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Auditors May Have to Give More Details About Firms That Assist Them

The PCAOB plans to soon adopt rules requiring accounting firms to identify firms they hire for portions of their work for public company clients. The requirement may move forward in September as part of a planned standard to provide more information to investors about the audit work.

The PCAOB plans to soon adopt rules requiring accounting firms to identify firms they hire for portions of their work for public company clients.

The requirement is part of a broader effort to provide investors with more information about auditors and the work they do for public companies that were proposed in December 2013 in Release No. 2013-009, Improving Transparency Through Disclosure of Engagement Partner and Certain Other Participants in Audits. The proposal updates the 2011 proposal in Release No. 2011-007, Improving the Transparency of Audits: Proposed Amendments to PCAOB Auditing Standards and Form 2.

“The chairman said he anticipates that we will move forward in September with the transparency project to disclose the name of the engagement partner and identify other firms participating in the audit,” PCAOB spokeswoman Colleen Brennan said.

The proposed requirement to name the lead partner in an audit has received most of the attention as the proposal has been debated. But some financial professionals believe the information about other participants in the audit may be more important to investors.

In many large public company audits, the lead auditor doesn’t review all of the client’s documents. Much of the supplementary work is done by other firms or independent accountants.

“There’s no way for an investor to tell today how much of an audit was performed by firms other than the signing firm,” PCAOB Chairman James Doty said in December 2013 when the board issued Release No. 2013-009. “In some cases, the undisclosed auditor has been inspected by the PCAOB, in which case the public inspection report may give the public a sense of the quality of that firm. In other cases, the PCAOB may not be able to inspect the firm.” The PCAOB, despite years of negotiations, is barred from inspecting audit firms in China and some European nations, and some foreign auditors participate in the work that larger firms do for U.S.-listed companies.

“Investors may justifiability want to factor those risks into their conclusions about the reliability of the audit report,” Doty said.

During a June 24 meeting of the PCAOB’s Standing Advisory Group, Chief Auditor Martin Baumann said there’s little transparency about the supplementary work contracted out to other firms.

“There are some smaller audits as well where it can be signed by a U.S. firm. But we are seeing where much of the audit, as much as 90 percent of it, is in a foreign jurisdiction, which is not transparent at all,” Baumann said. “And that work may be done by an audit firm that’s not even subject to inspection because of restrictions on inspection in that country. We think this will be a meaningful disclosure for investors.”

Under the proposal, the names of other firms and their locations will be disclosed. Unlike the 2011 proposal, the names of persons won’t be disclosed but indicated as “persons not employed by our firm.” The auditor will also have to disclose the percentage of the total hours in the most recent period’s audit that’s attributable to other participants.

The revised proposal raised the threshold for disclosure to 5 percent of the total audit hours from 3 percent. It also allows the audit firms to write the disclosure within a range or as a single number.

Jeff Mahoney, general counsel of the Council of Institutional Investors, wrote in a comment letter that the information may be particularly relevant to investors if the other firm “is not subject to inspections by the PCAOB or other regulators; has a disciplinary history with the PCAOB or other regulators; or is subject to different, and potentially conflicting, legal and regulatory requirements than the firm issuing the opinion.”

Senator Carl Levin, a Michigan Democrat who chairs the Senate Permanent Subcommittee on Investigations, supports the disclosure.

“When investors see the name of a major auditing firm on an audit report, they may make certain assumptions about the quality of that audit based upon that company’s reputation,” Levin wrote in a comment letter to the PCAOB. “A yearlong investigation conducted by the subcommittee into illicit money flows involving banks in foreign jurisdictions uncovered a host of problems with foreign auditors, especially those operating in foreign jurisdictions with strong secrecy laws and weak anti-money laundering controls.”

Accounting firms that have written comment letters to the PCAOB that said the named firms will be exposed to increased legal liability and litigation costs because of consent requirements under securities laws if the names are put on the auditor’s report.

 

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