One of the Public Company Accounting Oversight Board’s (PCAOB) new strategic goals under Chair Erica Williams’s leadership is to step up its enforcement activities. And during recent interviews, there were mixed reactions to the development among experts.
Investor protection advocates welcomed the move while others questioned whether it will ultimately achieve its desired outcome to improve audit quality.
“First, the PCAOB should, of course, have a strong and active enforcement program,” former PCAOB acting chair Daniel Goelzer said. “I think the board’s enforcement efforts have been a hampered a bit in the past by a tendency for the SEC’s enforcement staff to want to take the lead on cases of national significance. This has left the PCAOB with cases involving smaller firms or more technical violations of board rules. If the PCAOB is going to be pursuing a broader range of cases in the future, I think that’s positive.”
The Securities and Exchange Commission (SEC), which oversees the PCAOB, also brings enforcement actions against accounting firms and individuals. There does not seem to be a hard and fast rule of who takes the lead on a case. But the commission has not been shy in pursuing headline-grabbing cases. For example, late June, the SEC fined Ernst & Young LLP $100 million for cheating by its auditors on ethics exams.
Now the PCAOB, with a new sheriff who has litigation experience in town, has been bringing cases under provisions that have not been used before, including violations that resulted from negligent conduct such as failure to supervise and levying the highest penalty on an individual.
Williams, who became chair of the PCAOB in January 2022, has been much more active in pursuing enforcement cases in part to send the message that wrongdoers will be held accountable. The previous leadership in particular was criticized for being more lenient towards auditors, and some advocates have been loud and clear that the board should do more to protect investors, which is the sole mission of the PCAOB.
The PCAOB has more than tripled the total dollar amount of penalties on individuals in 2022 compared to each of the past five years. Over the same period, the board quadrupled the average penalty against firms in cases where firms failed to meet PCAOB reporting requirements. And the regulator increased the average penalties against firms in all other cases by about 50 percent. In the past five years, the PCAOB assessed penalties against individuals less than half of the time and firms only about 86 percent of the time. This year it was 100 percent.
“I have said before, and I will say again, the PCAOB means business when it comes to enforcement,” Williams said at a conference hosted by the AICPA in Washington on Dec. 12.
“Those who break the rules – whether they are ethical rules or auditing rules – should know we won’t be constrained by the types of cases the PCAOB has pursued in the past. We won’t be limited to the level of penalties that have been seen before,” she said. “And we will seek admissions of wrongdoing in appropriate cases – for example, where the conduct is intentional or egregious.”
‘Somewhat Uneasy’
However, Goelzer said that he is “somewhat uneasy about the suggestion that enforcement is going to used more often to address inspection findings,” referring to a speech that Williams gave in September.
He prefaced his comments by saying that he is not suggesting that Williams’s comments indicate that is in fact going to happen. But Goelzer believes that there are risks when the inspection and enforcement programs are tied more closely together.
“Inspections do occasionally uncover some fairly egregious audit failures, and it makes sense that those would be referred to enforcement. But the great majority of Part I inspection findings, while technically involving violations of the auditing standards, don’t rise to that level,” the former PCAOB member explained. “One of the reasons the inspections program has been successful in improving audit quality is that the firms have generally cooperated in the process, accepted the board’s findings, and responded by seeking to improve their procedures.”
Moreover, “if auditors begin to think that each time an inspection results in a Part I finding, there is a real risk that the result will be an enforcement referral and an effort to permanently bar them from the profession, the inspection process will become much more adversarial and arm’s length,” Goelzer said. “ In my view, that would not be a positive step in terms of improving audit quality.”
‘Kudos’ to Current PCAOB Chair
Former SEC chief accountant Lynn Turner, who is on the PCAOB’s both advisory boards, begged to differ.
He explained previous board members and chairs, including James Doty, were lax on enforcement.
“This has been a ‘kindler, gentler PCAOB’ in the past. Erica’s remarks reflect her desire to put the interests of investors first, as the language in SOX [Sarbanes-Oxley Act of 2002] actually states,” Turner said. “It reflects a ‘new sheriff’ in town that believes in people complying with the law, and fair treatment for investors. They also clearly reflect and highlight the lax enforcement of prior boards, including on egregious cases found during inspections.”
Sarbanes-Oxley established the PCAOB in an effort to prevent large accounting frauds that would end up costing investors a lot of money. The board was not only given enforcement and inspection authority but also the ability to write audit standards that auditors of public companies must follow.
Turner also explained that there have been serious auditor noncompliance with PCAOB standards in the course of an audit.
“A prime example is the PwC audit of Colonial Bank, the largest bank to fail during the financial crisis,” Turner explained. “A federal judge in a bench trial found PwC failed to conduct their audit in a manner required by the standards, and in doing so, failed to detect material fraud. And yet both the PCAOB and SEC failed to bring any action” at the time.
“What Williams’s message has been, is that the penalties and fines have to match the violation,” he said. Until the current board, “the PCAOB fines and penalties were negligible,” pointing to reports by the Project On Government Oversight (POGO).
“Kudos to Erica on her enforcement” initiatives, Turner said.
More Balance Needed?
Still, others believe that there should be a more balanced approach between inspection and enforcement.
Richard Morvillo, a partner who co-chairs the white collar and internal investigation practice at Stroock & Stroock & Lavan LLP in Washington, does not think it is a good development at the board.
In his view, the PCAOB is taking cues from the SEC to try to strengthen the enforcement function when it is not necessary.
