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US Securities and Exchange Commission

Out with Trump’s SEC, In with Biden’s SEC

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 10 minute read

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 10 minute read

Just as President Joseph Biden has already reversed many of former President Donald Trump’s executive actions, will SEC chair nominee Gary Gensler undo some of former commission chairman Jay Clayton’s regulatory actions?

While his immediate priorities will be on standardized environmental, social, and governance (ESG) reporting and social-media-driven stock trading, this article explores some of the approaches that Gensler, former Commodity Futures Trading Commission (CFTC) chairman, might take on accounting and auditing matters during his tenure at the SEC if confirmed by the Senate.

SEC’s Oversight of PCAOB: Cleaning the Slate Again?

As part of the commission’s oversight authority, the SEC appoints the five members of the PCAOB for five-year terms, which can be renewed once. The Sarbanes-Oxley Act of 2002, among other reforms, established the PCAOB to supervise accounting firms that audit publicly listed companies in order to prevent accounting scandals that toppled Enron and WorldCom and cost investors an estimated $85 billion.

Before Clayton took the helm of the SEC, it was almost a given that board members would serve two terms, or at least serve out the remainder of a term. However, he shattered that norm when he let every board member go and named five new members in December 2017, the first time this has ever happened.

“That could be viewed as a precedent; it can happen with Gensler,” said Daniel Goelzer, who previously served as general counsel at the SEC and then as PCAOB acting chairman. “One of the constraints is, I think it just takes a little while to find people and get agreement among the commissioners on the people.”

Clayton’s initial picks for the board had three who were industry-leaning while two were more investor protection-oriented. When Democratic-leaning Kathleen Hamm’s term was up for renewal, she was given the boot in favor of Trump’s White House staffer Rebekah Goshorn Jurata. Then when former PricewaterhouseCoopers LLP partner James Kaiser said he did not want to seek a second-term, PCAOB Chief Auditor Megan Zietsman, previously a partner with Deloitte & Touche LLP, was elevated to be a member. Board Chairman William Duhnke, who was a Republican staffer in the Senate Banking Committee, had hired her to run the audit rulemaking division.

Jay Brown, a law professor at the University of Denver, who was a strong investor advocate, recently stepped down because his wife, Allison Herren Lee, would become acting chair of the SEC. This means there is currently no voice representing investors. And the sole mission of the PCAOB is to promote the public’s confidence in financial reporting. Towards the end of his tenure, Brown increasingly criticized the board publicly for not putting the interest of investors front and center. The board by a vote of 4 to 1, with Brown dissenting, moved ahead with a rule that gives more discretion to auditors to determine whether they are independent of their clients without due process. Investor protection advocates were vehemently opposed to it.

Even if Gensler does not move to clean the slate, Duhnke might not get to serve his full term, which ends in October 2022. When he became chair in January 2018, he proceeded to replace division heads, another break from previous practice. And the PCAOB took 19 months to hire an enforcement director and general counsel after their predecessors left.

“I would be pretty surprised if they didn’t change the leadership of the PCAOB,” Goelzer said. “I would think the approach probably would be for Gensler to put in someone that he was comfortable with or had confidence in the PCAOB. Let that person make the judgment in the auditing world.”

Robert Loesch, a partner with Tucker Ellis LLP, said he believes that given Gensler’s reputation as a tough regulator at the CFTC, he will probably try to make sure that the PCAOB is strong and independent. “I would think they would have strict enforcement against firms that don’t comply with professional standards,” he said. “Not that it currently doesn’t, but I think they would be a little bit tougher.”

JR Lanis, an attorney with Polsinelli LLP, agreed.

“From what I have seen from auditors auditing my clients in general is that they are increasingly focused on how the PCAOB is going to view them,” he said. “So, I have seen auditors become more and more conservative over the years because I think there is a concern over what the PCAOB might think about a particular audit decision. I think that’s going to get even more intense in the coming years.”

Gensler’s Sarbanes-Oxley Cred

Gensler served as a senior adviser to the late Sen. Paul Sarbanes when Sarbanes-Oxley was being drafted, and Barbara Roper, director of investor protection with the Consumer Federation of America, said she “would expect him to understand how vitally important it will be to restore both strong auditor oversight and rigorous auditor independence standards.”

