A dozen former members of the PCAOB’s now-abolished Investor Advisory Group (IAG) urged new SEC Chair Gary Gensler to restore investor faith in the audit regulatory board’s work.
The SEC oversees the PCAOB, which was established by the Sarbanes-Oxley Act of 2002 following accounting scandals at companies like Enron and WorldCom that cost investors an estimated $85 billion. The PCAOB supervises public company auditors with a single mission to protect investors and promote public interest.
However, in the past three years after then-SEC Chairman Jay Clayton replaced all five PCAOB members with former Republican Senate staffer William Duhnke as the chairman and four others, investor advocates have criticized the board for not paying attention to their needs.
“We are concerned that in this regard the SEC and the PCAOB are failing to carry out their respective roles and responsibilities as set forth” in Saranes-Oxley, the former IAG members wrote to Gensler on April 19, 2021, the first full day as chairman. “These failures increase risks to our financial system and require immediate attention.”
Gensler was a senior adviser to then-Sen. Paul Sarbanes in writing Sarbanes-Oxley.
Those signing the letter include Anne Simpson with the California Public Employees’ Retirement System (CalPERS) who previously also served as a member of the SEC’s Investor Advisory Committee (IAC); Barbara Roper, director of investor protection with the Consumer Federation of America who also served on the IAC; Parveen Gupta, a professor of accounting at Lehigh University and former SEC academic fellow; and former SEC chief accountant Lynn Turner.
Sarbanes-Oxley authorized the PCAOB to set up advisory groups to get input on their work, including standard-setting. However, in 2018, certain PCAOB members decided that the board would no longer seek the views of its advisory bodies, the letter says. The PCAOB did not hold a single advisory group meetings in 2019 and 2020.
The other advisory panel was called Standing Advisory Group. Both of them were abolished, and the PCAOB finally in March set up a new Standards Advisory Group (SAG) focused on the board’s standard-setting activities and is currently seeking nominations. This new panel that is being set up has been heavily criticized, however, for lack of investor input.
“Advisory groups are essential participants in the PCAOB’s processes for enhancing the quality of audits, and we strongly support reactivating the IAG and including it in PCAOB’s standard-setting deliberations and related regulatory processes,” the letter states.
The SEC did not immediately respond to a request for comment.
After PCAOB Chairman Duhnke took over in January 2018, the board began a comprehensive review of all aspects of the board with the goal of ultimately improving audit quality.
But the advisory groups have been a source of controversy and complaints in the past several years. Especially business groups did not like that investors had a separate advisory panel and criticized that the board did not get enough input from companies. The U.S. Chamber of Commerce pushed the PCAOB to set up a separate Business Advisory Group (BAG).
Some lawmakers also took note of such criticisms. The Financial Choice Act—passed in the House of Representatives in 2017 when Republicans had control of the chamber—contained a provision that would abolish IAG. The Senate at the time did not move forward with the Choice Act, instead focusing on narrower issues rolling back regulations for smaller banks.
After Duhnke became chairman, he said that the board was trying to reconstitute the advisory panels to maximize their effectiveness, but there had been no agreement yet on the best way to achieve it. The board adopted the charter shortly after the lone investor voice on the board, Jay Brown, stepped down as his wife, Allison Herren Lee, was designated acting chair of the SEC, which oversees the board.
In particular, Duhnke said the board has been trying to make sure that it separates its outreach from advisory function. Previously, he said the two functions were conflated. The PCAOB in the past three years instead has ramped up its outreach to auditors, audit committees, companies, and investors. The board also set up a separate office dedicated to that effort.
However, former IAG members said the new SAG charter is flawed because, among other things, the meetings will be generally non-public; gives the Center for Audit Quality (CAQ), an affiliate of the AICPA, the sole organization to recommend auditor members while no other organization gets that privilege; has a narrow qualification criteria for investor members; and the board will set agenda for the group unilaterally. This is a sharp contrast to previous practice.
Other Criticisms
The letter also described several examples at the PCAOB that the IAG members found troubling.
When new board members were installed in 2018, IAG members said division heads and other senior staff members were replaced.
“Discharging such personnel has undermined the Board’s ability to serve its purpose, and to do so with the expertise investors need,” the letter to SEC Chair Gensler says.
The group also said that in 2018, the PCAOB reduced its budget, including for its inspections function. Moreover, the PCAOB’s 2018 long-term plan only mentions investor protection once in stating the board’s mission, the letter says. It also mentioned enforcement only once. It took 19 months for the new PCAOB at the time to hire an enforcement director and general counsel. The letter said the strategic plan weakened inspection requirements and deemphasized diversity when compared to the PCAOB’s prior plan.
“Interestingly, the PCAOB failed to live up to even its less ambitious strategic plan,” former IAG members said.
The letter also noted the lack of due process when the PCAOB adopted final rules that line up with the SEC’s auditor independence rule. Then-PCAOB member Brown voted against it because the rule changes roll back the requirements for auditor independence without having done the board’s own economic analysis and without the input of investors.
Under Clayton’s leadership, the SEC’s revised the rule to give more discretion to auditors when figuring out whether they are violating independence rules. The commission said auditors and audit committees will not have to spend time analyzing non-substantive rule breaches.
However, the two Democrats on the commission at the time—Lee and Caroline Crenshaw—voted against the rule, arguing that it loosens standards and reduces transparency. They pointed out the important role that auditors play in promoting the integrity of financial reporting. However, they also noted that auditors play their role in an imperfect issuer-pays model world. This means that auditors are being paid by the clients they audit.
“Auditor independence rules provide the central method for addressing and mitigating this conflict of interest,” Lee and Crenshaw stated.
This article originally appeared in the April 21, 2021 edition of Accounting & Compliance Alert, available on Checkpoint.
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