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Is SEC Making Audit Regulatory Board Too Political?

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 9 minute read

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 9 minute read

When SEC Chair Gary Gensler in early June 2021 abruptly fired embattled PCAOB Chairman William Duhnke and said all five seats of the audit regulatory board would be filled, progressives who called for the house cleaning scored a victory.

Gensler’s move, however, raised some eyebrows not only over the merits of the planned replacements but also of the way the SEC announced the ouster of Duhnke, a former Republican Senate staffer: the commission used the word “removal” in its press release instead of euphemistic terms such as resigned or retired as is normally the case.

Critics called it unnecessarily brutal.

“It was sort of a low-class way of doing it,” said Dennis Beresford, former chairman of accounting standard-setter FASB and a former member of the PCAOB’s old Standing Advisory Group (SAG). “Certainly, he could’ve been more professional for somebody in that particular position.”

Substance of House Cleaning

Setting aside the optics of “removal,” what worries critics is politicization of the PCAOB, which should be non-partisan. Sarbanes-Oxley Act of 2002 set it up to prevent a repeat of big accounting scandals that toppled companies like Enron and WorldCom and cost investors an estimated $85 billion. Among other things, the board inspects accounting firms that audit public companies. As part of its oversight activities, the SEC appoints PCAOB members.

“This whole thing is just turning very political,” Beresford said. “It was very political when they put in Duhnke in there along with four other people. They replaced people who I thought were doing a good at job at that time.”

He was referring to then-President Donald Trump’s SEC chair appointee Jay Clayton who at the end of 2017 replaced all five board members. This was unprecedented at the time; member terms are staggered for smooth continuity of the board’s functions.

Now, Gensler, appointed by President Joseph Biden, is continuing with the precedent over the objections of the two Republicans on the commission.

“While I don’t have a problem with replacing the chair, I am afraid that removing the entire board will establish—or confirm—that as standard operating procedure whenever the administration changes,” said Daniel Goelzer, a former SEC general counsel and former PCAOB acting chairman. “I fear that, against this background, PCAOB board spots will now be seen as political plums up for grabs whenever the administration changes. That’s not what Congress intended when it created the PCAOB, and, in the long run, it’s likely to detract from confidence in the oversight of public company auditing.”

Some who care about auditing may not want to become a board member because they do not want to be seen as getting a political appointment. Goelzer also said qualified professionals may shy away from serving as senior staff members, “seeing that perhaps their position will only last as long as whoever the current chair was or the current political party is controlling the White House.”

Critics of PCAOB

For many, replacing all members is justified: The board veered off course during Duhnke’s tenure and had become too lenient with auditors, ignoring investor views.

Investor advocates cited a rulemaking last year—without any due process—that gave auditors more discretion when determining whether they are independent of their clients. The PCAOB said this will allow auditors to focus on truly substantive matters. But critics believe that this is a slippery slope that would put auditor’s bottom line ahead of investors’ confidence in the financial reporting process.

In late March, they blasted the PCAOB’s unanimously-decided plan to abolish existing advisory groups and set up a new Standards Advisory Group because it will not get sufficient input from investors even as the PCAOB’s sole mission is to protect them and promote the public interest. They were also concerned that advisory meetings would be held privately. At the same time, the board gave an outsize role to the auditing profession. The charter said that the board will select audit professionals based on nominations from the Center of Audit Quality, an affiliate of the AICPA which represents the auditing profession. No other group got such honor.

This was an example “of trying to steer the standard setting advice the SAG provides in a direction that won’t produce any disagreements or opposing views,” Goelzer said. “I think that one of the basic problems with the Duhnke PCAOB was a lack of openness or willingness to hear voices that might not agree with the PCAOB’s, or the chair’s, direction.”

Moreover, not only is Duhnke a subject of the SEC’s investigation of whistleblower complaints about his management style in which he reportedly instilled a culture of fear, he was also sued by a senior official for wrongful termination. Sue Lee, the board’s first chief risk officer, claimed that she was fired because of her Chinese origin and affiliation with the Democratic Party. Duhnke has denied any wrongdoings.

