Statement in Connection with the 2018 AICPA Conference on Current SEC and PCAOB Developments

Wesley Bricker

Chief Accountant

Washington D.C.

Dec. 10, 2018

The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This Statement expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.

This Statement describes, among other things, matters discussed among Wesley Bricker, Chief Accountant, and Julie Erhardt, Jenifer Minke-Girard, Marc Panucci, and Sagar Teotia during a Deputy Chief Accountant panel discussion at the 2018 AICPA Conference on Current SEC and PCAOB Developments held on December 10, 2018, in Washington, D.C.[1]

Introduction

The federal securities laws establish the authority of the Securities and Exchange Commission ("SEC" or "the Commission") to set accounting, audit, and independence standards to be followed in the preparation and the audit of general purpose financial statements of public companies.  The SEC's Office of the Chief Accountant ("OCA") is led by the Chief Accountant, who serves as the principal advisor to the Commission on accounting and auditing matters arising in the administration of the federal securities laws.[2]  The Chief Accountant leads a team of individuals who have a mix of experiences:  varied training and professional backgrounds, and work across domestic and international capital markets.  Our[3] objective is to develop well-informed viewpoints and limit blind spots, so that we learn from and strengthen our system of financial reporting that underpins decision-making within our capital markets.  We foster useful financial information that is comparable, verifiable, timely, and understandable by the millions of Main Street investors and others who participate in our capital markets. 

Audited financial statements enable investors to make more informed decisions.  Given their importance, the collective goal of all participants in the financial reporting architecture must be for the financial information to be complete and accurate and the audit report to be reliable, the first time the information is provided to investors.  When it is not complete or accurate, at best, investors are left seeking potentially imperfect remedies for the defects.  As a result, preventing defects should be our collective first priority, while detecting and remedying them should be our second.   

We invested our time during the fiscal year,[4] among other things, in the following key priorities:

• Engaging with participants in every phase of the financial reporting structure – which we documented and made available online in a "blueprint" of the structure[5] – regarding expectations for effectiveness and quality;
• Advising on key rulemaking initiatives and providing staff guidance;
• Overseeing the Financial Accounting Standards Board's ("FASB") accounting and reporting standard-setting activities;
• Assisting the Commission in overseeing the Public Company Accounting Oversight Board ("PCAOB") in its role of enhancing the quality of audit services for public companies and brokers and dealers;
• Addressing consultations regarding U.S. GAAP and International Financial Reporting Standards ("IFRS") accounting and reporting standards, internal control over financial reporting ("ICFR") requirements, and auditor requirements, including independence;
• Participating in the monitoring of the IFRS Foundation's activities and fostering high-quality international accounting and reporting standards; and
• Participating in the monitoring of the Public Interest Oversight Board's activities, which promote high-quality audit and audit-related standards used in over 120 countries.

We acknowledge the many participants – such as management, audit committees, auditors, advisers, standard setters, regulators, and academics – who hold vital roles, responsibilities, and accountability for preserving and advancing the quality of financial reporting for investors, particularly in this period of substantial change in the standards, technology, and use of financial information.  For example, many have been working on implementing or auditing the new revenue standard.[6]  These efforts have made financial reporting and therefore our capital markets stronger.

We also look ahead, informed by the Commission's recently updated strategic plan.[7]  As the plan describes, our securities markets and the technologies that support those markets are evolving and innovating at a fast pace.  The plan identifies three goals:  investors, innovation, and performance.  With this backdrop, we offer observations regarding how we and others can contribute to the shared objectives for maintaining high-quality financial reporting in our markets to meet the ongoing, sensible expectations of investors and the interests of the public.

Update on OCA staff from the Chief Accountant

I would like to acknowledge some recent changes in OCA.

Jeff Minton, who has served for many years as OCA's Chief Counsel, is retiring from the agency.  I want to thank him for his strong leadership over his 20 years of service at the agency, including over half of that as Chief Counsel for OCA.  He has provided critical counsel and assistance on oversight activities for the FASB and PCAOB, numerous SEC rulemakings, and technical assistance to Congress on legislation.  He also has directed OCA's enforcement liaison program, providing insightful analytical guidance and assistance to the Division of Enforcement on many enforcement actions and Commission on accountant suspension and reinstatement orders. 

Earlier, he worked in the Office of the Chairman under Chairman William H. Donaldson, as well as in the Division of Corporation Finance as an attorney in the Division's rule-writing office during implementation of the Sarbanes-Oxley Act of 2002.  Among his many awards, he received the SEC's Manuel H. Cohen Award, which recognizes outstanding legal ability and performance.

Jeff has been a dedicated public servant whose distinguished counsel, skill, intelligence, and wit has left an indelible mark on the SEC and OCA.  He demonstrated his steadfast commitment to protecting investors through his support for strong policies for financial reporting, audit, and independence.  Jeff retires with a legacy of accomplishments, including the development of a talented and dedicated group of professionals who continue to lead in OCA.

I have asked Giles Cohen, Deputy Chief Counsel, to serve as OCA's acting Chief Counsel upon Jeff's retirement.  Giles has a deep knowledge of the U.S. financial reporting system, the oversight activities for the FASB and the PCAOB, the disqualification and reinstatement of accountants, and the other responsibilities of OCA.  Giles first joined the SEC in 2005 in the Division of Enforcement after previously working as an attorney at the law firm of WilmerHale, and later served as counsel in the Office of Commissioner Luis Aguilar.  Giles is widely known and trusted throughout the Commission not only for his thoughtful counsel and insights to even the most challenging questions, but also for the generosity with which he shares his time and talents with his colleagues. 

