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NARUC – Staff Subcommittee on NARUC – Staff Subcommittee on Accounting and Finance Accounting and Finance
PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD
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LASTEST DEVELOPMENTS IN REGULATING THE ACCOUNTING PROFESSION
Ronald S. Boster, Ph.D.Special Advisor, PCAOB
May 2009Phoenix/Scottsdale
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CAVEAT CAVEAT (required by PCAOB Ethics Code)(required by PCAOB Ethics Code)
Opinions expressed may not represent the views of PCAOB, its board
members, or its staff (or even the speaker!)
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WHAT’S IN A NAME?WHAT’S IN A NAME?
QUESTION (answer at end of presentation)
[Prize for winner]
Which are wrong?
1. Public Company
2. Accounting
3. Oversight Board
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BARACK OBAMA IS NOT THE BARACK OBAMA IS NOT THE ONLY CHANGE AGENT! ONLY CHANGE AGENT!
The Sarbanes-Oxley Act of 2002 is “the most far-reaching reform[s] of American business practices since Franklin Roosevelt was president”
President George W. Bush
SOX formerly “…would have been an unimaginable incursion of the federal government into the corporate governance arena.”
Former SEC Commissioner Paul Atkins
Entirely new regulatory regime created for auditors of public companies (issuers) So, not all recent “regulatory” changes were de-regulation! Only second time a U.S. profession has been “federalized” (Q:
what was the first?)
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SOX WAS A BIG CHANGESOX WAS A BIG CHANGE
SOX passed Congress w/ only 3 dissenting votes
andit was signed into law by
a conservative president, so…
How/Why did this come about?
[see following chart for full explanation]
PRE-OBAMA CHANGE AGENTS (circa 2002)
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A POLITICAL “PERFECT STORM”A POLITICAL “PERFECT STORM”
Losses of Public Confidence in Financial reporting Accounting/auditing profession SEC’s willingness & capacity to enforce securities laws U.S. capital markets
Losses of Money “Dot-com bubble” burst Shareholders/employees of “bad” companies
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WHAT GOES AROUND COMES WHAT GOES AROUND COMES AROUND AROUND
DOES THIS SOUND FAMILIAR?
PERHAPS TODAY’S CRISIS?[see following chart for full explanation]
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TODAY’S CRISIS: TODAY’S CRISIS: only the cartoons are different! only the cartoons are different!
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BETTER THAN THE ALTERNATIVEBETTER THAN THE ALTERNATIVE
PCAOB IS ON THE PERIPHERY OF THE CURRENT ECONOMIC CRISIS
but
AUDITORS HAVE BEEN ACCUSED OF CONTRIBUTING TO THE PROBLEM (e.g., Fair Value/Mark-to-Market)
IS THIS A VALID CHARGE?
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PCAOB’s UNIQUE ARCHITECTUREPCAOB’s UNIQUE ARCHITECTURE
Uniquely Independent by Statute (SOX)
From accounting profession Board membership criteria & appointment Accounting/Auditing profession does not fund PCAOB
Financial independence Financing is outside the federal budget appropriations
process (but subject to SEC approval) __________________________
Subject, however, to extensive SEC oversight “A wholly-owned subsidiary of the SEC”
Never independent from Congress Just ask GM & Chrysler, TARP recipients, or FASB!
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STAFFING & BUDGET LEVELSSTAFFING & BUDGET LEVELS
Employees (total)* …………..……………………….... 497
Approx. half in Inspections
Year-end (’09) staffing level (planned) .....…………… 531
Approx. half in Inspections
Budget (2009) ………………………………………… $158m
99+ % of operating revenue comes from issuers, not from accounting firms, through Accounting Support Fee
*As of March 31, 2009
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STATUTORY RESPONSIBILITIES STATUTORY RESPONSIBILITIES
Registration of audit firms Inspection of registered audit firms Standard-setting Enforcement & discipline through investigations
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NOT OUR JOB!NOT OUR JOB! (WHAT PCAOB DOES (WHAT PCAOB DOES NOTNOT DO)DO)
Accounting standards (FASB) e.g., Fair Value
PCAOB does look at how auditors deal w/ Fair Value Public companies/issuers (SEC)
Including SOX 404(a), management assessment of internal controls, proxy voting, etc.