And Gensler said that he wanted to take the PCAOB into a different direction.

“I think he meant what he said; he just wanted a new direction,” said Jack Ciesielski, founder of investment research firm R.G. Associates. “It was needed. There hasn’t been much progress at the PCAOB since the days of the prior board. Auditing standards have not been written. Investor groups have been disbanded. It seemed as if the entire operations had been frozen. He probably figured it was easier to start over with a clean slate.”

Critic: Activists Want to Send Auditors to Jail

However, Beresford criticized those who urged Gensler to clean house. “It’s a shame that so many activists go after the politicians to make changes all the time, not just in the accounting area, just any time an election is held, it’s fair game to throw everybody out, I guess.”

For example, he said PCAOB member Megan Zietsman, who was previously deputy chair of the International Auditing and Assurance Standards Board and a partner at Deloitte & Touche LLP, is well-qualified to serve.

“I don’t have any reason to believe that she has any political bones in her body and that you could come up with anybody who’s better than her in terms of understanding what’s going on and being a good public servant,” he said. “On the other hand, there are those who have written the SEC people like Lynn Turner and others that believe the PCAOB has been too soft on the accounting firms and others. I don’t know who they want to put in there, but they want people who will send all auditors to jail or something along those lines.”

He was referring to former SEC chief accountant Lynn Turner, who was among the 34 organizations and individuals who recently asked Gensler to fix what they see as a broken system of financial reporting. They argued that weak implementation of Sarbanes-Oxley is recreating the conditions that led to such scandals.

“Many of the root causes of that crisis – deeply flawed and outdated accounting standards, weak and ineffective auditor oversight, and auditors who lack both independence and professional skepticism – have reemerged as pressing issues,” they wrote to Gensler.

In Beresford’s view, the system by and large has been working well. The PCAOB’s inspections program has improved audit quality. There have been no Enron-like accounting scandals.

“There is no such thing as a perfect audit,” he said, adding that many of the findings are based on judgments. “Some of them are pretty close calls, and most of them don’t result in having the financial statements being restated.”

“But some of the critics are still feeling that somehow or another we’ve got something drastically wrong with the system, and somehow or another if we throw out all the leaders of the organization, we’d be much better off, and I just don’t see it,” he said.

Reform Advocate: Auditors, Step Up

Turner, who also served on the PCAOB’s old SAG, disagreed.

“The PCAOB inspections in the U.S. and internationally have found very high rates of deficient audits that did not comply with professional standards, many of which were written by the auditing profession,” he said.

In a March report, the International Forum of Independent Audit Regulators, of which the PCAOB is a member, said that 34 percent of audit engagements inspected had at least one finding in 2020, compared to 33 percent in 2019.

“Notwithstanding that, the audit firms black and white told investors and the public they had complied.”

Among other issues, under Duhnke’s leadership, the PCAOB dropped a project on going concern—or a company’s ability to stay afloat—from the standard-setting agenda. The board’s Investor Advisory Group said the standards need to be improved because of the failure by many auditors to warn the markets about the severe problems banks were having prior to the 2008 financial crisis. Several large financial institutions collapsed, two of the nation’s Big Three carmakers had to be rescued by the federal government, and the pain was felt throughout the economy.

“As a result, there is a sound basis for investors to question what the auditors have told them in the audit reports,” Turner said. “There is a sound basis for a lack of trust. And there is a sound basis for investors to seek damages from auditors, when the auditor’s audits failed to comply with professional standards.”

SEC May Not Replace All PCAOB Members After All

In the meantime, whether one believes the PCAOB ought to correct course or not, Gensler may not end up replacing all members.

Current board members can reapply for their seats, and board Acting Chair Duane DesParte is likely to keep his old job, according to sources.

“It would take a little bit the edge off of this occurrence of politicizing the PCAOB if they do retain at least one person,” Goelzer said.


This article originally appeared in the July 16, 2021 edition of Accounting & Compliance Alert, available on Checkpoint.

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