Thank you for inviting me to this conference. Let me begin by
saying that the views I express are my own and should not be
attributed to the Public Company Accounting Oversight Board as a
whole or any other members or staff.
Today, I would like to talk to you about some of the PCAOB's
initiatives to enhance the relevance, credibility and transparency
of the audit to promote high quality financial reporting.
We meet in the midst of a robust and wide-ranging global debate
on how to promote audit quality. Whatever the outcome, it is clear
that the audit is indeed a valued, critical feature of the U.S.
financial system, and it enjoys an important position in the eyes of
people around the world.
I. High-Quality Audits Are Critical to Capital Formation and
High-quality audits are critical to capital formation and
economic growth. This has been so since the earliest days of our
organized securities markets.
Our colleague Bernard Black, on the faculty at Northwestern, may
have put investors' predicament best. He once wrote —
[C]reating strong public securities markets is hard. That
securities markets exist at all is magical, in a way. Investors pay
enormous amounts of money to strangers for completely intangible
rights, whose value depends entirely on the quality of information
that the investors receive and on the sellers' honesty.
It is to the credit of the securities bar that we have been able
to fashion a system of securities regulation that gives millions of
disorganized investors a basis to trust the information they
receive, to trust that their capital will be applied to the purpose
One of the best features of our system is that it is not
immutable. We have been able to improve it over time, as we develop
new forms of capital accumulation and allocation to meet new needs
of investors and new uses for public funds.
Through your efforts, among others, the U.S. has become a
clearinghouse for the fair allocation and use of capital.
Professional, skilled and independent auditors are key to helping
investors separate the credible managers from the charlatans. By
building a basis for confidence, auditors reduce financing costs,
and contribute to an efficient allocation of capital to fuel
But conferences like this do not exist to congratulate ourselves.
The bar has reconvened each of the 31 years in the history of this
conference to prepare for and channel new developments and
As with the Holmesian view of the law — not logic but
experience — so also with the audit. We
learn and improve from experience.
One principle that continues to stand, upon examination and
re-examination, is that, as Bernie Black said, the value of the
investor's intangible right — the value of the share — depends
entirely on the quality of information the investor receives and on
the seller's honesty.
In recognition of Black's insight, I believe we are in a high
risk period that merits more attention to the audit, not less.
Although we have never needed it more, the audit has, in the minds
of some, become a commodity to be contained with other compliance
Academic research confirms that the harm of fraudulent reporting
extends beyond the injury to direct stakeholders and reaches whole
industries and competitors. When trust in financial reporting
is lost, the markets question competitors' business strategies
Unwinding ill-conceived investments may be costly and
impractical. Moreover, confidence in new, valid proposals for
capital committment can be affected.
As a former securities law practitioner and counsel to boards, I
believe the audit is the most cost-effective way to avoid being
surprised by errors or malfeasance that have quietly grown to
approach a material level. While not foolproof, the audit confirms
But an audit that does not serve the needs of users is false
comfort and, over time, loses its relevance to market
To be relevant, the auditor must speak to and for the users of
the financial statements. For the audit to be relevant, the public
must be confident in the auditor's ability to apply both technical
expertise and skepticism to management's assertions.
Fair or not, that is in question today. And this is where the
PCAOB's initiatives come in.
I want to see a vibrant audit profession that competes on quality
more than price. I want to see a profession that is revered for
insight and clarity, not box-checking. I want to see a profession
that attracts and retains top graduates who are and remain committed
to excellence in public service. I doubt I need to impress upon you
the bar's interest in these goals as well.
Audit regulators around the world are engaged in confronting
these challenges. The PCAOB is deeply engaged with its counterparts,
both through inspection coordination and multi-lateral meetings in
venues such as the International Federation of Independent Audit
Regulators. I will share some of what we are learning from other
II. International Audit Oversight Coordination and Results
With that in mind, let me briefly describe our approach to
coordinating with our counterparts around the world.
To date, the PCAOB has conducted inspections in 40 foreign
jurisdictions. Last year, one-fourth of our inspections took place
outside the United States.