Our Activities

Engaging with Stakeholders

During the year, we met with participants in every phase of financial reporting – the preparation, audit, delivery, and use – regarding expectations for effectiveness and quality. 

We meet with those involved in the financial reporting landscape to listen to stakeholder concerns, understand emerging issues and risks, answer questions, and share staff views on current financial reporting matters to promote high-quality financial reporting and reliable audits.  Our interactions are often with and among investors, companies, audit committees, auditors, industry groups, standard setters, other regulators, academics, and students.  Examples of our speeches and other materials are available on our webpage. 

Consultations

One of the most direct ways we communicate with companies, audit committees, auditors, and other regulators is through the consultation process,[8] including:

• We encourage consultation submissions on accounting concerns or questions, including those involving unusual, complex, or innovative transactions for which no clear, authoritative guidance exists, as well as on issues regarding auditor independence.  
• We also work with accounting staff in other offices and divisions, such as the Divisions of Corporation Finance, Investment Management, Trading and Markets, and Enforcement on accounting, ICFR, and audit matters.   
• We also have a helpline for informal, oral inquiries from stakeholders. 

When we communicate our expectations regarding financial reporting responsibilities, we foster high-quality financial reporting among companies and auditors of all sizes and help prevent costly misstatements.  More information about how to initiate a dialogue with us is available on our website.  

Speaking Engagements

We frequently participate in financial reporting conferences and panel discussions with stakeholders.  In these forums, the staff can identify emerging issues, hear stakeholder concerns, answer questions, and share staff views on current financial reporting matters to promote high-quality financial reporting.    

Sharing information

We make good use of our webpage to extend the reach of our information.  During the year, we updated our webpage, which we encourage you to visit at https://www.sec.gov/page/oca.  Once there, you will find new content, including three charts that depict the financial reporting landscape,[9] one of which is a blueprint of the overall financial reporting structure.[10]  

These charts illustrate over 50 groups involved in the preparation, audit, delivery, and use of domestic and international public company reporting in the U.S.  The charts also shed light on some less obvious aspects of the landscape, such as the multiple points of oversight, review, engagement, and feedback that are necessary to both preserve and advance high-quality financial reporting. 

The information is useful for emphasizing in the U.S. and other capital markets the identification of roles, responsibilities, and accountabilities – and the vital importance of coordinating among all the participants – so that quality in financial reporting is built in from the front to the back of the process.   

Rulemaking Initiatives and Staff Guidance

We provide advice on rulemaking initiatives that have an impact on accounting and auditing.

Loan Rule

Earlier this year, the Commission issued a proposing release to amend the auditor independence requirements in a technical area, commonly referred to as the "Loan Rule."[11]  The proposed amendments would clarify what has been a source of ambiguity and uncertainty for investors, management, audit committees, and auditors alike.  The proposal represents a targeted approach to amend the Loan Rule, and also seeks input regarding whether other changes should be made to the auditor independence requirements.  We are assesing the comments received as part of our work in this area.  The SEC's current regulatory agenda targets the Loan Rule for final rulemaking in 2019.[12]

Coordination with Other Offices and Divisions on Other Rulemaking Initiatives

We advise the Commission and assist other offices and divisions with their rulemaking as it relates to accounting, ICFR, and auditing matters.  For example, we have assisted the Division of Corporation Finance in its various disclosure initiatives, including the Disclosure Update and Simplification Final Rule issued by the Commission in August 2018.[13]  This rule updates and simplifies disclosure requirements, mainly where provisions of Commission rules may be redundant, overlapping, outdated, or superseded in light of subsequent changes to Commission disclosure requirements, U.S. GAAP, or IFRS.

We also assisted the SEC's Office of Municipal Securities in preparing its recommendations for the Municipal Securities Disclosure Final Rule in August 2018,[14] which adds transparency to the municipal securities market by increasing the amount of information that is publicly disclosed about material financial obligations incurred by issuers and obligated persons.

We also are working with the Division of Investment Management on recommendations for updating the Commission's existing valuation guidance for Boards of registered investment companies regulated by the Investment Company Act of 1940  ("'40 Act") to reflect the evolution in the markets and the standards for accounting and reporting.  We are hopeful that together with the Division of Investment Management we can develop recommendations for Commission consideration that assist Boards in performing their valuation duties under the '40 Act in a way that builds upon the accounting standard setting activities in this area and better serves investors.

Technology

We are also looking to the future and the use of technology.  For example, we continue to engage with market participants on innovative ideas and technological developments.  We collaborate with the Commission's FinHub (Strategic Hub for Innovation and Financial Technology),[15] and find it an excellent resource for public engagement on FinTech-related issues.  

We welcome your input.  As you explore technological opportunities, are you running into regulatory barriers within accounting or audit?  Is the current mix of profession-wide (nonproprietary) and firm-specific (proprietary) technology for auditors appropriate for fostering quality in the audits conducted by firms of all sizes? Are there ways in which standard setters could write requirements to reduce regulatory barriers related to technologies being developed or used in the market, while maintaining or enhancing the quality of financial reporting?  We welcome the opportunity to hear from you on future technologies and how we can help reduce regulatory barriers to innovation that benefits quality for investors and the markets.

Providing Staff Guidance

We also provide staff-level guidance on challenging technical accounting and disclosure questions.  For example, on December 22, 2017, we and the Division of Corporation Finance communicated staff guidance to help foster timely public disclosures of the accounting impacts of the Tax Cuts and Jobs Act.[16]  It incorporated valuable input from investors, companies, and auditors about how to balance timely disclosure to investors with the practicability of completing the accounting for income tax effects of the change in tax law.

