Date: Dec. 15, 2015
Speaker: Steven B. Harris, Board Member
Event: PCAOB Open Board Meeting
Mr. Chairman – Congratulations to you and all involved on bringing this initiative to a final vote this morning. Without your patience, persistence and leadership I do not believe this transparency project could have succeeded.
This issue has been before the Board, in one form or another, since at least 2009 following President George W. Bush's Treasury Advisory Committee on the Auditing Profession recommended that the engagement partner be required to sign the auditor's report.
This is now the Board's fifth open meeting on this subject and my views concerning this topic are reflected in my previous open meeting statements. The Board has heard from a number of constituencies, each of which has strongly held perspectives on the subject.
Investors and regulators alike do not believe that audit quality is where it should be. Investor representatives believe that requiring a signature on an audit report would increase an engagement partner's sense of accountability and responsibility, and hence prompt positive changes in his or her behavior, all in the service of improved audit quality.
I should add that the same reasoning compelled the drafters of the Sarbanes-Oxley Act to include a provision mandating a personally signed certification from the chief executive officer (CEO) and chief financial officer (CFO) with the quarterly and annual reports filed with the Securities and Exchange Commission (SEC or Commission) wherein the executives certify, as the auditor does in the audit opinion, that the financial statements conform to generally accepted accounting principles (GAAP) and fairly present the financial condition and results of operations of the company.
On the other hand, the audit profession believes that while an engagement partner is the member of the audit engagement team with final responsibility for the audit, the audit is the result of a group effort.
My position is well known. I see no reason why auditors should be treated any differently from other professionals—such as architects and engineers—who must sign off on their work product or, as mentioned, CEOs and CFOs who are similarly required to attest to their company's financial statements. I also agree with investors that engagement partners should be held individually accountable for the audit work and ultimate result of the audit engagements they are responsible for supervising.
Since 2009 this Board has heard a number of arguments against our signature proposal and related disclosure proposal which provided auditors with the option of placing their names in the auditor's report instead of signing it. The most persistent of these arguments is the assertion that engagement partners would have to contend with heightened liability concerns if their names appear in the auditor's report.
It is worth noting that all the liability arguments that we have heard have been premised on the idea that the engagement partner should not be liable for deficient audits that harm investors, even if those audits are carried out so recklessly as to meet the legal standard for fraud. But it is not clear, to me at least, why this should be the Board's goal. As Brandon Rees, Deputy Director of the Office of Investment for the AFL-CIO, stated in his comment letter:
Many audit firms have objected that requiring engagement partners to personally sign or disclose their names in audit reports may result in enhanced legal liability under Section 11 of the Securities Act of 1933. However, from the standpoint of investors, imposing Section 11 liability on auditors for material omissions or misstatements is beneficial. Auditors may limit their Section 11 liability by conducting audits with appropriate due diligence, and this will create an incentive for improved audit quality.
As Anne Simpson, Investment Director of CalPERS, succinctly put it in her comment letter:
The fact is that a signature alone would not increase liability. Liability is created when there is a problem with the audit, not when the auditor signs the audit report...When there is a high quality audit there is no fear of liability. If the audit falls short, investors should have adequate recourse.
Second, these arguments seem to assume that engagement partners today face no liability. But the SEC and PCAOB can and do pursue disciplinary actions against engagement partners who fail to carry out their responsibilities. And, while Janus and other Supreme Court decisions may have limited engagement partners' potential liability in private federal court actions, as James D. Cox, Brainerd Currie Professor of Law, Duke University School of Law, explained in his detailed comment letter, state law actions against an engagement partner, although "rare," can be maintained and in such an action –
that partner's signing or not signing the opinion letter is of no consequence in determining the auditor's or his/her firm's liability to a relying plaintiff. That is, changing audit procedures to require the engagement partner to sign or otherwise identify himself/herself will not change the contours of the auditor's liability under existing state law.
Finally, there are other, more practical reasons to think that engagement partner transparency will not significantly affect those partners' litigation risk. As others have noted, the primary reason why engagement members are not included as defendants in private civil litigation is due to the general perception that they do not have sufficient assets to satisfy any judgment, not because their identity is unknown or because legal theories of potential individual liability are absent.
The bottom line is that engagement partner disclosure will neither significantly change the liability landscape, nor create adverse, unwarranted consequences.
The last time this issue came before the board I mentioned that requiring the engagement partner's name to be disclosed in a new form, as opposed to the auditor's report, "would isolate the United States from an emerging global consensus on the manner in which the name of the engagement partner should be disclosed." This is not just a matter of opinion but a well-documented fact. 16 out of the 20 countries with the largest market capitalization (80 percent), including 7 European Union member states, already require disclosure of the name of the engagement partner in the auditor's report and I continue to believe that investors in the United States are entitled to the same.
