Summary: The following article is a conversation with Thomas Quaadman, executive vice president of the U.S. Chamber of Commerce Center for Capital Markets Competitiveness about the PCAOB.
Thomson Reuters recently sat down with Thomas Quaadman, executive vice president of the U.S. Chamber of Commerce Center for Capital Markets Competitiveness, for a conversation about the Public Company Accounting Oversight Board (PCAOB).
The following questions and answers, which have been edited for clarity and length, come as the PCAOB has been working on a record-breaking number of standard-setting and rulemaking projects as well as bringing record-setting enforcement actions year after year under Erica Williams’ leadership since January 2022.
Question: What are your thoughts on the board’s ambitious standard-setting agenda?
Quaadman: The agenda is so expansive it’s unclear what problems you are trying to solve. That’s a big issue because normally there’s going to be an articulation as to what the board’s trying to or the SEC is trying to accomplish, how they are going to press forward on that.
Editor’s note: The SEC oversees the PCAOB. And the market regulator under Gary Gensler’s leadership has also been pursuing an ambitious regulatory agenda, both in terms of rulemaking and enforcement.
Quaadman: The SEC’s rulemaking agenda under Chairman Gensler, at some points, was larger than it was with Dodd-Frank implementation. What’s the market failures you are trying to solve? Same thing with the PCAOB. Statistics show there’s been steady march towards improved audit quality for 20 years. What’s the market failure they are trying to solve? There hasn’t been an articulation like that. So, why do you have such an expansive agenda? The PCAOB’s proposal on noncompliance with laws and regulations (NOCLAR) is an example. The existing rule has been in place since 1977, and there’s not been an articulation as to why there needs to be such a radical change with it.
Question: The PCAOB’s quality control standard is another one that audit firms and the U.S. Chamber strongly opposed, in particular the requirement for larger firms to set up an external quality control function. But among other reasons, the board pointed out that some firms already have such advisory boards up and running.
Quaadman: Why shouldn’t the marketplace decide? And the marketplace has been deciding whether or not you should have advisory boards, not have advisory boards. They are not public companies. What’s the regulatory failure that occurred as to why you have to now mandate this for the profession? Why can’t the firm sort of figure out the best way to manage themselves and make sure that they are providing a product that conforms with the law.
Question: But the PCAOB has brought enforcement actions against firms because of quality control failures, including exam cheating scandals, especially at the foreign affiliates of Big Four firms.
Quaadman: I agree that cheating is a serious problem. But what are the reforms that PCAOB has done on its side of the cheating scandal?
Editor’s note: He was referring to a scheme that KPMG LLP professionals and PCAOB staff members engaged in to fraudulently improve the Big Four firm’s inspection results.
Quaadman: What are the reforms that the board has undertaken to make sure this is going to happen on their end because I would agree that’s a serious issue, and people should go to jail for that, which they did.
And for other cheating scandals, well, those are issues that are outside the United States. So, are we seeing the same type of issues in the United States that you are seeing elsewhere? The answer is not really, or at least not on the same level because we would argue that audit quality has greatly increased since 2002. But it’s hard for the board to mandate changes based on a scandal that they were a party to.
Question: But one of the things the PCAOB is doing is replacing interim AICPA standards that it adopted over 20 years ago as part of its strategic plans to modernize its standards.
Quaadman: Which we don’t necessarily disagree with either.
Question: And then there’s been technological change.
Quaadman: But what’s the technological advances the PCAOB has brought in house to make sure that they can stay on top of audit? If you take a look at the audit firms, they are very sophisticated tech players. The PCAOB has to have not only the technology but also experts who are able to use the technology. I would argue that the PCAOB, in trying to modernize standards, is actually looking at an audit profession from 15 years ago. But audit firms are doing that with AI, they are doing that with quantum computing that’s going to be coming online in several years. There have been these technological leaps over 15 years that the board has neither acquired the resources, the expertise, or even had the vision for how they should be using that to be a better regulator. And by the way, we were saying that to Bill Duhnke [January 2018 to June 2021] when he was chair. So we have said that to both sides.
Question: Moving on to inspections, which played a big role in improving audit quality. But then in the past few years, the deficiency rate has been going up. For example, in 2022, the rate was 40% and 46% in 2023. I am not sure what could explain this, but firms seem to be saying that remote work had something to do with it.