Overall, there are around 240 non-U.S. audit firms in over 50
foreign jurisdictions that have issued audit opinions on U.S.
issuers and are required to be inspected at least every three
A. Audit Regulators Around the World Are Developing a New
Paradigm for Working Together.
Gradually, together with our counterparts, we are creating a
network of regulators to match the networks of firms. The aim is to
work seamlessly together to meet our respective inspection
We now jointly inspect with local regulators in Australia,
Canada, Germany, Korea, the Netherlands, Norway, Singapore, South
Africa, Switzerland, Chinese Taipei and the United Kingdom.
Two weeks ago, the PCAOB entered protocols on cooperation and
information-sharing with the audit regulators in France and Finland.
These agreements will allow the PCAOB to begin conducting joint
inspections of PCAOB-registered firms in France and Finland with the
Our non-U.S. inspections are important, not only because of the
foreign private issuers that sell securities in U.S. markets. Many
of the non-U.S. audit firms that have registered with the PCAOB also
perform significant audit work for U.S. companies that have
This is the nature of the global audit. The principal auditor —
that is, the auditor that signs the audit report — refers a portion
of the audit to local auditors in a country or countries where the
company has subsidiaries or significant operations.
The local auditor may perform specified procedures that the
principal auditor asked it to perform. Or it may perform for the
principal auditor a complete audit, with audit report, on the local
In either case, generally speaking, the principal auditor uses
the work of other audit firms to form an opinion on the financial
statements as a whole.
B. Regulators Around the World Have Expressed Shared Concerns
About Disappointing Inspection Results.
Let me turn to results. What benefit does coordination yield? As
we deepen our relationships with fellow independent regulators, we
deepen our understanding of audit risks.
We have identified significant audit failures after issues
identified jointly with another regulator in an inspection of the
principal auditor led us to review a subsidiary audit in a third
Our inspectors have also found situations where a U.S. firm has
used the work of another audit firm that turned out to be
unreliable. Sometimes the work requested by the principal auditor
was never performed.
Both in this joint work and independently, regulators around the
world have expressed concerns about disappointing inspection
In Australia, Greg Medcraft, the Chairman of the Australian
Securities and Investment Commission recently commented in the
Australian Financial Review about ASIC's review of inspections
conducted in the 18 months up to June 30, 2012. He said it "showed
an increase in auditors failing to obtain reasonable assurance the
audited financial statement was not materially misstated."
In particular, he called for improvement in three key areas — the
sufficiency and appropriateness of audit evidence, auditors'
professional skepticism, and auditors' use of other auditors and
Similar results have been reported across Europe and in Canada.
According to a compilation of inspection results from Canada, the
U.S., the U.K. and Australia, prepared by the Canadian Public
Accountability Board's Chairman, Brian Hunt, "Insufficient
Professional Skepticism . . . is undoubtedly the most common finding
— that auditors are too often accepting or attempting to validate
management evidence and representations without sufficient challenge
and independent corroboration."
Since it began operations in 2003, the PCAOB has tackled
progressively more of the vexing issues with which the audit
profession has struggled for decades — such as the failure to apply
professional skepticism in difficult audit areas, including
management estimates and valuations.
The PCAOB also performs increasingly refined and sophisticated
risk assessments to identify where the most significant challenges
to audit quality exist. This contributes to the increase in
inspection findings over time.
Tackling these tough issues has also contributed to an
improvement in audit quality, I believe. Nevertheless, as other
audit regulators around the world have concluded too, the rate of
failure is unacceptably high.
III. The PCAOB's Initiatives Aim to Help the Profession Realize
Its Potential by Enhancing the Relevance, Credibility and
Transparency of the Audit.
There is a lot going on at the PCAOB to examine these issues and
find ways to improve auditor performance. We have an active
standards-setting agenda developed through extensive outreach,
including with the PCAOB's Standing Advisory Group as well as other
In this outreach, we hear from numerous stakeholders, including
auditors themselves, as well as preparers and their representatives,
experienced members of the bar, investors, and others.
