From time to time, a particular proposal or another has been floated to transfer the Public Company Accounting Oversight Board’s (PCAOB) functions to the Securities and Exchange Commission (SEC), but it never became a reality. And more recent efforts are not likely to lead to the elimination of the audit regulatory board, with so much else happening—from recent bank failures to the agency’s climate change rulemaking, artificial intelligence and crypto.
Thus, for now, this issue seems to have been sidelined. But it was not for lack of trying.
During the Trump administration, the matter surfaced as a cost-saving measure when in February 2020 proposed to fold the PCAOB into the SEC beginning in 2022. This never gained traction. At the time, the White House believed that it would also eliminate regulatory ambiguity and duplicative authorities.
Then in October 2021, Representative Bill Huizenga, a Republican on the House Financial Services Committee, introduced a bill that would “transfer” the PCAOB to the SEC. It has not moved beyond the proposed stage. The congressman in part might have introduced the bill because he was unhappy over SEC Chair Gensler’s June 2021 firing of former PCAOB Chairman William Duhnke, who had the support of Republicans on the Hill. Gensler removed Duhnke after investor advocates and some Democrats said that he was ignoring investor views while being too lenient on audit firms.
After the bill was introduced, Big Four accounting firms, including KPMG LLP and Deloitte LLP, disclosed the legislative proposal as a lobbying matter with Congress. It does not say which way the firms are lobbying, whether in favor or opposition.
Further, SEC Commissioner Hester Peirce gave a speech in October 2022, saying that the current construct is flawed. The PCAOB develops standards that auditors of public company financial statements must follow. The board also has audit inspection and enforcement authorities. But because auditors are gatekeepers of financial reporting in capital markets, the PCAOB is overseen by the SEC, the $100 trillion capital market regulator. This audit regulatory framework was established by the Sarbanes-Oxley Act of 2002 to prevent a recurrence of large accounting scandals that led to the demise of Enron and WorldCom. At the time, Enron’s bankruptcy was the biggest in U.S. history.
“Had Congress simply charged the SEC with regulating auditors, it could have avoided the PCAOB’s constitutional defects and consolidated related authorities in one government agency,” Peirce said last fall. “This approach would also have diverted the considerable SEC resources that have since gone into overseeing the PCAOB, its budget, and its standard-setting, inspections, and enforcement activity to go, instead, directly into fostering audit quality.”
With 20 years of insight, she said it may be time to keep the law’s provisions that work while removing those that do not. All significant PCAOB decisions—from yearly budget to revised auditing standards—must be approved by the securities regulator before they become effective, which can be a cumbersome process. Moreover, the SEC appoints the five voting members of the PCAOB.
No Apparent Current Efforts
But now, in 2023, it is unclear whether Rep. Huizenga will reintroduce the bill. His office did not respond to a query by Thomson Reuters.
Moreover, Big Four firms did not list it as a lobbying item on the latest quarterly disclosure filed in April.
While any proposals may have been dropped for now, it is likely that the matter will resurface in the future.
Pick One: Budgetary Reasons or Audit Quality
In terms of cost-saving measure, the Trump administration at the time estimated that this would save $237 million over five years and $580 million over 10 years.
The SEC’s budget, which goes through legislative appropriations process, has been roughly about $2 billion in the past few years.
The PCAOB’s 2023 budget is almost $350 million, and personnel costs take up about 75 percent of total expenditure. And the budget for the board’s Division of Registration and Inspections takes up a huge chunk of the budget, set at nearly $155 million. Audit inspections take up almost all of the $155 million with nearly $153.4 million. Under Sarbanes-Oxley, the PCAOB collects accounting support fees from public companies and broker-dealers to fund its operations and supervise public accounting firms.
Daniel Goelzer, who served as a PCAOB member and previously as SEC general counsel, believes the consolidation may not pass a cost-benefit test.
A bit of money might be saved. If the board were eliminated, the services of its members, who draw large salaries, would not be needed. Some of the staff, including from administrative, HR and IT divisions, would also become redundant.
Still, “most of the PCAOB’s functions… would have to be duplicated inside the SEC,” Goelzer said.
Take inspection, for example: the SEC is “not geared or qualified to inspect accounting firms’ auditing [work], so you have to hire essentially the same people at the PCAOB,” he said. “I think the same is true with standard-setting.”
In terms of enforcement, Goelzer said the SEC tends to pursue different cases.
In describing Sarbanes-Oxley, Natasha Guinan, chief counsel of the SEC’s Office of the Chief Accountant, explained at a conference in May that Congress envisioned both the SEC and the PCAOB as having jurisdiction with respect to enforcement. But it does not totally overlap—for example, remedies are different.
And it is questionable that Congress would appropriate the same amount of money that the PCAOB is currently spending on inspections, Goelzer said. But many experts say that the board’s inspection has arguably been the most effective tool in improving audit quality.
“I think the costs are that you wouldn’t have a specialized body, the knowledgeable staff that’s focused on auditing,” Goelzer said. “It would just be one other priority in a large bureaucracy.”
The SEC’s big remit ranges from corporate disclosure review to equity market structure rulemaking.
“I just don’t think it would have the same discipline … that you have with the PCAOB today,” Goelzer said. “That’s certainly not to say that the PCAOB is perfect, but the SEC has really complete power over the PCAOB: if they have a problem with size of the budget or its priorities or anything else it’s doing, they have the power to do that, at least if a majority of the commission agrees.”
If the PCAOB is absorbed by the SEC, then Goelzer asked about other organizations, such as the Financial Accounting Standards Board, the Municipal Securities Rulemaking Board and the Financial Industry Regulatory Authority. Should they be folded into the SEC as well?
