conditions that indicate heightened fraud risk,
such as fraud in bank confirmations, including through forgery or
collusion. It also discusses risks involved in auditing variable
While the alert is intended for auditors, it is a general guide
to the fraud risks that anyone in international business might face,
including audit committees and corporate counsel. Indeed, the role
of audit committees and their counsel in combating fraud is
particularly important given the PCAOB's inability to protect
investors through inspections in other countries.
While we work toward accords in China and elsewhere, it's going
to be important to do what we can to protect investors in companies
that have operations in countries where we can't inspect. The PCAOB
is looking harder at how U.S. firms get comfortable that they can
rely on the work of affiliates in countries that have resisted
inspection. Through the audit committee, your corporate clients too
should take pains to understand how their auditor is handling
foreign audit work.
III. The PCAOB's Policy Agenda to Enhance the Relevance,
Credibility and Transparency of Audits
Let me turn now to the PCAOB's policy initiatives. We have an
active standards-setting agenda that aims to improve auditing and
related professional practice standards as we find the need to do so
in our inspections. Arching over this work, though, the Board is
engaged in several high profile initiatives to address lessons
learned in the financial crisis.
These initiatives relate to (i) the relevance and value of
audits, (ii) the relationship of the auditor to the audit client,
and (iii) the role of various participants in the audit. These
projects are founded on the principle that audit regulation should
foster conduct and a culture consistent with the franchise that the
securities regulatory regime accords the audit profession. I'll
briefly describe them, but I encourage you to read the recent papers
and proposals that the Board has published on our website.
A. The Auditor's Reporting Model
First, the PCAOB has initiated a broad debate on the form and
content of the standard auditor's report. In June, the PCAOB
released a concept release on potential changes to the auditor's
We issued this paper to seek broad public input on whether the
auditor's report could better serve investor needs. Given the effort
involved in an audit of a large company, and the complexity of many
financial statements, investors have called for deeper insight from
The concept release invited discussion on four, broad
alternatives, ranging from expanding use of emphasis paragraphs and
clarifying terms in the current standard audit report, to providing
for a narrative discussion of the auditor's views on significant
matters relating to the audit or the financial statements, to
requiring auditor assurance on certain information outside the
financial statements, such as Management's Discussion and Analysis
and earnings releases.
We have received more than 150 comment letters to date. In
addition, in September we held a public roundtable to foster further
From the PCAOB's recent roundtable, one takes away an emerging
consensus shared by the profession and stakeholders that the audit
report can and should provide more than simply the pass-fail
opinion. Differences develop over whether auditor communications
should include non-financial statement information, how to assure
consistency and yet avoid boilerplate, whether broader auditor
communication will chill the nuances of auditor-audit committee
communication, and (conversely) why if auditors are now
required to form judgments about accounting practices and
policies, the stakeholders cannot have that knowledge.
One point I have emphasized throughout is that, if we make
changes, they will be focused on enhancing the relevance of the
auditor's communication to investors. They may require auditors to
communicate more, or different, things, such as the auditor's
assessment of management's estimates and judgments, of significant
unusual transactions, or accounting changes. They might require the
auditor to discuss the quality of a company's accounting practices
Such new communications might, or might not, require new audit
procedures. But they would not change the fundamental role of the
auditor to perform an audit and attest to management's assertions as
embodied in management's financial statements.
This initiative will be of particular interest to disclosure
counsel, but others as well. I encourage you to follow.
B. Auditor Independence
The PCAOB is also focused on auditor independence. Our inspectors
have conducted annual inspections of the largest U.S. audit firms
for eight years. They have reviewed more than 2,800 engagements of
such firms and discovered and analyzed hundreds of cases involving
what they determined to be audit failures.
Every now and then, inspectors can trace an audit failure to a
competence issue, such as in the design of the audit methodology or
in its execution. But on the whole, these firms are highly
competent. And yet the failures continue to occur, in spite of
firms' remediation efforts. I am left with the inescapable question
whether the root of the problem is auditor skepticism, coming to
ground in the bedrock of independence. The loss of independence
Inspections by other audit regulators have also given rise to
concerns about auditor skepticism, as reported by the U.K.'s Audit
Inspection Unit, the Dutch AFM, the Australian Securities and
Investments Commission, the Canadian Public Accountability Board,
the Swiss Federal Audit Oversight Authority and the German Auditor
Oversight Commission. Based on such concerns, the
European Commission is also reportedly considering reforms to
enhance auditor independence. I understand a draft of proposals from
the EC is expected in November.
In August, the PCAOB issued a concept release to seek public
comment on how to enhance auditor independence, including whether
audit firms should be subject to term limits.
Under existing U.S. rules, all but the smallest audit firms are
required to rotate engagement and quality review partners. This
requirement dates back to the profession's self-imposed quality
control requirements. But it was imposed and strengthened by law as
part of the Sarbanes-Oxley Act's independence reforms. My
understanding is that it is now widely accepted globally as a best
Partner rotation allows a firm to become aware of a partner's
decisions in the audit. But a new partner may feel the need to live
with those decisions and agreements; he may have little motivation
to reopen them. What is lost is the true "fresh pair of eyes."
