It is a pleasure to be here today. I addressed this conference exactly one year and one day ago, six months into my chairmanship of the Public Company Accounting Oversight Board. Now, with Auditing Standard No. 5 adopted -- and its implementation underway -- other challenges are vying to be at the top of our agenda. I’d like to take this opportunity to step back and reflect with you on some critical initiatives that are underway at the PCAOB.
In addition to providing an overview of where we are as an organization, I would like to address three important areas: the PCAOB and cross-border cooperation; implementation of Auditing Standard No. 5; and how the PCAOB is prudently exercising its enforcement authority. I purposefully will not address the current standard-setting priorities of the PCAOB, as our chief auditor, Tom Ray, will have the opportunity to share our priorities with you today.
Before I go further, I must note that the views I express today are my own, and not necessarily those of other Board members or staff of the PCAOB.
The PCAOB is on the verge of its fifth birthday. Five years ago, the U.S. markets were actively moving to recover from the aftermath of a number of corporate scandals. The Sarbanes-Oxley Act was several months old, and the first set of board members of the PCAOB had been identified. In fact, a small number of professional staff and the founding board had begun to set the foundation for what would become the organization we have today. Since my first day here, I have been impressed by the numerous good decisions this core group made as it set forth to launch the PCAOB.
By April 25, 2003, the SEC made the determination that the PCAOB was appropriately organized and had the capacity to carry out the requirements of the Act. So, I suppose we’ll technically view April 25, 2008 as our fifth birthday.
The PCAOB now numbers just under 500 employees and has offices in eight cities across the country. Since 2003, the PCAOB has registered over 1800 audit firms. Remarkably, while over 980 are U.S. firms, a stunning 840 registrants are from outside of the United States. This is because the Sarbanes-Oxley Act of 2002 requires firms that audit U.S. public companies (including foreign private issuers) to register with the PCAOB and undergo regular inspections. In addition, as most of you know, firms are required to register with the PCAOB if they play a substantial role in the preparation of an audit report with respect to a U.S. issuer. While over 1800 firms are registered with the PCAOB, currently 10 are subject to annual inspections and roughly 875 are subject to PCAOB inspection on a triennial basis (and about 230 of this category of firms are located outside of the United States).1
Due to the mandate given to the PCAOB from Congress, the PCAOB must inspect many non-U.S. registered firms, which means we are now conducting inspections both across the United States and across the globe. Combined with our standard-setting responsibilities, the PCAOB is well aware that it has a tall order to fill when it comes to fulfilling its mandate effectively.
To assist the Board and its staff in guiding its programs and operations in the coming years, in May of this year the PCAOB adopted its first multi-year strategic plan. The strategic plan sets forth the overall goals of the PCAOB and serves as a roadmap for us. It is intended to assure alignment of the PCAOB’s programs, operations, and budget with the organization’s overall mission, goals, and objectives. The plan covers the years 2007 through 2012, and I encourage those of you with an interest in the PCAOB to review the plan.2
What has struck me since I became chairman is how rapidly independent auditor oversight has spread. Since the PCAOB was established, there has been a dramatic evolution worldwide. Including the European Union member states, approximately 40 countries have taken the decision to establish independent oversight of auditors. This is tremendously encouraging.
We have invested substantial time in developing productive relationships with our peers – both collectively (through our membership in the International Forum of Independent Audit Regulators) and individually (through bilateral relationships). Our mutual oversight and cooperation is fundamental to the global strengthening of audit quality, which is vital to the efficient operation of our increasingly inter-dependent capital markets.
As more and more households have become equity investors, the importance of the public company audit has increased. The audit also has become even more essential as our markets have increased their global reach. Simply put, audited financials enhance investor confidence, but of course, this is based on the presumption of a high-quality audit. Auditors and audit oversight bodies must work together to enhance audit quality.
Again, the PCAOB understands the importance of working closely with our counterparts. Cross-border cooperation enhances audit quality and better-leverages respective resources. Taking into account these goals and the progress that we are seeing worldwide, last week the PCAOB issued for public comment a policy statement on enhancing cooperation. The statement establishes a framework that builds on the five principles enumerated in PCAOB’s Rule 4012 (Inspections of Foreign Registered Public Accounting Firms). The policy statement articulates an approach that would enable the PCAOB to move beyond joint inspections toward full reliance on our counterpart oversight bodies in other countries that meet certain essential criteria. We would be able to do this without sacrificing our duty to inspect for compliance with PCAOB standards and issue inspection reports, including a public portion. The comment period closes on March 4, 2008, and I encourage those of you with an interest in this area to review the document and provide comments.
Another area of significant challenge for auditors and the PCAOB is the successful implementation of Auditing Standard No. 5. Getting the new standard issued this year was a major initiative of the Board, but the success of that standard really rests with all of you. This is especially true for next year, when those smaller companies that have never before had an audit of internal control will require your audit services.