“It makes sense to have an expert body that just focuses on those functions,” he said. “I would think it would tend to get lost inside the SEC. They can still be performed, but would they be performed as effectively?”
Moreover, Goelzer said if PCAOB inspectors were to be transferred to the SEC, they would become government employees and their pay would be cut drastically. The PCAOB today offers competitive salary to attract talent.
Douglas Carmichael, the first chief auditor of the PCAOB who is now an accounting professor at Baruch College in New York, said the idea, if implemented, would be “a total disaster” both in the short run and the long term.
The PCAOB’s mission is to protect investors by improving audit quality, Carmichael pointed out.
“The best way to do that—all the things that PCAOB does are important, like setting its own standards but the standard only goes so far—you need to see ‘are those standards being implemented properly, are the firms doing their job and that’s essential to protect investors?’ And I think it would be very difficult for the SEC to do a good job of that along with all the other things it needs to do,” he said. “The SEC relies greatly on people that come in for a short period of time and kind of rotate through, and sometimes that’s criticized as a revolving door, and the PCAOB has been able to build up a significant group of inspectors with experience that stay there. I think that would be lost and one of the things you need to do in order to do that is pay a reasonable salary, not a government salary.”
When he went to Washington to become PCAOB chief auditor 20 years ago, Sen. Paul Sarbanes emphasized to Carmichael that Congress deliberately made the PCAOB an independent non-government entity so that it would be able to pay private sector salaries because professionals at the SEC at higher levels go to the agency, stay there only for a few years, recognizing that the tenure will benefit their future careers.
“It would be detrimental to be doing that on a rotating basis, of having people come in for only two or three years because that’s all they can afford in their careers to work for a government salary,” Carmichael said. “So, it would immediately have that disastrous effect of reducing the accountability of audit firms and the protection of investors that the PCAOB supplies.”
Not everyone agrees that it will be detrimental if the SEC absorbed the PCAOB’s work.
Former SEC Commissioner Paul Atkins, currently chief executive of Patomak Global Partners, said that while Congress was writing Sarbanes-Oxley, a hearing was held whether a special regulatory organization regulating public company auditors should be set up.
“One of the witnesses was my old boss, [then-SEC chairman] Richard Breeden. And so, I believe it was Jon Corzine, the senator from New Jersey at the time posed a question to Richard and asked him, ‘do you think there should be a special regulatory organization to oversee accountants?’ and Richard said, ‘yes, so there should be, and there is one. And it’s called the Securities and Exchange Commission.’” recalled Atkins, who served as a staff adviser to Breeden. “So, Richard was among the number of folks who were saying that, you know, the SEC is the one to provide that, and to have another organization to do the same thing will just cause a duplication and kind of awkwardness, potential holes in oversight and that sort of thing. It’s best to leave it with one particular agency.”
In terms of budget, Atkins was a critic of large pay given to board members when he was a commissioner from 2002 to 2008. In 2007, Atkins voted against the PCAOB’s 2008 budget, objecting to a 3.3 percent increase in board member salaries.
“As a matter of policy, I believe the board’s salaries are disproportionately high,” said Atkins at the time, as he displayed a chart comparing PCAOB salaries with those from executives at not-for-profit organizations and government agencies.
The 2008 budget raised then-chairman Mark Olson’s salary to $654,353 per year from $632,400, and each board member’s pay to $532,000 from $515,000. In 2009, the salary for chair increased to $672,676, and the four other members will be paid $546,891. But the figures have remained the same for 14 years.
Fix GAAP First?
For others, like Tom Selling, author of the Accounting Onion blog and a former PCAOB advisory group member, believes that fundamentally accounting should come first, and the idea of focusing on auditing may not be the best way to go about it.
“Focusing on audit regulation to improve financial reporting quality is putting the cart before the horse,” said Selling, who is a writing a book on financial accounting. “The elephant in the room is U.S. GAAP. Some would say that auditors are currently faced with an impossible task. They essentially have to determine whether an overly complex, opaque and inherently biased system of financial accounting produces ‘reasonable’ results. The garbage-in-garbage-out adage comes to mind.”
“If the SEC were truly concerned about quality financial reporting, it would use its powers to make financial reporting more transparent, more relevant and less subject to manipulation by management,” Selling said. “Removing the PCAOB from the picture by transferring its functions to the SEC does little more to financial reporting than folding up the deck chairs before hitting an iceberg.”
Institutional Amnesia and Collective Suspension of Disbelief?
Ultimately, in Carmichael’s view, the long-term effect of folding the PCAOB into the SEC will be even worse than the short-term impact.
“If I were cynical, I would say, ‘well, that’s the whole point, to get rid of the PCAOB, go back to the old formula of the SEC relying on the auditing profession to set its own standards and inspect its own audits. And we know that was a disaster,” he said.
Before the PCAOB was established by Congress, the AICPA wrote its standards and supervised the auditors. Today, the AICPA still writes standards but only for audits of private companies.
“So, it’s a double disaster, the immediate effect on protecting investors, and even further disastrous effect of what would eventually happen,” Carmichael said, pointing out the different budgeting process for the SEC and the PCAOB today.
“To me, it would seem inevitable that in a relatively short period of time, it would be necessary for the SEC to rely more on the auditing firms to set the standards and do the inspections. The old ways led to the formation of the PCAOB in the first place,” he emphasized. Any consolidation proposal “kind of reflects an institutional amnesia about why the PCAOB was established in the way it was in the first place.”
One would have to have “a suspension of disbelief to think that investors would still be protected if the PCAOB duties were folded into the SEC,” he added.
This article originally appeared in the July 18, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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