For me, this issue has always been more about improving audit quality, which is not where it should be, by enhancing and influencing a leader's sense of individual accountability and acceptance of responsibility for a team effort he or she has led by signing his or her name to a most commonly reviewed report, as opposed to simply being identified in a newly developed form.
However, I understand that reasonable people may agree to disagree, which is why I support today's compromise which will result in the creation of a new standardized form – the Form AP, the "AP" standing for "Audit Participants."
As a result of this proposal, audit firms will now be required to identify the audit engagement partner for a particular audit on this form rather than the audit report, which is the primary vehicle by which the auditor communicates with investors about the audit. Furthermore, the audit report is available upon filing with the Commission while Form AP can be filed up to 35 days after it is included in a document filed with the Commission.
The information in Form AP will be available on our website, which will provide investors, audit committee members, and other interested parties with an opportunity to evaluate and compare the performance of individual engagement partners as well as other participants in the audit.
Some of the benefits of identifying the engagement partner on a standardized form include, over time:
In addition, I would like to believe that the identification of the engagement partner would serve to enhance the reputation of partners whose engagements are not associated with restatements or enforcement actions, thereby creating incentives that promote audit quality and investor protection.
I also support requiring audit firms to disclose the names and locations of any other firm that provides at least 5 percent of the total audit hours for any given audit report.
Currently, audit quality differs materially among various countries and this additional disclosure will, as Jeffrey Johanns of the University of Texas says, allow "users of financial statements to understand which public accounting firms are actually performing the audit work and where they are located, because many recent accounting fraud cases in the U.S. have involved poorly supervised foreign firms performing low quality audits."
Mr. Chairman, after more than six long years of contentious debate on this subject, I am glad we are now able to get this issue behind us and move forward to finalize other longstanding proposals such as:
Allow me to offer a brief word about each.
The auditor's reporting model remains a high priority of mine because it is the primary means by which investors and other stakeholders acquire information about the audit. In its current incarnation, the auditor's report conveys minimal information about the data obtained and evaluated by the auditor as part of the audit. The report has changed very little since the 1940s. Investors contend that it must be updated to provide additional information that will make it more relevant and useful to investors and other stakeholders – and I strongly agree.
As with the identification of the engagement partner, I would note that the United States lags behind much of the rest of the world in this area as well. I mentioned this as another top priority of mine upon first joining the Board in 2008. American capital markets are an international resource as well as a major force within the U.S. economy. The cornerstone of our capital markets has been our strong commitment to transparency and investor protection. Improving the audit reporting model would be in keeping with that commitment.
With respect to going concern, investors do not understand how so many large companies that were significantly affected by the events in the recent financial crisis received clean opinions from their auditors.
Nor do they understand how it is possible that out of the 25 largest issuer bankruptcies that occurred between fiscal years 2003-2012– representing a combined market capitalization of approximately $70 billion – only three received a going concern opinion in their most recent audit report before filing for bankruptcy protection, which raises the question "where were the auditors?"
In August 2014, the Financial Accounting Standards Board (FASB) updated U.S. generally accepted accounting principles to establish new requirements for a management going concern assessment and related financial statement disclosures.  If the PCAOB were to follow FASB's threshold for "substantial doubt" in the auditing standards, it would result in auditors issuing even fewer going concern opinions; in other words, more clean opinions, notwithstanding the recent financial crisis.
The PCAOB, however, must adhere to a different obligation than the FASB. Section 10A of the Securities Exchange Act requires auditors to include "an evaluation of whether there is substantial doubt about the ability of the issuer to continue as a going concern during the ensuing fiscal year."
This provision was enacted into law in 1995 in response to the savings and loan crisis which cost the American taxpayer some $132 billion and was intended to give investors an "early warning" before a company's financial difficulties became severe.
Given the expectation of investors and the legislative history of Section 10A, I feel strongly that the Board should take meaningful steps to improve auditor going concern reporting as soon as possible, including specifying what kind of early warning disclosure investors should expect from auditors in the future. This subject has been repeatedly discussed by the Board's Investor Advisory Group in 2011, 2012, 2014 and 2015. And, this issue has been taken up internationally.
But, taking one step at a time, at this point I am pleased that we have at long last concluded this transparency project, and that investors will soon know the name of the engagement partner as well as the other participating firms on a particular audit.
As I mentioned at the outset, Mr. Chairman, without your leadership, I do not believe we would be finalizing this initiative today, and I commend you and my fellow Board members for bringing this to a vote this morning.