 

We are also currently in the process of evaluating conforming changes to Staff Accounting Bulletin ("SAB") 102, Selected Loan Loss Allowance Methodology and Documentation Issues,[17] to align our guidance with the relevant concepts for an expected loss measurement model as a result of the FASB's standard on current expected credit losses ("CECL").[18]  Procedural discipline and documentation applicable under today's incurred loss model will continue to be relevant under the new standard. 

Overseeing the Financial Accounting Standards Board

The SEC is responsible for establishing accounting principles for public companies.  As provided for under the securities laws, the Commission has designated the FASB to serve as an independent, private sector accounting standard setter. [19]  Accounting standards play a vital role in establishing requirements for companies to provide investors with the information that they need, instilling confidence in the participants in our capital markets, and encouraging capital formation.

There is a long history of coordination and collaboration between the SEC and the FASB that has served investors and our markets well.  We believe investor confidence in a visibly independent and strong FASB creates substantial positive economic consequences. 

Consistent with our relationship, shared interest, and the FASB's approach, standard-setting is most effective when stakeholders from across the financial reporting process provide input.  We oversee the standard-setting activities of the FASB, in part, by:

• Participating in standard-setting projects by providing feedback to the FASB staff through reviews of proposed and final Accounting Standard Updates;
• Participating in or observing FASB-related meetings such as those of the Emerging Issues Task Force, the Financial Accounting Standards Advisory Council, Small Business Advisory Committee; and
• Working collaboratively with the FASB staff to share insights and perspectives on a variety of matters.   

Supporting Implementation of the New GAAP Standards

Quality in financial reporting starts at the front of the process, management's accounting.  Accordingly, an essential part of our work is monitoring the implementation of accounting changes, of which there have been many.  Companies have recently or soon will be implementing the FASB's new standards on revenue, leases, and CECL,[20] which we collectively refer to as "new GAAP standards."  Our initiatives, in part, include:

• Helping companies and their auditors interpret the new GAAP standards through our voluntary consultation process, described earlier;[21]
• Meeting with various working groups to understand implementation progress and questions;
• Overseeing the FASB's decisions to make any necessary clarifications to the standards to address unintended consequences, if any; and
• Participating in educational forums, such as the FASB's Transition Resource Group for Credit Losses.[22]

Through these initiatives, we have worked collaboratively with the FASB, IASB, other regulators, auditors, preparers, audit committees, and investors to promote successful implementation of the new GAAP standards.  We welcome both domestic and international stakeholders to consult with us on the new GAAP standards.  Our long-standing decision-making framework continues to apply.  OCA staff will continue to accept reasonable judgments in the application of the new GAAP standards.  We note that well-reasoned judgments frequently require the essential element of time to gather the facts and consider the accounting alternatives. 

Revenue Recognition

Earlier this year, the majority of public companies filed their first financial statements prepared using the new revenue standard, which was effective January 1, 2018 for most calendar year public companies.  The new standard requires companies to provide a comprehensive view of revenue arrangements in their financial statements, including their disclosures.  Registrants regularly consult with us on revenue recognition matters, for various reasons, including the significance of the top line and the related disclosures to investors.  The implementation of the new standard was a substantial, yet manageable, effort involving extensive collaboration among preparers, auditors, investors, standard-setters, industry groups, and others with the shared goal of advancing high-quality financial reporting in our capital markets. 

As summarized in previous speeches,[23] we have advanced implementation of the new revenue standard over its multi-year implementation period by: 

• Addressing consultations on revenue matters from registrants and other divisions and offices throughout the Commission;
• Actively monitoring implementation groups such as the sixteen AICPA Revenue Recognition Industry Task Forces;[24]

• Participating in a wide variety of meetings with preparers, industry groups, investors, other regulators, and accounting firms to provide insights into application issues;
• Delivering over 20 published speeches and participating in public panel discussions with the goal of sharing the results of our consultations to create institutional knowledge across the profession; and
• Contributing to the training of accountants across the SEC.

We will continue to monitor implementation of the revenue standard.

Leases

Many companies are planning for adoption of the new leases standard, which will be effective soon.[25]  The guidance affects both lessees and lessors.  While nearly all companies will be affected, the magnitude of the impact on any one company will depend on the nature and extent of its leasing activities.  As we have previously noted,[26] steps for implementation include:

• Understanding the accounting and disclosure requirements of the new standard;
• Identifying relevant arrangements and leases within those arrangements;
• Determining appropriate accounting policies, including applicable transition elections;
• Applying the guidance to arrangements within the standard's scope;
• Preparing transition and ongoing disclosures; and
• Establishing adequate and appropriate processes and controls to support implementing and applying the new standard, including preparing required disclosures.

Based on our meetings and dialogue with registrants, audit firms, and working groups, we believe companies are well on the way to executing their implementation plans.  As the remaining adoption runway is short, it is critical for companies to continue to focus their implementation efforts to allow investors to benefit from the improved transparency and consistency intended by the FASB in the accounting and disclosure of lease arrangements.

It is crucial for each registrant to ensure its implementation plans include sufficient time to identify arrangements that are leases in their entirety or that include embedded leases.  Evaluation of agreements to determine whether the leases accounting standard applies is not a new concept, but it is one that can take time.  Identification of leases is critical for lessees as the new standard requires lessees to recognize most leases on balance sheet.  Additionally, the new leases standard requires new disclosures by both lessees and lessors.  A thorough process to identify arrangements subject to the new standard will enable investors to benefit from transparency about a registrant's leasing activities.