We don't rewrite standards just for the sake of change. But
through our consultation process we identify areas of auditing that
deserve improvement or updating in light of developments in
We consider alternatives to achieve our intended outcome. We
consider potential costs, as well as potential unintended
consequences. We are adding resources to involve economists more
deeply in our work.
Our agenda is available on our website and is updated
periodically. Today, I will highlight a handful of projects that may
be of particular interest to the bar.
A. Facilitating the Work of Audit Committees.
The first two such initiatives focus on arming audit committees
with more and better information about the audit, as well as more
and better information about the auditor's strengths and
According to a January 2013 Global Audit Committee Survey,
released by KPMG's Audit Committee Institute, only 38% of audit
committees claimed to have a formal and comprehensive annual
external auditor evaluation process in place.
Audit committees cannot make decisions about hiring and
compensating auditors on the basis of quality without transparency
and insight about quality. Our audit committee initiatives aim to
help audit committees obtain that information.
1. Auditing Standard No. 16 Improves Auditor Communication with
The PCAOB has recently adopted a new auditing standard — Auditing
Standard No. 16 — on what the auditor should communicate to audit
committees in order to protect the public's interest in keeping
audit committees informed of important audit matters.
I know you'll have a panel on the Jumpstart Our Business
Start-ups Act of 2012 tomorrow. So it may be of interest that this
standard is the first promulgated after the JOBS Act was enacted.
Consistent with Section 104 of the JOBS Act, when the PCAOB
submitted the final standard for approval by the SEC, we included a
discussion of efficiency, competition and capital formation.
The SEC approved the standard on December 17, 2012. It is
effective for audits of fiscal years beginning on or after December
AS 16 is intended to foster a more robust discussion between the
auditor and the audit committee. It is intended to focus the audit
committee on the importance of probing and understanding challenging
audit issues and significant auditor judgments, and championing the
auditor's independence and professional skepticism in resolving
those issues and making those judgments.
I would expect the best audit committees to demand this kind of
dialogue already. Yet we see situations where this was not the case.
AS 16 is an attempt to change that.
2. The PCAOB Has Issued Guidance on What Audit Committees Can
Learn from PCAOB Inspections.
The PCAOB has also recently issued guidance about how audit
committees can learn more from their auditors about the results and
implications of the PCAOB's inspection findings.
Description in the public portion of the inspection report of
failure to obtain sufficient evidence to support the firm's opinion
means that the inspection staff has determined that the firm failed
to fulfill its fundamental responsibility in the audit: the firm
failed to obtain reasonable assurance about whether the financial
statements are free of material misstatement.
Firms' characterizations of inspection results can sometimes
distort them. How an auditor approaches inspection results can tell
an audit committee a lot about the firm's commitment to
Your role as corporate counsel makes a difference: how an audit
committee addresses inspection results can affect the tone of the
audit. An audit committee that is impatient with the technicalities
of an audit, or accepts weak arguments to dismiss the findings in an
inspection report, may inadvertently signal to the audit firm and
audit team that the audit committee is not concerned with
An audit committee that, on the other hand, expresses explicit
concern for how the auditor has resolved noted deficiencies tells
the auditor that quality matters.
And then, there is the fallacy of elevating the fee above the
quality of the auditor. As counsel for corporate boards, you will
want to be attuned to these nuances.
B. The PCAOB Has Proposed New Standards on Related Party
Transactions and Audit Transparency.
The PCAOB has also proposed two new standards.
The first would enhance the public's understanding of the audit
by requiring disclosure about participating firms as well as the
name of the engagement partner who supervises them. Today, only the
principal audit firm's name goes on the audit report that the public
We are reminded, from time to time, that even sophisticated
business people and government officials who use audit reports do
not realize that audits for large companies are often performed by
consortiums of separate audit firms.
For companies, and their counsel, concerned about the risk of
override of controls and material misstatements in far-flung
locations, it is the work of these undisclosed subsidiary auditors,
and the rigor of the principal auditor's oversight of their work,
that provides the company (and investors) with assurance that the
necessary controls are in place and working effectively.