I would like to thank Marty Baumann, Jennifer Rand, Jessica Watts, Karen Wiedemann, and Lisa Calandriello from our Chief Auditor's office, Andres Vinelli and Morris Mitler from our Center of Economic Analysis, Gordon Seymour and Vince Meehan from our Office of General Counsel, Sarah Williams and Karl Heermann from the Division of Registration and Inspections, and Nirav Kapadia and Steve Raia from our Office of Information Technology for their tremendous work on this project. I look forward to a productive year of standard setting in 2016.
 See Final Report of the Advisory Committee on the Auditing Profession to the U.S. Department of the Treasury (October 6, 2008), at VII:20 (recommending that the PCAOB undertake a standard-setting initiative to consider mandating the engagement partner's signature on the audit report).
 See International Forum of Independent Audit Regulators (IFIAR) Press Release: International Audit Regulators Express Concern Over Continued Significant Deficiencies in Audits of Public Companies (March 3, 2015), available at: https://www.ifiar.org/IFIAR/media/Documents/IFIARMembersArea/MemberUpdates/Member%20Updates/IFIAR-2014-Survey-press-release.pdf?ext=.pdf; See also Mary Jo White, Chair, U.S. Securities and Exchange Commission, Keynote Address at the 2015 AICPA National Conference: Maintaining High-Quality, Reliable Financial Reporting: A Shared and Weighty Responsibility (Dec. 9, 2015), available at: http://www.sec.gov/news/speech/keynote-2015-aicpa-white.html.
 See e.g., comment letter from Sir David Tweedie, dated March 11, 2014, located at http://pcaobus.org/Rules/Rulemaking/Docket029/051c_Tweedie.pdf and Statement on Concept Release Requiring the Engagement Partner to Sign the Audit Report by Steven B. Harris, Board Member, dated July 28, 2009.
 See Section 302 of the Sarbanes-Oxley Act of 2002.
 See e.g., comment letter from Ernst & Young LLP, dated February 12, 2014, located at http://pcaobus.org/Rules/Rulemaking/Docket029/039c_EY.pdf.
 Per Appendix A of Auditing Standard No. 9, Audit Planning, the engagement partner is the person "with primary responsibility for the audit."
 Comment letter from American Federation of Labor and Congress of Industrial Organizations, dated Aug. 31, 2015, available at: http://pcaobus.org/Rules/Rulemaking/Docket029/038d_AFL_CIO.pdf.
 Comment letter from California Public Employees' Retirement System (CalPERS) dated Aug. 31, 2015, available at: http://pcaobus.org/Rules/Rulemaking/Docket029/044d_CalPERS.pdf.
 See e.g., In the Matter of Turner, Jones and Company PLLC; Stephen M. Turner, CPA; and Mark E. Turbyfill, CPA, PCAOB Rel. No. 105-2015-038 (Oct. 15, 2015), In the Matter of Mark Shelley CPA, Mark A. Shelley, CPA, and Allan J. Ricks, PCAOB Rel. No. 105-2015-010 (May 28, 2015), In the Matter of Ronald R. Chadwick, P.C. and Ronald R. Chadwick, CPA, PCAOB Rel. No. 105-2015-009 (May 28, 2015), Gregory M. Dearlove, CPA, SEC Administrative Proceeding File No. 3-12064 (Sept. 30, 2005), and John V. Back, Jr., CPA, SEC Rel. No. 34-52258 (Aug. 15, 2005).
 Janus Capital Group, Inc. v. First Derivative Traders, 131 S.Ct. 2296 (2011).
 Comment letter from James D. Cox, Brainerd Currie Professor of Law, Duke University School of Law (August 5, 2015), available at: http://pcaobus.org/Rules/Rulemaking/Docket029/008d_Cox.pdf.
 Statement on the Supplemental Request for Comment: Rules to Require Disclosure of Certain Audit Participants on New PCAOB Form (June 30, 2015).
 The 16 out of the 20 countries with the largest market capitalization (based on data obtained from the World Bank, World Development Indicators) that currently require disclosure of the name of the engagement partner are Japan, United Kingdom, France, Germany, Australia, India, Brazil, China, Switzerland, Spain, Russian Federation, the Netherlands, South Africa, Sweden, Mexico, and Italy. The four countries that currently do not require the disclosure of the name of the engagement partner are the United States, Canada, Republic of Korea, and Hong Kong.
 See "More audit transparency for investors makes a bitter proposal easier to swallow", The Conversation (Aug. 19, 2015), available at: http://theconversation.com/more-audit-transparency-for-investors-makes-a-bitter-proposal-easier-to-swallow-46067.