The new standard is just that – it is new. As I have said to the CEOs of the largest firms, it is important that all of you re-challenge the way you have conducted these audits in the past to ensure that you have made the necessary adjustment to your audits for this year. The new standard incorporates a top-down, risk-based approach that is meant to focus on the areas of greatest importance to financial reporting for each public company.
Audit quality continues to be a priority for the Board. In developing the new standard, we removed those required procedures from the audit of internal control where such procedures were not necessary to achieving a quality audit. In order to achieve successful implementation of the new standard, auditors should be making similar modifications to their audit plans. The standard, and the staff guidance for the audit of smaller public companies that we put out earlier this year for comment, provides for a truly scalable approach. It is imperative that all of you question how you are going to scale your audits for the size and complexity of your clients company.
The staff of the PCAOB has begun early dialog with the national offices of the largest firms, and the firms have made good progress in both re-challenging their audit methodologies and embracing the changes in the standard. As we all know, however, the execution in the field is a crucial aspect of the implementation of any standard, and this one is no exception. I look forward to hearing of your success over the coming year.
In October, we issued staff guidance in order to assist auditors in scaling the audit of internal control to the smaller issuer environment. The guidance highlights some attributes of smaller companies that are unique and relevant to the audit of internal control. PCAOB staff will carefully consider comments before issuing the staff guidance in final form. Although auditors are expected to be able to benefit from this guidance immediately, the comment period may provide the opportunity to improve the document before it is made final.
The PCAOB also understands the critical role that our inspectors play in the successful implementation of this new standard. We are focusing inspection training on this area to ensure that inspectors fully understand the numerous critical decisions that went into the development of the new standard. Moreover, we appreciate that the new standard places a higher level of reliance on auditor judgment. We are also aware that some auditors view this with fear – that is, they fear that their judgments will be unfairly evaluated. While I can assure you that our inspectors will evaluate the judgment exercised by auditors with an appropriate level of skepticism, we are committed to performing these evaluations fairly to provide for an environment that encourages the auditor to use judgment where appropriate. It is with this goal in mind that we have included training on evaluating auditor judgment in our inspector training program.
Under Sarbanes-Oxley, Congress also granted the PCAOB enforcement authority over PCAOB-registered firms and their public company auditors. The Board exercises its enforcement authority, in support of its supervisory model, to focus on serious violations of PCAOB standards or securities laws by auditors under its jurisdiction. In this area, as I have said before, we do not measure our success by the number of violations identified or actions taken. For any financial supervisor, though, the ability to escalate to an enforcement action is a critical tool.
A PCAOB enforcement development today illustrates how we use our authority. Earlier this morning, the Board announced settled disciplinary proceedings against Deloitte & Touche LLP and one of its former audit partners for violations of Board standards in connection with an audit. The Board’s disciplinary orders today are the first against a large audit firm and the first against an audit partner of a large firm.
The Deloitte order is an important reminder that audit firms must adequately staff their audits and, where necessary, take appropriate action to assure audit quality. I commend the Board's enforcement staff, led by our Enforcement Director Claudius Modesti, for their excellent and diligent work in bringing this investigation to an appropriate and timely conclusion. Claudius will discuss the action in more detail later in the conference.
By any measure, this is an interesting time to be an auditor. Among other things, the SEC is considering a move to IFRS for U.S. public companies (having just done so for foreign private issuers), financial markets are cutting their teeth on fair value accounting and its challenges, and further globalization appears inevitable. It is happening before our eyes and complexities abound. Some additional complexities are also driven by the growing complexity of the underlying business and financial transactions – such as structured transactions and off-balance sheet activities (not just at financial institutions). Our educational structure and curriculum must keep up with all of these developments, and there is an equally important responsibility placed on firms to ensure that they are providing appropriate training to their staffs.
At the same time, policymakers have a greater appreciation today of the challenges that the audit profession and educators are confronting. Secretary Paulson’s advisory committee is just one example of the efforts underway to fully understand -- and take measures to improve -- the environment in which auditors operate today.
The PCAOB understands its role and will continue to improve its oversight tools to ensure that it is an effective supervisor; it will scrutinize accounting developments to determine when changes in PCAOB audit standards or guidance to auditors is warranted. We also will periodically issue reports to share aggregate inspection findings that we believe would be useful in enhancing practices more broadly – such as our report on small firm inspection findings issued in October. I encourage you to be part of our efforts – when the PCAOB puts something out for comment, take the time to consider and comment on our proposals. We take the comments that we receive seriously.
Thank you for your time today. I believe I have a few minutes for questions.
1 Not all of the registered audit firms require routine inspection by the PCAOB because many of them do not currently serve as principal auditor for a U.S. public company. Many of these firms registered with the PCAOB, even though not required to do so.
2 See http://www.pcaobus.org/About_the_PCAOB/Strategic_Plan.pdf