I recognize that audit firm rotation presents considerable
operational challenges. I am interested in hearing about them in
Like any professional service firm, audit firms invest
considerable resources in pitching new clients. And in the early
years of an engagement, they may even take in less in fees than it
costs them to do the audit. Alright, law firms wouldn't do that
unless they had to. But why would they? Because they hope to make up
these costs and more in a long stream of future fees.
That future stream of fees may be cut off if the company is
displeased. That, some would say, is the risk inherent in the
client's payment of the fee. The auditor may perceive that
displeasing management on a substantive accounting or auditing issue
— one of those so-called "close calls" — may increase the risk of
losing those future fees.
For the record, I do not by these voiced concerns impugn the
ethics, integrity and good faith of the entire profession. To
recognize the complexity of transactions, the velocity of financial
reporting schedules and the pressures of competition does not,
cannot, blind us to the risks and the "predictable surprises" — in
this case unpleasant predictable surprises.
Skepticism can fail in spite of high ethical standards, when the
cited pressures, for example, result in the audit team skipping over
disconfirming evidence. In short, we are not talking about the
ethics, integrity and good faith of the profession. We are talking
about causalities of judgment in the heat of the moment. As
standard-setters, the PCAOB should try to find ways to counter the
pressures, and fortify the judgment.
If the audit firm were seeking a finite engagement, say ten
years, would they feel the same incentives? Would audits be more
objective, in early years and all years, if the auditor knew within
the reasonably foreseeable future another firm would take over the
We have a long comment period, extending to December 14. We will
then hold a public roundtable to further discuss the subject in
March of 2012.
C. Audit Transparency
The third policy initiative I want to talk about is audit
transparency. Earlier this week, the Board proposed amendments to
its auditing standards to improve audit transparency by enhancing
disclosure about the participants in audits, including disclosure
about the partner in charge of the audit as well as other firms
involved in the audit.
This proposal stems from a concept release that the Board issued
in July 2009 to obtain comment on whether the Board should require
engagement partners to sign audit reports.
The names of key management executives, not to mention corporate
board members, have long been disclosed. The names of audit
engagement partners are also disclosed in many countries, but to
this point not in the United States.
As I said at the PCAOB's open meeting on Tuesday, I fail to see
why shareholders in large European banks and other companies should
be able to see the name of the engagement partner in the audit
report, but shareholders in U.S. banks and companies should not.
Indeed, the names of engagement partners for some European
companies that are listed on the NYSE are disclosed in U.S. filings.
Why are their shareholders to be favored over shareholders in U.S.
At the concept release stage, the Board received certain
objections to requiring engagement partner signature, most notably
that the change could unintentionally imply a reduction in the
firm's overall responsibility for the audit and the audit opinion.
The proposal is intended to address those concerns.
Our audit standards set forth the responsibilities of the
auditor. The proposal does not change the responsibilities of the
audit firm or the engagement partner.
The proposal would also provide investors disclosure about other
accounting firms and certain other participants in the audit, given
the nature of cross-border audits today. Enhanced transparency into
the composition of cross-border audits should help investors gain a
better understanding of how an audit was conducted and make more
informed decisions about how to use the audit report. Investors will
see, for example, the significant participation of audit firms from
jurisdictions where we cannot inspect.
Our comment period for this proposal extends through January 9.
IV. Secrecy of Enforcement Proceedings
Before I close, I would like to touch on one more initiative that
I believe will be of interest to you as counsel to companies and
boards that engage auditors.
As I mentioned at the outset, both PCAOB investigations and any
contested disciplinary proceedings we bring are by law under
Sarbanes-Oxley non-public unless the respondents consent to
publication of our complaints and decisions. We have asked Congress
to change this.
In the years since Sarbanes-Oxley passed, the PCAOB has built an
active enforcement program, but unfortunately for investors, audit
committees, the bar, and the audit profession itself, it takes place
largely behind the scenes.
The Board's Division of Enforcement and Investigation conducts
rigorous investigations before recommending that the Board file any
complaint. But when the Board does determine that the facts merit
the filing of a complaint, it will not be public. Nor will any
decision by the Hearing Officer or the Board to impose a sanction,
until any appeal to the SEC is exhausted.
Litigation postpones — often for several years — the day on which
the public learns that the Board has charged the auditor or firm and
the nature of those charges. This secrecy has a variety of
unfortunate consequences. Interested parties, including investors,
audit committees, issuers and other auditors, are kept in the dark
about alleged misconduct.
Audit committees may be unaware for years that their auditor has
been charged by the Board. Counsel representing other auditors are
deprived access to the Board's precedents. And auditors don't learn
important information about conduct or actions that draw the Board's
reproach, denying the public any benefit from the deterrent effect
that the filing of public complaints would have on other auditors.
A case that recently became public only after the completion of
SEC review of the Board's decision provides a good example. In
Gately & Associates, a Florida firm issued 29 additional audit
reports on public company financial statements between the
commencement of the Board's proceeding and the public disclosure of
the Board's charges, which did not occur until the SEC affirmed the
Board's decision to expel the Gately firm from public company
auditing and allowed the Board's sanction to take effect. That
information, had it been available, could have made a difference to
client and investor decisions regarding the firm or the companies it
* * *
It's been a pleasure to be back in Texas and to have this chance
to talk with you. Thank you for your time and interest in the PCAOB.