It is no secret that—under the leadership of Erica Williams—the PCAOB has been aggressive in pursuing enforcement actions to better protect investors. And this will continue to be the case as the board is strengthening its enforcement program and sending a message to audit firms that it is serious about cracking down on misconduct.
‘We are Making the Sanctions Count’
“And egregious conduct will be addressed with stiff sanctions,” John Abell, the chief accountant in the PCAOB’s Division of Enforcement and Investigations (DEI), said during a briefing to the PCAOB’s Investor Advisory Group (IAG) on Oct. 10, 2023.
“We are making the sanctions count. That means higher sanctions. That means not being able to access indemnification,” he said.
DEI is also expanding how it identifies cases.
“We are looking at a broader panoply of potential issues to investigate, working very closely with our inspections group to understand what they are finding to make sure that they understand the fact patterns and areas that we believe are heightened risk of potential audit problems such that we can identify where those things are being seen by our inspectors and investigate them as necessary,” Abell said.
Further, the division is expanding the types of cases that it pursues. This means that DEI is not just looking at violations but also evaluating firm culpability.
“How was the firm involved in it? If they were involved in it, were there policies that weren’t really up to snuff? Were there gaps in policies and procedures? Were there consultations with national office people, and is there some allocation of blame that goes to the firm?” he said. “As well as looking at things like compliance with our rules, forms, and making sure that things like the cases that we’ve done involving failure to supervise—which was something new under this board—that we continue to push for enforcing those rules where the underlying conduct supports charges.”
Another example has to do with negligence even if the conduct does not rise to the level of recklessness. This would be in cases where the auditor’s conduct can be tied to some significant consequence, such as a significant financial restatement.
Significant Increase Both in Number of Cases and Fines
The division’s briefing comes against the backdrop of significant increases in enforcement activities. (See Number of PCAOB Enforcement Actions Sharply Increased in 2022 in the Feb. 27, 2023, edition of Accounting & Compliance Alert.)
Michael Davis, DEI chief of staff who also spoke during the IAG meeting, said that 2022 represented a very strong year for the division with 42 enforcement orders, with 41 of those settled and one adjudicated. This is double from 2021. And there were 17 settled orders in 2020.
“Already this year through September 30, we had 24 orders. Of course, no one can predict the future, but we also think we are going to have a strong year this year.”
In terms of civil penalties, it was $1.5 million in 2020, $1.1 million in 2021, $10.9 million in 2022 and $7.6 million through Sept. 30 this year.
Penalties provide “deterrence to individuals and the firms in question in doing such conduct again,” Abell said. “It also provides a warning for other auditors who are reviewing those orders.”
‘Aggressive but Appropriately So’
Davis was quick to point out that the division’s primary goal is not about meeting a quota for any given year. And he quoted DEI Director Robert Rice’s favorite sayings to better explain the division’s mindset.
“He likes to be aggressive but appropriately so,” Davis said. “That’s what we are trying to do. We want to be aggressive in enforcing the standards, but we want to be fair and appropriate in doing so. Also one of Bob’s big initiatives has been to bring more significant sanctions to better reflect the gravity of the violation that had occurred. We have been very successful in doing that in the last year to 18 months.”
Priorities of DEI
Abell said the most important priority is investigations of significant audit violations that present risks to investors.
“These are audit failures. These are on matters that often involve multiple years of audits and significantly egregious conduct,” he said.
PCAOB investigators, for example, will scrutinize closely when companies make financial restatements to see whether auditors did what they were supposed to do.
‘Zero Tolerance’ for Egregious Behavior
DEI continues to prioritize matters that threaten or erode the integrity of the board’s oversight functions. This is primarily when audit firms and their employees fail to cooperate with an inspection.
Typically, “a firm and its associated persons find out there’s going to be an inspection of particular audit,” he said. “They modify the workpapers associated with that audit to be inspected. So those work papers do not reflect the work papers that were presented at the time that file was archived. It clearly undermines the process of our inspections and doesn’t give the inspectors an opportunity to evaluate what the work looked like and the work that was performed at the time that the audit report was released. And then the ensuing time that the team has to document that audit.”
There are also situations when firms do not cooperate with the board’s investigation.
“We have zero tolerance for that type of behavior,” he said.
The DEI also continues to focus on audit matters related to significant independence violations.
“Independence is the bedrock of a professionally skeptical and objective audit,” Abell explained. “It is very important that these independent rules be upheld. And so where there are indications there violations of those rules, we investigate those and we brought a number of actions related to violations of the Independence rules.”
The division is also focusing on deficiencies in the firm’s system of quality control (QC).
“I mentioned that we are looking at the firm’s culpability as it relates to audit failures in individual audits, but we are also looking at where there are trends in quality control areas that may arise as a result of multiple inspections, or that may arise from some combination of matters and inspections has found, and then that we identified in the investigations that we’re doing,” he said. “We think that it’s very important that the firms do have systems of quality control that provide them with reasonable assurance that the relevant rules are being followed. And where there are indications that they are not, we are going to investigate those.”
Kyra Armstrong, counsel to Director Rice, who also spoke during the meeting, said that during 2022 through Sept. 30, 2023, the board settled actions involving QC standard violations.
Abell describe a variety of sanctions the PCAOB can impose in enforcement orders:
- Civil monetary penalty
- Suspend or permanently bar an individual from association with a firm registered with the PCAOB
- Temporary or permanent revocation of a firm’s registration
- Temporary or permanent limitation of activities, functions or operations of a firm or person
- Remedial undertakings Independent monitor
He said that suspensions or bars is an “extremely” significant sanction.
If auditors are suspended or barred, “they also cannot associate in any way by which they get renumerations from those audits,” Abell clarified. “So, it goes beyond just doing the work of audits.”
In terms of limitation of activity, the auditor, for example, will not be able to sign audit reports or to function as an engagement quality reviewer.
The remedial undertakings could include additional continuing professional education related to the areas that were subject to the deficiencies in the order. Or the audit firm would not be able to take on new engagements until the identified deficiencies are fixed.
This article originally appeared in the October 17, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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