It is also critical for companies to identify and resolve transition, application, and other implementation issues arising from the new leases standard.  A lesson learned from the implementation of the new revenue standard is that entities benefit from an early and thorough discussion of implementation issues with their auditors and audit committees.

To date, registrants have raised some implementation questions, including questions relating to the application of the standard's transition provisions and also matters relating to the ongoing recognition, measurement, and disclosure under the new standard.  The FASB has been actively engaged in implementation efforts, and has issued guidance to address a number of implementation issues.[27]  We continue to work closely with the FASB staff by providing feedback throughout the standard-setting process.  In addition, we also continue to actively monitor the implementation efforts through sustained engagement with preparers, industry groups, auditors, audit committees, and others.

Finally, reflecting on best practices from implementations of the new revenue standard, in addition to management and auditors, the audit committee plays a significant role in the financial reporting oversight of management's implementation of new accounting standards.  Audit committees should understand management's implementation plans to help achieve a high-quality implementation and ongoing application of the new standard.  Oversight by the audit committee can foster rigorous approaches by management to:

• Establish appropriate controls and procedures over transition;
• Maintain appropriate controls and procedures over ongoing application of the new standard; and
• Understand how the effects of the new standard are communicated to investors at transition and on an ongoing basis.

Current Expected Credit Losses

The new credit losses standard[28] will be effective for many companies beginning in 2020.[29]  The standard generally applies to financial assets and net investments in leases that are not accounted for at fair value through earnings.[30]  

Under the new standard, companies will move from recognizing credit losses under an incurred loss model to recognizing credit losses under an expected loss model.  Companies will need to estimate credit losses for assets in the scope of the standard over their contractual terms based on reasonable and supportable forecasts and historical information.  The standard also enhances the disclosures for investors regarding credit risk and credit losses.  

We continue to actively monitor the implementation of the new standard, including the resolution of questions through the FASB's Transition Resource Group.  In addition, we have observed a number of industry forums in which stakeholders are discussing implementation issues, including the AICPA's Depository and Lending Institutions Expert Panel and Financial Reporting Executive Committee.[31]  We have received consultation submissions regarding CECL, from which we continue to provide observations.[32]  More generally, the nature of consultations received has shifted from scoping questions to more specific application questions, which we believe is a positive sign that companies are making progress on implementation.

We urge companies to not let their implementation planning or disclosure of the anticipated effects of the new standard lag during 2019 as the FASB continues to consider and respond to implementation questions.

Fostering Internal Control over Financial Reporting

Internal control over financial reporting contributes to reliable financial reporting, including as companies implement new GAAP standards.  With the application of the new revenue standard substantially behind us, companies and auditors can reflect on what went well and what can be improved in considering any potential changes in internal controls when implementing the remaining new accounting standards.

Well-run public companies have adequate internal controls not just because internal controls are the first line of defense against preventing or detecting material errors or fraud in financial reporting, but also because strong internal controls are good for business and can have an impact on the companies' costs of capital.  It is essential for audit committees, auditors, and management to continue to have appropriate discussions of ICFR in all areas—from risk assessment to design and testing of controls, as well as the appropriate level of documentation.  If left unidentified or unaddressed, internal control deficiencies can lead to lower-quality financial reporting which can ultimately lead to higher financial reporting restatement rates and higher cost of capital.[33]

We have spoken about the importance of identifying and communicating material weaknesses before they manifest in the form of a financial statement restatement. We have seen progress made in the evaluation of the severity of internal control deficiencies.  However, we encourage ongoing attention, including audit committee participation and training as needed, regarding the adequacy of and basis for a company's effectiveness assessment, particularly where there are close calls in the assessment of whether a deficiency is a significant deficiency (and reported to the audit committee) or a material weakness (and reported also to investors).  During 2018 the Commission settled an enforcement action concerning a company's alleged failure to (a) devise and maintain a sufficient system of internal accounting controls and (b) adequately evaluate the effectiveness of its ICFR.  Due to these control failures, the Commission's order also alleged that the company failed to make and keep accurate books and records.[34] 

It is vital for companies and auditors to focus not just on an actual misstatement but also on whether it is reasonably possible that a material misstatement will not be prevented or detected on a timely basis.  Also, if a material misstatement exists then the reasonable possibility threshold has been met in considering the severity of the control deficiencies identified.      

The thresholds for auditor attestation do not change management's requirements related to their responsibility to design and maintain a system of internal accounting controls and assess the effectiveness of ICFR.  Even when auditors are not engaged to provide an attestation on ICFR, the PCAOB standards for a financial statement audit require the auditor to consider the internal controls that are critical to the auditor's risk assessment process and communicate to a company's audit committee deficiencies that are significant or material.  The auditor involvement, with or without an auditor attestation, can (and should) contribute to enhancements to a company's internal controls. 

Oversight Activities with the PCAOB

We devote substantial time to assisting with the Commission's oversight activities with the PCAOB.  The PCAOB fills a critical role in our capital markets. When companies issue their financial statements, investors expect and deserve the information to be complete and accurate.  An informative, accurate, and independent audit report provides, in part, the basis for an investor's confidence in the financial statements. 

The PCAOB contributes to that confidence through its role in overseeing the audits of public companies and SEC-registered brokers and dealers to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports.  The PCAOB's responsibilities are broad as it pertains to the audit profession; they include standard-setting, registration and inspection, and investigation and enforcement authority.

The Commission's oversight of the PCAOB includes the appointment of its Board members, approval of PCAOB rules and standards, oversight of disputed inspection reports and enforcement actions, and approval of the PCAOB's budget and accounting support fees.

