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Revised Audit Partner Identification Proposal Moves Forward

December 5, 2013

The PCAOB voted to issue a second version of a proposal requiring identification of the engagement partner. Investors want the name of the audit partners who lead the reviews of company financial reports made public. Auditors are skeptical of potential benefits of such disclosure and believe that it will increase their legal liability.

The PCAOB on December 4, 2013, unanimously voted to issue an amended proposal that would require audit firms to disclose the name of the lead partner on the audit report.

Comments are due on February 3, 2014.

The effort is proceeding with some controversy. Two board members, Jay Hanson and Jeanette Franzel, hedged their yes votes with assertions that they wouldn’t support a final standard, partly because the costs could be greater than the benefits.

“The key questions surrounding this proposal are whether and how additional transparency about the identities of engagement partners and other participants in audits would solve a particular need or problem, serve appropriate policy objectives, achieve certain benefits, and impose compliance or other costs,” Franzel said. “Frankly, it is surprising that we are at this point in the standard-setting process with such basic questions still unanswered.”

“Identifying the engagement partner and providing additional information about the other participants in the audit will increase the usefulness of the auditor’s report for investors when making their investment decisions, as well as when voting on the ratification of a company’s choice of accounting firm as its auditor,” said PCAOB Chairman James Doty.

In July 2009’s Concept Release No. 2009-005, Requiring the Engagement Partner to Sign the Audit Report, the audit regulator said the signature may increase the engagement partner’s sense of accountability to investors, who believe auditors need to be pushed to be more independent from client interests.

The auditing profession has resisted the rule change at every step of the regulatory process, arguing that it would be a problem if the sense of responsibility for the audit shifts to the engagement partner from the firm. They also feared an increase in the legal liability for lead partners.

In response, the PCAOB dropped the requirement that the engagement partner sign the audit report. In the October 2011 proposal, Release No. 2011-007,Improving the Transparency of Audits: Proposed Amendments to PCAOB Auditing Standards and Form 2, the board proposed disclosure of the engagement partner’s name in the audit report without asking for the partner’s signature, which investors viewed as an acceptable compromise.

Audit firms still challenged the proposal based on their view that it provided no discernible benefit to investors. The firms said they’re already accountable to multiple parties. More importantly, they asked the PCAOB to clarify the liability implications from the SEC for the consent requirements under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 and Section 11 of the Securities Act of 1933.

Liability for engagement partners in actions brought under Section 11 allows for claims against “every accountant” who “has with his consent been named” as “having prepared or certified” any part of a registration statement or any report or valuation used in a registration statement, the PCAOB said in Release No. 2011-007.

Board member Steven Harris said the PCAOB’s analysis of Section 10 says it “should not affect the status quo as it relates to private liability. In other words, firms will continue to be liable in fraud cases, and the engagement partner’s liability should not be increased.”

As to any potential liability under Section 11, Harris said it depends on the SEC’s decision as to whether engagement partners and participating firms must file consents. “Our proposed amendment assumes that engagement partners and participating accounting firms named in the auditor’s report will have to consent to the inclusion of their names in the auditor’s report,” he said.

Hanson, who was a partner with the audit firm McGladrey & Pullen LLP before coming to the regulatory board, said the potential benefit is low because there is no evidence that it would lead to an observable improvement in audit quality. Further, he said the risk of liability is still not clear.

Hanson added that while engagement partners have significant responsibilities, they aren’t solely responsible for an audit’s quality. For example, firms have quality control systems, and large audits include multiple partners in supervising and reviewing work. The partners also frequently consult national office experts.

He’s willing to have the disclosures in other forms, given the interest investors show in the information, but not the audit report.

“I believe the best place for this information would be in the audit committee report, where the audit committee could expand on the information to provide additional context to its selection of the engagement partners and its oversight over the audit firm,” Hanson said. He wants the responsibility for the disclosure to rest with the SEC, not the PCAOB.

Hanson said he could also support disclosure in the firms’ Form 2 annual report, which the audit firms prefer.

“The release discounts these two alternative approaches because they would ‘require investors… to search two different places, at two different regulators…’ I find this rationale unconvincing,” Hanson said. “There is no value to obtaining only the engagement partner’s name. In order to make use of that information to evaluate the potential quality of a given audit, investors would still have to look at other regulatory filings, including searching for disciplinary records on the PCAOB website, and do other background research in order to find out relevant information about the partner’s experience and history conducting audits.”

The board also made some changes related to another part of the proposal, which would require disclosure in the audit report of other accounting firms and other persons not employed by the auditor that took part in the audit.

In many large public company audits, the lead auditor subcontracts part of the audit work, especially when auditing companies that have operations in several countries. The work is often done by other firms or independent accountants.

In the next proposal, the names of other firms will be disclosed. Unlike the 2011 proposal in Release No. 2011-007, the names of persons not employed by the audit firm wouldn’t be disclosed, but instead be indicated as “persons not employed by our firm.” The revised proposal also raises the threshold for disclosure from 3% of the total audit hours to 5%. Unlike Release No. 2011-007, the next proposal will allow the disclosure to be stated within a range of percentages or as a single number. Release No. 2011-007 did not allow a range of percentages.