“As a practical matter, I think the first essential step is to put a strong, pro-investor person on the PCAOB Board to fill Jay Brown’s seat and to immediately put that person in the chairman’s role,” Roper noted. “But it will take much more than that to return the Board to its investor protection mission. It will take a top-to-bottom overhaul, including something it never had during the Obama years, let alone under Clayton, a three-person majority on the board with a strong commitment to its investor protection mission. While that may not happen overnight, it needs to happen quickly.”

In the meantime, in another change from past practice, Clayton tapped Commissioner Hester Peirce, who espouses laissez-faire ideals, to help lead the commission’s oversight of the PCAOB along with SEC’s Chief Accountant. Previously, the chief accountant did not share that role.

This practice is not likely to be used as a precedent, however.

“If she has the position, I am sure Allison Lee would revoke it,” Goelzer said.

No Further Exemptions from Section 404(b) Requirements

Business groups were finally successful in getting Clayton’s SEC to give more categories of companies—in particular, smaller reporting companies—a break from the auditor attestation of management’s evaluation of internal control over financial reporting (ICFR) in Section 404(b) of Sarbanes-Oxley. Investors and auditors were opposed to the move, arguing it instills greater confidence in financial reporting. It is unclear if Gensler will try to undo the exemptions, but it is highly unlikely he will extend the exemptions to bigger companies.

The SEC’s proposal emphasized capital formation. And while Catherine Ide, vice president of professional practice with the Center for Audit Quality (CAQ), generally supports capital formation, the auditing profession had some concern because ICFR is important no matter what the size of the company in protecting investors and helping to maintain fair and orderly markets—the SEC’s tripartite mission.

“We have seen through trends in restatements that smaller companies can be more susceptible to ICFR problems,” she said. “And so obviously, we think ICFR is a benefit to companies of all sizes.”

However, Joseph Hall, a partner with Davis Polk & Wardwell LLP, who served as managing executive for policy under former SEC chairman William Donaldson, believes the debate is over.

“It’s an accepted part of the landscape,” Hall said. “They did ratchet back some of the requirements as they apply to very small companies. I don’t necessarily see a reason to revisit that. I mean, you can hypothesize how certain circumstance can change, and you could revisit it. It would have to be a scandal of some sort. And very small companies have very small scandals.”

Moreover, he said there are no longer huge accounting scandals because of not only Section 404(b), but also other requirements such as CEO and CFO certifications of financial statements and stronger audit committee roles. The PCAOB’s inspection of audit firms has also improved audit quality overall over the years.

Financial Reporting and Disclosures: Say Goodbye to Simplification

Only a few days after Clayton was sworn in in May 2017, he hired William Hinman to run the Division of Corporation Finance (CorpFin), which is responsible for the majority of the commission’s rulemakings and reviews corporate filings to make sure they are appropriate and sufficient.

The commission largely focused on scaling back requirements that businesses found onerous but believe do not provide much benefit to investors.

“Bill did an amazing job of rationalizing some of the financial statement requirements in terms of really creating a new ethos within the division,” Hall said. “They worked with the issuers to relax rules or requirements when it made sense to do so. It was a different approach from what we were used to previously…. In the financial statement areas, we were used to staff saying, ‘sorry that’s the rule.’”

CorpFin led by Hinman “also overhauled and streamlined some specific financial statement requirements…without harming legitimate investor protection concerns,” Hall said.

In the new administration, “I don’t know that the focus of the division’s effort will be on making things easier for issuers and getting rid of requirements that may have outlived their usefulness,” he added. “I just think you will probably have an agency whose focus will not be on simplifying the rules.”

Semiannual Reporting: “That Was Never Going to Happen”

Thanks to Trump’s August 2018 tweet asking the SEC to consider a six-month reporting system to replace the three-month quarterly and annual filing requirements that U.S. public companies have followed since 1970, Clayton went through the motion of studying it, first by issuing a preliminary rulemaking document asking for feedback, then following up with a roundtable. After that, he kept delaying issuing a proposal.

In general, companies would prefer lower frequency of reporting, but investors believe the current quarterly reporting requirements instill discipline and provide needed transparency in companies raising funds in public markets.

“That was never going to happen,” Davis Polk’s Hall said. “It was not going to happen under Clayton. Nobody [thinks] … that the way you make financial reporting better is to give people less information. He did whatever he needed to avoid getting a nasty tweet.”


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

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