 The top 25 ranking is based on market capitalization as of the fiscal year end before bankruptcy. Bankruptcy data are from Audit Analytics.
 See Financial Accounting Foundation, Financial Accounting Series, Accounting Standards Update No. 2014-15: Presentation of Financial Statements—Going Concern (Subtopic 205-40), Disclosure of Uncertainties About an Entity's Ability to Continue as a Going Concern (FASB ASC amendments), FASB (August 2014).
 As noted by FASB Board member Lawrence W. Smith in dissenting to the FASB ASC Amendments, FASB's increased threshold "will result in a decrease in the number of going concern disclosures as compared with current practice." FASB ASC amendments at 17.
 Section 10A(a)(3) of the Securities Exchange Act of 1934, 15 U.S.C. § 78 J-1(a)(3).
 From 1985 through 1989, more than 25 hearings were held in the U.S. House of Representatives regarding auditor and financial reporting that arose out of issues posed, in large part, by the savings and loan crisis. During those hearings, certain members of Congress expressed concern regarding the absence of "early warnings" regarding a company's potential failure or financial difficulties. See, e.g., Financial Fraud Detection: Hearing on H.R. 574 Before the Subcomm. on Telecommunications and Finance of the H. Comm. on Energy and Commerce, 103rd Cong. 1 (1993) 11 (Statement of Rep. Ronald L. Wyden) ("Whether it relates to the disasters at the savings and loans, defense contracting fraud, health care fraud, a variety of financial fiascos over the years, shortly on the heels of a clean audit one of these companies goes belly up and the system has not produced the kind of early warning lights and bells that is necessary to ensure that regulators who have the responsibility to deal with these things can get there in a prompt fashion.")
For a discussion of the ten major topics debated at the Congressional hearings, including the absence of auditor "early warnings" regarding company financial failures, see CPA Audit Quality—Status of Actions Taken to Improve Auditing and Financial Reporting of Public Companies, United States General Accounting Office (March 1989), GAO/AFMD-89-38.
 See, e.g., 132 CONG. REC. E1837-01 (daily ed. May 22, 1986) (Statement of Rep. Ronald L. Wyden), 1986 WL 779515 ("All too often in recent years, independent auditors either have failed to detect or to report fraudulent activities at a number of major corporations and financial institutions in this country. In one financial disaster after another, . . ., the disaster struck virtually on the heels of a stipulation by audit firms that the companies were financially sound. The result? Hundreds of thousands of investors and creditors were out hundreds of million (sic) of dollars").
Expanding Auditor Responsibility: Hearing Before the Subcomm. on Telecommunications and Finance of the H. Comm. on Energy and Commerce, 100th Cong. 3 (1990) (Statement of Rep. Matthew J. Rinaldo) (noting that "many Oversight and Investigation Subcommittee hearings have been held on the collapse and near collapse of large financial institutions. Testimony has made it clear the resulting hardships on depositors and investors could have been avoided by more diligent reporting of discovered irregularities and illegalities by the auditors of these institutions"), available at http://hdl.handle.net/2027/pst.000017583404;
see also Private Litigation Under the Federal Securities Laws: Hearings Before the Subcomm. on Securities of the S. Comm. on Banking, Housing, and Urban Affairs on A Growing Increase in Class-Action Securities Litigation Against Publicly-Traded Companies, Particularly High Technology, Accountants, Outside Directors and Lawyers, 103rd Cong. 115 (1993) (Statement of William R. McLucas, Director, Division of Enforcement, U.S. Securities and Exchange Commission) (stating that "given the unprecedented level of financial fraud witnessed over the past decade, particularly in the banking and savings and loan sectors, the investing public and this Subcommittee have a legitimate right to ask why so many financial institutions failed shortly after receiving an unqualified audit opinion"), available at http://hdl.handle.net/2027/pst.000022363787.
 See archives of the March 16, 2011, March 28, 2012, October 20, 2014, and September 9, 2015 IAG meetings, available at: http://pcaobus.org/About/Advisory/Pages/IAGMeetingArchive.aspx.
 For example, in January 2015, the International Auditing and Assurance Standards Board (IAASB) revised ISA 570, Going Concern. The IAASB originally undertook its project to revise ISA 570 because "[t]he topic of going concern is of significant interest in light of the global financial crisis. Stakeholders have called for increased focus on going concern matters by management and auditors." See Auditor Reporting on Going Concern, prepared by the IAASB's Auditor Reporting Implementation Working Group (Jan. 30, 2015).