As the U.S. Chamber of Commerce and some Big Four firms have argued, Morvillo also said that the PCAOB has traditionally been a supervisory regulator. This means that the board improves audit quality through inspections.
“And the enforcement function needs to be balanced with the supervisory function,” Morvillo said. “And I think that they’re going in the wrong direction by emphasizing the enforcement side of things when there is anecdotal evidence that audit quality has improved through inspections.”
Indeed, most credit the PCAOB’s inspection program for having made audit quality better over the years.
While having a tough enforcement program sends a message, “I think the inspections already create an environment in which the firms are trying their best to promote good audit quality,” he said. “Making individuals responsible for errors in judgment is not conducive to developing the highest professional standards.”
Moreover, Morvillo said that the PCAOB may be following the playbook that SEC Chair Gary Gensler is using in bringing rigorous enforcement actions. Just as he did when he was chair at the Commodity Futures Trading Commission, he is also pursuing enforcement cases aggressively. When he was interviewing candidates to serve on the PCAOB last year, he emphasized the importance of enforcement and supposedly told them that he wanted a certain number of enforcement cases.
But Morvillo said that he just does not think it is necessary.
“There’s no empirical evidence that they haven’t accomplished their mission through the inspection process,” he said.
Moreover, imposing a high penalty, for example, $100,000 on former KPMG Vice Chair Scott Marcello, is unnecessary, Morvillo believes.
“I don’t think it’s an effective deterrent,” Morvillo said. “Look, getting sued by the SEC or the PCAOB is usually a career ending event. Hitting somebody with a $100,000 fine as opposed to a $50,000 fine doesn’t do anything.”
Former PCAOB acting chairman Goelzer offered up another reason.
“Asking for high penalties and permanent bars also creates incentives to litigate, rather than settle,” he said. “Taking these two things together, the PCAOB may find itself involved in a lot of litigation. Litigating cases, especially those based on negligence or other less-than-compelling circumstances, is time consuming and expensive and limits the number of cases the board can actually pursue. So, bottom line, interesting speech and potentially some very far-reaching changes in the PCAOB’s enforcement program, but we will have to wait and see how it all plays out.”
In a comment letter, Ken Goldman, former chef financial officer of Yahoo who previously served as an adviser to the PCAOB, said that he is against upping fines.
“Doubling penalties on individuals and the firms is the wrong message to be proud of. I suggest being more proud of using the carrot approach and working with firms and Individuals collaborately to encourage them to do the right thing as my experience is all the major firms are conscientious and are supporting the public good,” he wrote. “Your approach could drive more good executives and employees to leave the profession when the profession urgently needs to encourage the profession as a great and proud full career.”
Maybe Necessary Following Lax Enforcement in the Past?
In the meantime, Tim Gearty, an accounting instructor at Becker Professional Education, acknowledged that this is the most aggressive enforcement stance that the board has taken in its 20 years of existence.
“Under James Doty, there was a lot of enforcement actions, but not in the form of monetary fines against the accounting firms. Under William Duhnke, it was far more [about] testing their quality control standards, and making sure they were up to speed,” Gearty said. “Now, it is clearly going after any deficiency that occurred within the accounting and auditing function.”
He believes that this may be happening in part because both the SEC and PCAOB are worried about eroding culture of ethics at accounting firms with widespread cheating on ethics exams at Big Four firms. Moreover, KPMG LLP tried to get the board’s internal documents in an effort to pass board inspections.
“And one of the interesting comments was from the [SEC] Acting Chief Accountant Paul Munter where he said that there’s been a lot of relaxing of the audit standard, and that has really become a check the box as opposed to engaging in an understanding of your consulting, the magnitude of it, etc. And therefore, I think the enforcement actions are because of what they perceive as a change in the dynamics of the culture at some of the accounting firms,” Gearty said.
When asked whether the PCAOB’s fines are too excessive, Gearty said he can see both sides of the issue.
For example, on the KPMG scandal, three of the partners were fired for their attempt to get information from the PCAOB on upcoming inspections.
“By losing their jobs, their annual compensation was probably north of $2 million a year. And they were young. They had 10, 12, 14 more years to go, which means they forfeited you know, $20 to $30 million in compensation. They incurred legal fees; they incurred the scandal and the shame. They were sentenced to one year in jail. And in addition to all of that, they’re banned from serving as an officer or on a board of any public company,” Gearty said. “So, the opportunity to make that up is probably lost. So, you know, the consequences, the financial consequences have always been there. It’s just they’re more visible when you hear there’s also a fine to be paid.”
Thus, it can send an effective message to everyone.
“On the other side, you know, the loss of job and reputation is probably greater than the $100,000 that a vice chairman has to pay in total,” he said.
In terms of deterrent effect, the PCAOB’s aggressive enforcement posture may make someone who was marginally thinking about pushing the envelope to pause and think, Gearty said.
“But just as in fraud at corporate America, there’s always going to be bad actors, and unfortunately, our profession has people that are willing to compromise their audit responsibilities in order to retain a client,” he said. “And I suspect that an auditor who looks the other way, who allows something to go through that shouldn’t, their thought is it will never get caught. So it may be that these fines have no significant impact on their determination since their expectation is, it will never come to light, and there will never be a consequence for it, which is wrong, but it does seem to be how individuals make their decisions.”
At the end of the day, the PCAOB is a regulator whose job is to protect investors, and its own Investor Advisory Group in a comment letter said it fully supported the board’s objectives of “rigorously enforcing” applicable laws and regulations and impose heftier fines, among others.
Editor’s Note: This article was updated to include comment letter responses.
This article originally appeared in the December 19, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.
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