In the past year, the PCAOB has welcomed five new Board members.[35]  The new Board's collective experience spans all phases of the financial reporting process.  As a body, the Board's broad perspective and focus on consensus-based decision-making should allow the PCAOB to continue to advance its mission in the years to come. 

The Board has demonstrated its dedication to strategic planning, outreach, and communication as a means of advancing audit quality.  In November 2018, the PCAOB finalized its five-year strategic plan after submitting a draft for public comment.[36]  In this case, the process to develop the strategy is perhaps as significant as the strategy itself.  In developing it, the Board looked outward for insights with an anonymous public survey and a series of one-on-one interviews to seek views on strategic priorities.  The Board also solicited feedback from its entire workforce, not just those in leadership, reinforcing a belief that the front lines are vital to the development and execution of the strategy.  Third, after developing it, the draft plan was submitted for comments from the public on the specific goals and objectives.

The process led to a well thought-out strategy, reflecting the current state of audit quality and the rapidly changing business and technology environment in which audits occur.  The approach also emphasizes an essential, strategic priority:  prevention.  The Board recognized that it must focus regulatory attention and efforts not only on detecting and remediating audit deficiencies but also on preventing them from occurring in the first place.  Doing so from the front to the back of the organization is critical.

Through our oversight activities, we support the Board's direction in advancing the PCAOB's vital mission and are grateful for the PCAOB members and staff's commitment, energy, and agility in improving quality in audit services upon which investors rely.  

Implementation Activities for Communicating Critical Audit Matters

We are focused on the implementation activities for the PCAOB's new requirement for auditors to discuss critical audit matters.[37]  We believe that successful implementation beginning in 2019 of the critical audit matters standard starts with proper planning, involvement, and communication by the PCAOB, audit firms, audit committees, investors, and us.  

In this regard, we have several observations and suggestions arising from our involvement during the year on the topic.  We encourage auditors and registrants to:

• Conduct (or participate in) a dry run this year especially for those engagements that will be adopting the critical audit matter requirements in 2019 – practice builds confidence and improves results.  These dry runs are occurring with constructive dialogue among auditors and audit committees about the value of starting the conversation early in the audit cycle, keeping the discussion current for changes and close calls throughout the year, and building into the plan how and to whom a draft of the report will be provided in advance of completing the audit.  This dialogue should help prevent mistakes in reports prepared for investors next year.
• Share implementation questions and other observations with the PCAOB staff and us.  Information sharing allows the PCAOB to consider whether any additional communications or guidance is needed and contributes to a post-implementation review the PCAOB is undertaking.
• Understand similarities and differences in different disclosure requirements and standards.  For example, management is required to provide disclosures of critical accounting estimates in MD&A – accounting estimates and assumptions that may be material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and that have a material impact on financial condition or operating performance.[38]  Critical audit matters are not designed to duplicate management's disclosures. 

Promoting Auditor Independence

Auditor independence is another area of focus.  The Commission's independence rules contain both a general standard of independence and also specific prohibitions to foster the auditor's objectivity and impartiality.  Absent independence, in fact and appearance, public confidence in the audit is diminished.

The flow of auditor independence consultations continues to be steady, although their nature and number have fluctuated over time.  These consultations help inform our thinking about whether there is a need to make (a) recommendations to the Commission regarding the independence rules or (b) update our existing staff guidance.   

As a result of consultation trends, in May 2018 the SEC proposed amendments to its auditor independence rules to refocus the analysis that must be conducted to determine whether an auditor is independent when it has a lending relationship with certain shareholders of an audit client at any time during the audit or professional engagement period.[39]

The Commission received thoughtful comments that were generally supportive of the proposed rule.  The comments also included recommendations for other changes to our independence rules.  We are analyzing all of these comments and considering next steps. 

As audit firms consider how they can contribute to better financial reporting as part of the overall business landscape, we encourage them to invest in their policies, procedures, and training, among other elements of a quality control system, that provide an audit firm with reasonable assurance that independence is maintained (in fact and appearance).  Independence is not only a legal requirement but also a professional and ethical duty.  Audit firms must promote ethical behavior by their staff, as a misstep here could impair the auditor's independence in fact or appearance.

We have previously emphasized that compliance with auditor independence rules is a shared responsibility of both the audit firm and the company and its audit committee.  Companies can help promote compliance by regularly monitoring corporate structural changes or other operational events that may result in new affiliates or business relationships and timely communicate these changes to the audit firm.  We encourage management and audit committees, along with audit firms, to evaluate the sufficiency of their monitoring processes and practices in these areas. 

The Role of Auditors and the Expectations Gap

Auditing is also about confidence and trust in the completeness, accuracy, and reliability of the financial statements.  An annual audit or interim period review performed by an independent auditor provides investors with confidence that a company's financial statements are presented in accordance with the financial reporting framework.[40]  Audits are not without limitation, however.  For example, audits are not designed to provide absolute assurance, nor are they intended to provide a guarantee of the integrity of management's financial statements or the viability and soundness of a business model. 

Quality in Audit Services

The quality of an auditor's interim reviews and annual audits is crucial to meeting investor expectations.  While many have quite reasonably concluded that audit quality has improved over time, reported deficiencies cited in regulatory inspections around the world remain prevalent, even as they are decreasing for many firms. 

