The Securities and Exchange Commission (SEC) has scheduled a meeting for September 9, 2024, to consider approving the Public Company Accounting Oversight Board’s (PCAOB) new quality control (QC) standard following delays amid opposition by large audit firms.
The SEC oversees the PCAOB, and changes to its standards must be approved by the commission before they can become effective.
It is likely that a divided commission will approve the standard. The SEC usually schedules a vote when it knows that it will be able to move forward.
However, the approval may include some instructions to the board on the External Quality Control Function (EQCF) requirement, which has proven to be a major sticking point in the PCAOB’s QC standard. The U.S. Chamber of Commerce even threatened to sue if the SEC goes ahead with approving the PCAOB’s standards without addressing concerns about the EQCF which would apply to larger accounting firms that audit more than 100 public companies.
Among other things, the EQCF must evaluate significant judgments and the related conclusions reached by the firm when evaluating and reporting on the effectiveness of the QC system. The EQCF would be composed of one or more persons who are not part of the firm to promote independent oversight of QC system, which is foundational to audit quality.
In comment letters to the SEC, the Center for Audit Quality (CAQ), the larger firms, including the Big Four, and the U.S. Chamber noted that the EQCF is not a logical outgrowth of the PCAOB’s proposal issued in November 2022. The board adopted the rules in May. They also claimed that the board has not sufficiently demonstrated why EQCF’s benefits outweigh costs.
Investors, on the other hand, said they support the new QC standard as it will significantly improve upon the PCAOB’s interim standards, which the board adopted from the accounting profession when the board was established.
Before the Sarbanes-Oxley Act of 2002, the AICPA wrote the rules even for public company audits. Today, the association only writes audit standards for private companies. And the PCAOB has a single mission of protecting investors.
After the SEC decided to take more time to decide whether to approve, reject, or institute proceedings to determine whether to disapprove the standard, the PCAOB fought back, writing a 28-page long letter to the commission outlining the steps it took to write the standard, including what it calls “extensive stakeholder input over many years.”
The PCAOB pointed out that large firms already voluntarily have in place some type of independent advisers or monitors intended to showcase how great they are doing in terms of their audit work. And “the existence and variety of those roles demonstrate that implementing the EQCF requirement is feasible rather than unrealistic,” the PCAOB said.
Moreover, the board disputed the claim that the EQCF requirement is not a logical outgrowth of the board’s proposal. It noted its 2019 concept release which sought comments on independent oversight over a firm’s QC system. The PCAOB then moved to issue a proposal in November 2022, which included a provision for larger firms that their governance structure incorporate an oversight function that included at least one person whose relationship with the firm would not “interfere with the exercise of independent judgment.”
Latest Reactions: Big Four vs Investor Advocate
After the SEC on August 13 opened up the comment period yet again on the PCAOB QC standard, the commission has so far received four letters, including the one from the board itself and Senate Banking Committee Chairman Sherrod Brown who wants the SEC to sign off on it.
The other two letters, as of September 3 early afternoon, are from Ernst & Young LLP and former SEC chief accountant Lynn Turner, a strong investor advocate.
EY insisted that the final requirement for the EQCF is not a logical outgrowth of the 2022 proposal because it is a significant departure from the proposed requirement. The Big Four firm also said that the PCAOB’s August 16 letter “does not address these concerns and raises additional questions that have not been subject to due process.”
The proposal had a flexible requirement under which the largest firms would incorporate some form of external oversight. The PCAOB in the proposing release said it “would not specify” how a firm would do this. But in the final standard, the PCAOB mandated “a never-before-discussed” EQCF and specified types of involvement in a firm’s QC evaluation.
In EY’s view, this is a “novel requirement” that should have been addressed through the PCAOB’s standard-setting process, “and not at this late stage of SEC consideration.”
Further, the additional arguments provided by the PCAOB letter “do not substitute the diligence of the standard-setting process, because fundamental concerns and questions regarding the EQCF role and its potential consequences remain.”
Turner, well-known in the accounting circle for his strong investor protection advocacy, said that the comment letters by the firms “appear to reflect a lack of understanding of the circumstances and process which has led to the consideration and/or adoption of new QC rules by the PCAOB.”
In a 22-page letter full of history, he pointed out that Sarbanes-Oxley established the PCAOB because existing AICPA standards “had failed for several decades to consistently produce high quality audits.”
The law mandated the PCAOB to write QC standards that would protect more than 100 million investors.
It has taken 20 years for the PCAOB to finally do so, Turner said, and thus the current leadership of the board should be instead “applauded.”
The PCAOB’s efforts to update its standards have included research and economic analysis, meetings with advisory groups, roundtables, concept release, and proposal, he said.
Others, including the U.S. Treasury Advisory Committee on the Auditing Profession (ACAP) and the Panel on Audit Effectiveness studied the quality and effectiveness of audit over the years. Moreover, the PCAOB has a wealth of knowledge that it has gained through thousands of inspections. Findings consistently showed high levels of deficiencies. In 2023, the PCAOB found 46% deficiency rate overall. Among the largest six firms, it was 40%. Among the Big Four, it was 26% last year.
In Turner’s view, the EQCF, whether adopted by the PCAOB or by establishing an independent governance board, is “necessary in light of ongoing instances around the globe which suggest the firms suffer from a lack of ethics throughout the firms, including senior leadership.”
To counter the arguments of costs associated with implementing the standard, he flipped the cost-benefit analysis scenario. Turner said existing QC standards proved to be “catastrophic” because the global capital markets lost trillions in value at the last turn of the century because of deficient and failed audits.
Now that the PCAOB is finally doing something to try to up audit firm’s game, Turner said that investors who suffered because of ineffectual AICPA standards should ask the profession and the SEC “how much longer do we have to wait for adoption of appropriate and effective auditing quality control standards that will provide accountability for the profession?”
This article originally appeared in the September 4, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
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