Depending on where a company's operations and accounting are, the
underlying source of half or more of this assurance work may be
performed by a firm or firms other than the firm whose name is on
the audit report. But even those who are aware that multiple firms
may be involved in an audit generally don't know the extent of work
performed by other audit firms. The PCAOB has proposed to address
The second proposal is a new auditing standard on related party
transactions, describes basic tools that good auditors have used for
years to identify financial reporting risks. For example, it
requires auditors to understand management's compensation as a way
to understand management's motivations.
To be clear, nothing about the standard would put the auditor in
the role of setting or passing on management compensation. Some
commenters have expressed concerns in this regard, but as the
standard itself makes clear it's simply not the case.
I doubt I need to tell you, though, that changes in performance
metrics provide important information about management's incentives
that may not otherwise be understood. They offer the auditor — and
audit committee — insights about where management's financial story
could be weak.
We are currently evaluating comments on both the related party
proposal and the transparency proposal.
C. The PCAOB Has Issued Concept Releases to Commence Debate on
More Broad-Ranging Topics.
The PCAOB standards-setting work also includes two rather more
broad-ranging projects, commenced not with concrete proposals but
with concept releases.
1. The Auditor's Reporting Model
One involves consideration of changes to the form and content of
the standard audit report. The current model is essentially three
boilerplate paragraphs. For a long while, investors have called for
more insights from the auditor's work.
This project is intended to develop a better, more transparent
reporting model, one that will impart the auditors' insights about
key aspects of the financial statements and other matters to
The project is not about changing the nature or scope of the
auditor's work. It's about making the results of that work more
2. Auditor Independence
The second concept release goes to the issue of auditor
independence, objectivity and professional skepticism.
In August 2011, the Board issued a Concept Release on Auditor
Independence and Audit Firm Rotation. The concept release notes
the importance of auditor independence to the viability of auditing
as a profession. It asked for comment on ways to enhance auditor
independence, objectivity and professional skepticism, including
through auditor term limits, which are being debated around the
As a concept release, it made no specific proposal. Rather, the
vehicle of the concept release is designed to pose questions to
solicit public input before any proposal is considered or
Independence and skepticism are complex issues that warrant deep
study. The PCAOB has embarked on a series of public meetings to
engage prominent and thoughtful commenters with various, often
One outgrowth of the meetings so far has been a PCAOB staff audit
practice alert on Maintaining and Applying Professional
Skepticism in Audits issued in December 2012. The Alert reminds
auditors of the critical importance of professional skepticism to
The Alert also describes a number of impediments to professional
skepticism — including, for example, unconscious human biases and
other circumstances that can cause auditors to gather, evaluate,
rationalize, and recall information in a way that is consistent with
client preferences rather than the interests of external users.
Finally, the Alert describes steps that firms and auditors can take
to enhance professional skepticism in audits.
We must also watch and evaluate the implications of international
developments. The Dutch Parliament recently adopted audit firm
rotation. It appears likely that some companies plan to implement
auditor switches ahead of the 2016 deadline.
The European Commission, Parliament and Member States are engaged
in their own inquiry. Their legislative deliberations indicate a
real likelihood that some form of term limits could be adopted this
year. Firms in Europe have had to factor the possibility into their
strategic business planning.
This is not a new issue: concerns over independence and the role
of anticipated or established auditor tenure predate the
It is now, however, a broad international debate. People disagree
on what the best reforms will be, how to implement them, and indeed
whether reform is necessary. Costs and any potential unintended
consequences will have to be considered.
We should not rush to decision. I don't have the view that
independence and skepticism can only be achieved through term
Through the responses to the August 2011 concept release and the
substance of our public meetings, we have elucidated many of the
questions asked by the concept release. Our job at the PCAOB is to
be alert to the changes that are afoot: to understand them, to
analyze their effects on the audit, and to consider what it all
implies for the future of the audit.
* * *
You have been a gracious audience and I thank you very much for
your interest in the PCAOB's work.