Audit firm governance serves a vital purpose in maintaining an effective, proportionate firm-wide (enterprise) risk management system, as a framework to anticipate and mitigate the risk of breakdowns and failures.  As noted in a speech earlier this year,[41] leaders of the largest, most complex audit firms have appointed, or are taking steps to appoint, independent directors or independent advisory council members with meaningful governance responsibilities.  Regardless of the design, the purpose is the same:  to foster audit quality and safeguard against noncompliance threats and the resulting costs to the reputation of the firm, its network of affiliates, and the audit profession generally.

Another source of quality in audit services is collaboration.  Audit firms are part of the community that fosters high quality financial reporting.  Questions for all accountants and firms include:

• Do you as a firm or professional within a firm have a quality first mindset, which balances both prevention of deficiencies in the audit as well as timely detecting them?  Or is the concern disproportionately focused on detection without the preventive measures such as good quality controls and firm governance?
• Do you identify and discuss what good practices and prior mistakes look like across engagement teams and within the profession, both being used as an opportunity to promote greater consistency and the quality of the audit services which investors rightly demand and deserve?      
• Does the approach over-rely on technology and data?  Have you applied sufficient professional skepticism? Sometimes the "human" intelligence is more important than any "artificial" intelligence in preventing or sorting through failures when individuals over-rely, manipulate, or compromise technology.  

Communication to Audit Committees and Others

Beyond required communications, audit firms in the U.S. commonly provide to the public generally, and audit committees specifically, information to assist in understanding how the systems of the firm are designed and functioning.  These reports can contribute substantially to the audit committee's oversight of the audit relationship.  They also can be used as a companion document to PCAOB inspection reports.  In our view, these voluntary reports are most useful when they include robust information, such as three-year comparative data, discussion and analysis of results and trends, and are presented annually and updated on an interim basis, as needed.  As a related area, audit firms should consider whether there is enough information in the reports to understand the audit firm's level of investment in quality control functions, technology, its safeguards against overreliance on technology over time, and ultimately the connection of technology to audit quality.

Expectations

Collaboration among the parties involved in financial reporting is essential to meet the sensible expectations of investors and other users.  Among all parties, it is essential to continue a policy of ongoing coordination and collaboration on national and international standards, practices, and needs so that the best thinking is identified, shared with each other, and can prompt action.

This has implications.  For example, what more could be done to understand and coordinate technological issues (and the technology languages used) within and across each phase of the financial reporting structure?  Are standards developed in an optimal format?  Could professional accountancy bodies around the world do more to foster more consistent implementation and application of standards, such as through the use of workflow tools, job aids, and video illustrations?  For example, we strongly support the PCAOB's inclusion of technology as a separate goal within its Strategic Plan.  The PCAOB has engaged stakeholders in discussions regarding how technology will (and should) impact the execution of audits.

Expectations are normative.  And, the sources of expectations gaps are varied.  For example, the sources may be in the design of the standards, their application by accountants or auditors, or invalid expectations.  Also, the complexity of expectations only increase when accounting or audit standards are used across the diverse business, legal, social, cultural, and political environments in our world.  Thus, these expectations and any gaps are best addressed when the best thinking is shared across all phases of the financial reporting system and around the world, appreciating that the world is not flat and is likely to remain with similarities and differences.

Contributing to International Accounting, Audit, and Disclosure Work

Turning to cross border activities, companies operate in a global market and seek capital globally.  Today in the U.S., more than ever before, American investors are investing directly in the securities of foreign private issuers and companies based outside the U.S. and registered in non-U.S. jurisdictions.  At the end of 2017, U.S. investors had invested $12.4 trillion (of which U.S. mutual funds had invested approximately $6.0 trillion, and U.S. pension funds had invested over $1.5 trillion) in equity and debt securities listed in non-U.S. jurisdictions.[42]  Also, as of the end of 2017, according to one industry ranking of the world's largest asset managers, U.S.-based asset managers occupied the top four positions and seven out of the top 10 slots.[43] 

This global capital market presents both opportunities and challenges to securities regulators in executing their mandates.  The possibilities include greater competition among markets.  Also, investors may diversify their portfolio risk across borders more effectively and at less cost, and companies may seek the lowest price of capital wherever it might be. 

Before discussing our international activities, we want to acknowledge that the International Organization of Securities Commissions ("IOSCO") recently announced that it had elected Nigel James of our staff to become the new Vice Chair of IOSCO's Committee on Issuer Accounting, Audit and Disclosure, which is known as Committee 1.  We are pleased that with Nigel's appointment the OCA staff will continue to play a leadership role for the committee, given that Jenifer Minke-Girard recently completed her two year service as Vice Chair with outstanding leadership.

Promoting High-Quality IFRS  

Many U.S. companies and investors continue to have an ongoing interest in the quality of IFRS, as they produce and use financial information prepared in accordance with IFRS on a regular basis.  Reduced differences between U.S. GAAP and IFRS make the preparation and use of financial statements considerably more effective and may lead to higher-quality financial reporting by U.S. registrants.  Accordingly, we will continue to encourage the FASB and the IASB to work together to keep converged standards converged, to reduce differences in standards where they continue to exist, and to continually look for opportunities to improve standards in producing decision-useful information for investors.