Quaadman: First off, what is an audit deficiency? It can be as simple as the auditor and the inspector having a difference in opinion. That doesn’t necessarily mean something’s wrong. They’re just looking at something differently. And in fact, we had a very extensive discussion where we brought in CFOs and controllers at the end of Doty’s tenure [January 2011 to January 2018], with Jim Schnurr when he was SEC chief accountant, because we were also showing from the company side where the PCAOB, through its inspections process, was actually getting things wrong. Because one of the markers that some in the audit regulatory community actually use is increase in audit fees as a marker for audit quality, and what they were saying is, ‘well, audit fees have been flat because companies are actually eating the costs.’ So even the metrics that they are looking at don’t even necessarily make sense.
The other part of that is, if you’ve got a regulator that has got a 46% failure rate now, they are not necessarily a good regulator. Think about transportation safety. Think about the FAA having a 46% failure rate.
Question: The PCAOB has been bringing a record number of enforcement actions as well as imposing record-setting amount of fines.
Quaadman: But you are not seeing any uptick in major restatements.
Question: The PCAOB is talking about sending a clear message to the auditing profession.
Quaadman: What’s the message? The message to the business community is: don’t become a public company.
Question: You say that a lot.
Quaadman: That’s exactly the message. I have been going out to Silicon Valley to talk about tech issues. But I keep getting back from companies that say they are having trouble raising capital. ‘The one thing we don’t want to do is become a public company. The PCAOB is a part of that problem.’ So that’s the clear message Erica Williams and Gary Gensler are sending is: Don’t go public. People are just looking at the PCAOB, which is putting all these different things in place, which doesn’t make audit quality any better, doesn’t provide any additional high quality information for investors. You have got proxy advisory firms, which are a separate problem, and businesses are looking at that like, ‘why do I want to go through that mess? I just want to run a company.’
Question: Do you think that certain investor protection advocates who are on advisory groups have an outsize influence? For example, the PCAOB would put certain projects on its agenda after recommendations by its Investor Advisory Group.
Quaadman: Yes, we said this with the FASB, too. But with the PCAOB very often you hear that ‘well, we’ve heard from investors.’ Well, have you heard from a representative cross section of the investor community? And you get a blank stare. You see a small cabal that is putting out proposals and thoughts that have been around for 20 years, and then they end up on the agenda. Well, it shows you exactly who they are listening to.
Question: But the PCAOB could also say that it has only one mission: to protect investors.
Quaadman: We disagree with that. They have public company in their name. We have suggested to them that they also have a public company advisory group as well, the business advisory group. We’ve suggested that for years.
When we went back and showed how the inspections process was driving up costs around internal controls without improving audit quality, we were actually able to show where some things could be changed. During that same dialogue, the PCAOB was also able to show what its rationale was for its related-party rule as an example, which I think was also informative for the business community as to why the PCAOB did what it did and why, despite opposition, was probably the right thing to do. So again, they’ve got public company in their name. They don’t talk to public companies.
Question: They do talk to audit committee chairs during inspections.
Quaadman: But are they bringing in CFOs? Are they bringing in controllers to have these discussions outside the inspections process around what their policies mean and what they mean to companies?
Question: What about the Standards and Emerging Issues Advisory Group? It has public company representatives.
Quaadman: We’ve got a couple. The impression we’ve gotten is that they are not necessarily looking for diverse set of opinions in those groups.
Question: NOCLAR is being opposed strongly, but the PCAOB is planning to finalize it in the coming weeks or months.
Quaadman: We think they should leave the existing rule in place because under the existing standard, it’s: Is there a violation of law that is material in nature that should be disclosed. So, using the materiality definition and screen to determine whether or not something should be disclosed. This now changes to any violation of any rule or regulation in any jurisdiction.
Think about if I run a delivery service in New York City, how much do you think I pay in parking tickets a year? It could be tens of millions of dollars. Those are violations of law. Is that an audit issue? It’s cost of doing business. But that’s now an audit issue.
But an investor may care about in the other way of if you are not getting parking tickets, it means you’ arenot doing enough business. So, it’s an extreme example, but again, this now becomes the Wild Wild West. And activists are going to start to use that to go after companies. If you have an expansive agenda like that, why do you want to be a public company?
This article originally appeared in the October 24, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
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