One of the most important changes that the new Public Company Accounting Oversight Board (PCAOB) will bring is increased effort to incorporate investor views in its work.
After firing then-PCAOB Chairman William Duhnke in June, the SEC named four new members on November 8, 2021. Gary Gensler, chair of the SEC which oversees the board, had said that he wanted to take the board into a different direction.
Investors criticized that the board under Duhnke’s leadership had strayed from its mission of protecting investors and furthering the public interest in the audit of public companies under the Sarbanes-Oxley Act of 2002 (SOX).
The law established the PCAOB to set auditing standards and inspect auditors in an effort to prevent another round of big accounting scandals that toppled companies like Enron and WorldCom and cost investors a lot of money two decades ago. Their auditors signed off the cooked books.
“It’s absolutely essential that we fully understand investor needs and investor perspective,” PCAOB Acting Chairperson Duane DesParte said during the Corporate Financial Reporting Insights (CFRI) Virtual Conference hosted by the Financial Executives International (FEI) on November 9. “Investors are seeking increased transparency in engagement with us, including through our advisory groups.”
The PCAOB Chairperson appointee, Erica Williams, a partner with Kirkland & Ellis LLP, has yet to be sworn in. DesParte will remain chairperson until Williams is sworn in. He will serve his remaining term as board member afterward.
Christina Ho was sworn in as a member on November 9. She was most recently Vice President of Government Analytics and Innovation at Elder Research. Others named to the board are former SEC Commissioner Kara Stein and Anthony Thompson, who currently serves as executive director and chief administrative officer (CAO) of the Commodity Futures Trading Commission (CFTC).
“In June, I asked in my role as acting chairperson, I asked the staff to reassess our approach for advisory groups, to reassess our approach for engagement more broadly,” DesParte said. “And I fully expect this will be an essential near-term focus for the new board.”
In particular, when Duhnke became chair of the PCAOB in January 2018—after being appointed by then-SEC Chairman Jay Clayton, he said he would evaluate every aspect of the board’s functions. Clayton at the end of 2017 replaced all board members at the time.
Clayton and Duhnke took a more business-friendly approach to regulation as promised by then-President Donald Trump.
One source of contention was the PCAOB’s Investor Advisory Group (IAG), which the U.S. Chamber of Commerce and Republicans on Capitol Hill were unhappy about. And IAG is likely to come back in some fashion under the new board.
The PCAOB in March abolished IAG as well as its main advisory panel, the Standing Advisory Group (old SAG), in favor of one panel, the Standards Advisory Group (new SAG). However, investor protection advocates became furious when the new group’s charter diminished investor representation.
Among other things, the Center for Audit Quality (CAQ), an affiliate of the AICPA which represents the public company auditing profession, got a seat at the nominating table for auditor members of the new SAG. No other groups got such a privilege. The new SAG would advise the board on its standard-setting activities, and the meetings would in general not be open to the public.
The U.S. Chamber and Republicans were unhappy that investors got more attention at the board. The business group had lobbied the board to set up a separate Business Advisory Group (BAG) despite the board’s sole mission is to protect investors. And the PCAOB’s old SAG had more representatives that represent companies, auditors, and audit committees than those that represent investor views.
Other Topics of Interest
Investors also want the PCAOB to prioritize several other topics, including updating the board’s quality control standards for audit firms, DesParte said.
“I think there is significant interest in our project to update quality control standards that firms need to follow and establish their control system,” he said. “By updating those standards, I think it can be a real game changer for audit quality.”
A firm’s quality control deals with its system of employee training and compliance with professional standards and its standards of quality. The regulatory board believes that strong quality controls are important to audit quality, and the board determined to update them as the inspections staff has continued to find deficiencies in audit engagements as well as problems in firms’ quality control systems in certain areas.
After the board in December 2019 issued a preliminary rulemaking document to seek the public’s input about ways to improve the board’s quality control standards for audit firms, the staff has been developing a proposed standard for the board’s consideration.
Currently, the PCAOB uses the AICPA’s quality control standards issued in 1997 when the board did not exist. The audit environment has changed dramatically since then, especially with advances in technology.
The PCAOB’s 2019 Concept Release builds on the International Auditing and Assurance Standards Board’s (IAASB) quality management standards. In comment letters to the U.S. board, audit firms, businesses, and investors said it is a good starting point for the board to consider and to tailor it for domestic use.
Big audit firms “are already well ahead in terms of things that they are doing with quality control above and beyond our existing standards, and I think it has resulted in improvements over time in quality,” DesParte said.
Another topic that investors have expressed an interest in is congressional response to address the PCAOB’s inability to inspect auditors of Chinese companies listed on U.S. stock exchanges.
The Holding Foreign Companies Accountable (HFCA) Act, which was signed into law in December 2020, requires the SEC and the PCAOB to identify the companies whose auditors that the board cannot inspect fully because of positions taken by local authorities. This mainly targets China and Hong Kong. China fears that audit work papers may contain state secrets and believes that opening up to inspections will impinge on its sovereignty.
The SEC on November 4 approved a framework the PCAOB will use in determining the audit firms that will fall under HFCA. After the board makes its determination, it will send a report to the SEC. In turn, the commission will use it to identify U.S.-listed Chinese companies whose auditors were not inspected by the PCAOB.
These identified companies then must submit documentation to the SEC establishing that they are not owned or controlled by the government in their jurisdiction. Most significantly, HFCA directs the SEC to prohibit trading of the identified company if the PCAOB is unable to inspect its auditor for three years in a row.
“What’s interesting there is investors really do convey to us that they believe it’s so important that all investors be protected by the regulatory oversight that’s embedded in our framework under SOX for any investment regardless of where that company’s audit is performed,” DesParte said. “And our staff is currently assessing potential determinations for board’s consideration later this year.”
This article originally appeared in the November 11, 2021 edition of Accounting & Compliance Alert, available on Checkpoint.
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