During the year, we contributed to high-quality IFRS by, among other activities:

• Monitoring the governance of the IFRS Foundation and the IASB, including through IFRS Foundation Monitoring Board meetings;
• Participating in various forums to carry out the Monitoring Board's work in reviewing the IFRS Foundation Trustees' oversight of the IASB's standard-setting process, including monitoring and conferring with the Trustees on their responsibilities;[44]
• Attending, as an official observer, three meetings of the IFRS Advisory Council, engaging in discussion on a range of topics including, among others, the effect of technology on corporate reporting and the IFRS Foundation; the IFRS Foundation's communications strategy; and several topics to be addressed during the IFRS Foundation's planned review of its due process handbook;
• Participating in over 40 activities that involved providing feedback to the IASB on its exposure drafts, discussion papers, external review requests, and outreach requests; 
• Participating in six meetings of the IFRS Interpretations Committee to discuss the application of IFRS globally, including several issues involving the largely converged standard on revenue recognition;[45] and
• Engaging in over 30 meetings and teleconferences with non-U.S. securities regulators, including both bilateral and multilateral discussions, on IFRS development and application through our participation and leadership role on IOSCO's Committee on Issuer Accounting, Audit and Disclosure ("Committee 1").

Although U.S. GAAP continues to serve well the interests of investors and other stakeholders and will for the foreseeable future, it does not diminish the need – in the United States and abroad – to continue strongly supporting high quality international standards.  We all, particularly U.S. investors and companies, have a very strong interest in such standards, including IFRS.

Consider, for example that U.S. investors make many investment decisions using financial statements of foreign companies that apply IFRS issued by the IASB, investing directly in the securities of many foreign private issuers that apply IFRS in filings with the Commission.  These companies alone represent a worldwide market capitalization in excess of $7 trillion across more than 500 companies. 

The strong U.S. interest in high-quality, globally accepted accounting standards is not limited to market investing.  While U.S. companies apply and use U.S. GAAP, it is not to the exclusion of IFRS.  U.S. companies, for example, make acquisitions and enter into joint ventures relying on IFRS financial information.  U.S. companies also rely on IFRS financial statements when entering into transactions with non-U.S. companies and other parties that apply IFRS.  Still other U.S. companies look to IFRS when preparing financial information for management and boards of directors. 

Building upon the quality of IFRS is of central importance to U.S. investors and companies as business transactions and investor needs continue to evolve globally.  We appreciate, for example, that the FASB makes full use of its membership on the IASB's Accounting Standards Advisory Forum.  Trustees and management of the Financial Accounting Foundation also support their counterparts at the IFRS Foundation.  These various efforts are examples of collaboration that have greatly enhanced the quality of accounting standards in a number of important areas, and they provide footing for deepening the support.

Implementation of New IFRSs

As we look ahead, IFRS preparers, like U.S. GAAP preparers, are working to implement the new leases standard.[46]  As we have learned from the preparer adoption of new standards on revenue recognition and new requirements for financial instruments,[47] transition disclosures are critical to keeping investors informed.  Financial statements prepared using IFRS as issued by the IASB are required to contain disclosure of information relevant to assessing the possible impact that application of the new IFRS will have on preparers' financial statements in the period of initial application.[48]  A useful source of information about implementation disclosures continues to be the IOSCO Statement on Implementation of New Accounting Standards ("IOSCO Statement").[49]  The IOSCO Statement highlights the importance of the implementation process by issuers and their audit committees, and the importance of full, accurate, and timely disclosures of the possible impacts of adopting the new standards.

Throughout the year, we consulted on matters involving the application of U.S. GAAP and IFRS.  However, we continue to note that the level of consultation activity from foreign private issuers that file with the SEC using IFRS or U.S. GAAP is low compared to what we see from U.S. domestic companies.  As a reminder, our consultation process[50] is available to provide staff views on technical accounting positions, whether involving IFRS or U.S. GAAP.

Advancing International Audit-Related Standards

Both local and international audit, assurance, ethics, and education standards ("audit-related standards") are relevant to the U.S. and its capital markets participants.  The quality of international audit-related standards, for example, is relevant to U.S. investors and asset managers that hold or manage foreign equity and long-term debt securities.  The quality of international audit-related standards is also relevant to U.S.-based multi-national companies.  For example, in many cases, U.S.-based multi-national companies have local country statutory and other reporting obligations in jurisdictions outside of the U.S. that are met by the audit reports from audit firms that applied international audit-related standards as a starting point for the execution of the consolidated audit.  Moreover, the U.S.-based audit team may also use the results of the statutory audits as part of their audit risk assessment for the audit of the consolidated financial statements.

Many U.S. accounting firms are members of various global networks that incorporate international audit-related standards as part of a common audit methodology, training, and governance, with an aim to increase the consistency of audit execution and reduce the risk of audit failure.  Additionally, the U.S. accounting profession through the American Institute of Certified Public Accountants Auditing Standards Board ("ASB") has a strategic objective to converge its standards with those of the International Auditing and Assurance Standards Board ("IAASB") for audits that are not conducted using the PCAOB standards.[51]  The standards of the ASB may be used in conducting governmental and pension plan audits, as well as audits of entities with SEC filing obligations, such as in examination engagements under the Custody Rule; review and audit engagements under Regulation Crowdfunding; and audit engagements under Regulation A.

High-quality audit standards make audits—and the work of audit committees and others that oversee the audits of companies on behalf of investors—considerably more effective.  Accordingly, we all have an interest in the accountability and inclusiveness of the international audit-related standard-setters.  During the year, we contributed to high-quality international audit-related standards by:

• Monitoring the governance of the standard setting by participating in Monitoring Group meetings and calls;
• Participating in activities that involved providing feedback to the Public Interest Oversight Board, IAASB, and International Ethics Standards Board for Accountants on their exposure documents and through their advisory groups;
• Engaging in over 30 meetings and teleconferences with non-U.S. securities regulators, including both bilateral and multilateral discussions, on international audit-related matters, including through our participation and leadership role on IOSCO Committee 1.

