The Public Company Accounting Oversight Board (PCAOB) on Sept. 19, 2023, issued a proposal intended to more effectively deter auditor misconduct by fully using the enforcement authority granted by the Sarbanes-Oxley Act of 2002.
The proposal in part would update the board’s auditor contributory liability standard from “recklessness” to “negligence,” aligning it with the same standard of reasonable care auditors are already required to exercise when they perform audits of a public company’s financial statements. Recklessness represents a level of culpability that is higher than negligence.
Thus, the proposed revision would “match what investors already expect: that when an associated person’s negligence directly and substantially contributes to firm violations that can put investors at risk, the PCAOB has tools to hold them accountable,” Chair Erica Williams said.
The contributory liability standard in question is in Rule 3502, Responsibility Not to Knowingly or Recklessly Contribute to Violations, which became effective in 2006. When the PCAOB was first drafting the rule almost 20 years ago, it decided to use the reckless threshold because of pushback from the largest accounting firms at the time against the negligence standard of conduct.
However, Sarbanes-Oxley allows the board to bring charges against any registered firm or any associated person. The PCAOB is also authorized to go after violations committed in negligence—a result of the failure to exercise reasonable care. And now today’s board wants to align Rule 3502 with the mandates conferred to the PCAOB two decades ago.
“This is a positive step towards holding those engaging in unprofessional conduct accountable for their actions,” said former SEC chief accountant Lynn Turner who is a member of the PCAOB’s two advisory groups.
Under Sarbanes-Oxley, “the PCAOB may impose sanctions when appropriate for a single act of negligent conduct that constitutes a violation, and it may impose certain enhanced sanctions when appropriate if a registered firm or an associated person has engaged in repeated instances of such negligence,” PCAOB Acting General Counsel James Cappoli better explained during the rulemaking meeting. Yet, existing 3502 “requires a showing of recklessness and requires the contributory act to be associated with a particular firm that committed the violation before contributory liability may be imposed.”
The PCAOB is in part making changes to Rule 3502 because it now has ample experience with the provisions, and the Securities and Exchange Commission already has the ability to bring charges related to negligence. For example, the SEC about a week ago sanctioned the national assurance leader of Marcum LLP for widespread quality control failures.
Both the SEC and the PCAOB can bring enforcement actions against auditors.
Existing Rule 3502 states that a “person associated with a registered public accounting firm shall not take or omit to take an action knowing, or recklessly not knowing, that the act or omission would directly and substantially contribute to a violation by that registered public accounting firm of the Act, the Rules of the Board, the provisions of the securities laws relating to the preparation and issuance of audit reports and the obligations and liabilities of accountants with respect thereto, including the rules of the Commission issued under the Act, or professional standards.”
The PCAOB said that the proposal maintains the requirement under existing Rule 3502 that an associated person must have contributed to the firm’s violation both “directly and substantially” in order to be held liable.
The proposal would clarify the relationship between the contributory actor and the primary violator.
Currently, an associated person who contributes to a firm’s violation must be associated with that firm.
“Given the increasing complexity of arrangements among firms and the constantly evolving nature of technology, the proposal clarifies that associated persons of any firm can be held liable as long as their conduct at least negligently, and directly and substantially, contributes to any firm’s violation, not just violations by a firm with which they are associated,” the board said.
‘Directly and Substantially’: Junior Professionals Not Affected
Williams emphasized that the proposed revisions are not intended to affect junior professionals or other auditors who are responsibility doing their job.
“Again, to be held liable under the proposal, not only do associated persons have to act negligently, this proposal also maintains the current requirement that their negligence must have contributed to the firm’s violation both ‘directly and substantially,’” Williams explained. “That does not include auditors whose conduct is remote from, or tangential to, the firm’s violation.”
While the decision to propose the revisions was unanimous, two board members—departing member Duane DesParte and member Christina Ho—had some reservations.
Ho said that she supports the proposal primarily because the SEC already has existing authority to discipline an associated person for negligently causing or contributing to an accounting firm’s violations of laws and rules pertaining to the preparation and issuance of auditor’s reports.
“I therefore for the proposing in alignment make sense,” Ho said. “I have concerns about the lack of discussion on how the proposed amendments will be implemented.”
She said that she is concerned about whether the revisions, if adopted, will do more harm than good for investors. She is worried that it may discourage auditors from accepting important audit engagements. It may exacerbate the shrinking number of accountants. And this may cause small accounting firms to exit a public company audit service.
New Proposed Language
The proposal is in PCAOB Release No. 2023-007, Proposed Amendments to PCAOB Rule 3502 Governing Contributory Liability.
If adopted, Rule 3502 will be revised to: Responsibility Not to Contribute to Violations. “A person associated with a registered public accounting firm shall not directly and substantially contribute to a violation by any registered public accounting firm of the Act, the Rules of the Board, the provisions of the securities laws relating to the preparation and issuance of audit reports and the obligations and liabilities of accountants with respect thereto, including the rules of the Commission issued under the Act, or professional standards, by an act or omission that the person knew or should have known would contribute to such violation.”
Comments on the proposal are due Nov. 3.
This article originally appeared in the September 20, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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