Participating in the Monitoring Group

The Monitoring Group is a group of international financial institutions and regulatory bodies committed to advancing the public interest in areas related to international audit standard setting and audit quality.[52]  Wes Bricker was elected by IOSCO to serve as a representative to the Monitoring Group, currently as its vice chair, transitioning to co-chair in January of 2019, and then to chair in May of 2019.

We have been working throughout 2018 with the other Monitoring Group members regarding possible recommendations to the existing standard-setting structure and governance.  The Monitoring Group's work is vital to the oversight of the development and acceptance of international audit-related standards, in part because international audit standards are not binding of their own accord.  The standards nonetheless can and do affect audits by obtaining general acceptance among practitioners and influencing the content of binding, local requirements.

Vital Role of Independent Audit Committees

Audits and financial reporting more generally are also enhanced by strong, independent audit committees.  Boards of public companies in the U.S. have a financial reporting oversight responsibility, which they usually assign to their audit committees.  In the U.S., the entire Board has to approve the release of public company financial reports, even though management is responsible for their preparation.  As a result, both management and directors have a vital interest the quality of the company's books and records and related internal accounting controls in order to address their responsibilities adequately.

Companies and directors should carefully choose who serves on their audit committees, selecting those who have the time, commitment, and experience to do the job well.  Just possessing financial literacy may not be enough to understand the financial reporting requirements fully or to challenge senior management on major, complex decisions.  Audit committees must stay abreast of these issues through adequate, tailored, and ongoing education.

The audit committee also must be committed to its oversight of financial reporting, including through a properly balanced agenda toward understanding the accounting, ICFR, and reporting requirements.  For example, as business, technology, accounting, and reporting requirements change, it is crucial that the audit committee understand management's approach for designing and maintaining effective internal controls.  To illustrate, does the audit committee understand management's approach to attract, develop, and retain competent individuals who have responsibility for the design and operation of manual control activities, which are applicable when reasonable judgment and discretion is required, such as may arise in the application of the revenue recognition standard?  The audit committee can take insights from the conversation with auditors about whether, where, and why they were unable to rely on internal controls.  

The audit committee's expectations for clear and candid communications from the auditor should not be taken lightly, particularly when it is time to evaluate the relationship with the auditor.  Just the same, the auditor should expect appropriate support and tone from the audit committee when issues arise.

We also note positive trends in audit committees voluntarily providing enhanced disclosure regarding their role in overseeing the external auditor.  We encourage audit committees for listed public companies of all sizes to communicate how the listing requirements related to the "appointment, compensation, and oversight of the work of any registered public accounting firm…"[53] are carried out, especially among smaller companies.  We note positive trends from one survey of proxy statement disclosures among S&P 1500 companies,[54] but with opportunities for more progress among mid- and small-cap companies.  For example: 

• 40 percent of S&P 500 companies disclose considerations in appointing the audit firm, compared to 27 percent of mid-cap companies and 19 percent of small-cap companies.
• 20 percent of S&P 500 companies disclose that the audit committee is responsible for fee negotiations, compared to 5 percent of mid-cap companies and 4 percent of small-cap companies.
• 46 percent of S&P 500 companies disclose criteria considered when evaluating the audit firm, compared to 36 percent of mid-cap companies and 32 percent of small-cap companies.

Audit Committees in the Global Environment

During 2018, we continued to participate with other national securities regulators through IOSCO in producing a report on good practices of audit committees in their role of promoting and supporting audit quality.  In April 2018, IOSCO issued for public comment a consultation report,[55] with comments due in July 2018.  The consultation report proposed good practices for audit committees in several areas, including recommending the appointment of an external auditor; assessing potential and continuing external auditors; matters to consider in setting audit fees; facilitating the audit process; evaluating external auditor independence; communicating with external auditors; and assessing audit quality.  IOSCO members are considering comments received on the consultation report and the next steps toward publishing a final report.  We anticipate that the report will provide helpful suggestions for audit committees on a global basis. 

Risk and Innovation

Turning now to risk and innovation, several observations for accountants to consider in thinking about the risks arising from innovation are along the following lines:

• Accountants are able to effectively contribute to risk assessment and risk mitigation discussions and analyses because they are trained to, for example, proceed until they understand the heart of an explanation, verify what is represented with evidence, and proceed in their work with due care.

• Accountants are able to effectively analyze the quality of a risk analysis or risk mitigation approach because they are familiar with the timeless objectives by which the veracity of a fact set or situation can be analyzed—e.g., its completeness, accuracy, validity, timeliness. 

• Accountants have the tools to analyze a risk and control situation "from top to bottom" because the accounting profession has developed control analysis frameworks which they can draw upon to organize their thinking and their work.

In summary, in both risk identification and remediation of control deficiencies, it is helpful for accountants to use their skills, their knowledge, and their control frameworks to help others to "pull the thread" all the way from the nature of the overall control environment to the nature of particular ongoing monitoring activities in order to completely evaluate a situation.

Conclusion

As we reflect on a very productive and successful year, we are grateful to the many accountants and auditors who work diligently to promote reliable financial reporting.  The financial reporting system's strength is the result of the shared and weighty responsibility of all participants in providing investors the right financial information the first time. 

We are witnessing a broad range of technological innovations, but these will not do away with the need for integrity in the individual or the ability to think, which always need to be present. 

We look forward to working with you all in 2019 and beyond to continue to advance financial reporting for the U.S. capital markets.

Appendix I

The following table presents a list of published speeches and statements given by OCA staff members during 2018.  We encourage you to refer to these speeches for additional information regarding accounting and auditing matters. For the content of each speech, please refer to https://www.sec.gov/news/speeches.