PCAOB does inspect audits of issuers Other “not-our-jobs”
Safety and soundness of accounting/auditing firms (does anybody?) Competition and competitiveness of registered firms Coverage/applicability of AS 5 for non-accelerated filers (SEC) Market concentration & competition of audit firms (does anybody?) CPA professional standards (state boards/AICPA) Auditor liability (Congress/SEC) IFRS vs GAAP (SEC) Ultimate civil sanctions against firms (SEC/courts) Criminal sanctions against firms (Justice Dept./courts) Inspection of audits of non-issuer broker-dealers (at least, not yet!)
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REGISTRATION – where it beginsREGISTRATION – where it begins
1. SOX requires that public companies be audited by PCAOB registered firms
2. Registration is the basis for any PCAOB action because PCAOB’s authority extends only to registered firms and their associated persons
Inspections of registered firms Investigations/enforcement/discipline of registered
firms and associated persons PCAOB has no direct authority over issuers
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REGISTRATION UNIVERSEREGISTRATION UNIVERSE
Firms registered by PCAOB..………….…. 1,874U.S. firms (52%)..……………………….. 983Non-U.S. firms (48%) ..…………………. 891
Foreign countries ……………….. 86
Firms w/ ≥ 1 issuer clients (39% of total)... 735U.S. Firms (54% of U.S. reg. firms) . …. 527 Non-U.S. firms (23% of non-U.S.
registered firms)…………………. 208
Firms withdrawn from registration …….. 279
___________________________________________________Data as of 12.31.08 (4.23.09 for number of withdrawn firms)
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A CLASSIC OLIGOPOLYA CLASSIC OLIGOPOLY
FACTS
The Big Four* accounting firms audit public companies that comprise:
97.5% of total U.S. issuer revenue, and 97.5% of total U.S. issuer market cap
* aka Final Four.
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INSPECTIONSINSPECTIONS
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PCAOB INSPECTIONS ARE NOT PCAOB INSPECTIONS ARE NOT LIKE THE OLD PEER REVIEWSLIKE THE OLD PEER REVIEWS
Enhanced professional skepticism Risk-based
For firms, engagements, and “slices” of engagements
Special role of PCAOB Office of Research & Analysis
Suspected GAAP & independence violations are referred to SEC or to DOJ if criminal violations are suspected PCAOB cannot force restatements (but inspections have caused them)
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FOCUS OF INSPECTIONSFOCUS OF INSPECTIONS
Is on two broad, integrated elements:
Audit Performance – Adherence to professional standards (GAAP, auditing, ethics, independence)
Quality Control – firm’s QC policies and procedures (see next slide)
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QUALITY-CONTROL CRITERIAQUALITY-CONTROL CRITERIA
1. Tone at the top2. Partner evaluation (admission, assignment of
responsibilities, disciplinary & compensation policies and practices)
3. Independence (non-audit services, business ventures, alliances, personal financial interests, & commissions and contingent fees)
4. Client acceptance & retention policies/practices5. Firm’s internal inspection program6. Practices for communication of audit policies, procedures,
and methodologies (including training)7. Practices for consultations on accounting, auditing, and
SEC matters8. Supervision of foreign affiliates
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PCAOB INSPECTIONS PCAOB INSPECTIONS (Facts)(Facts)
Since PCAOB inception (Jan, 2003)
Completed field work on > 1,100 inspections Issued > 850 inspection reports Examined portions of > 5,000 audits
Data as of April 2009
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SIGNIFICANT or FREQ-OBSERVED AUDITING SIGNIFICANT or FREQ-OBSERVED AUDITING or QUALITY-CONTROL DEFICIENCIESor QUALITY-CONTROL DEFICIENCIES
Revenue Related-Party Transactions Equity Transactions Business Combinations & Asset Impairment Going-concern Considerations Loans & Accounts Receivable (incl. allowance accounts) Service Organizations Use of Other Auditors Use of the Work of Specialists Independence Concurring Partner Review GAAP departures Estimates/Fair Value Income Taxes Audit Scope – Audit Differences
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PRUDENTIALPRUDENTIAL SUPERVISORY SUPERVISORY REGULATIONREGULATION (for the most part)(for the most part)
Clearly intended by SOX Raison d’être parts of inspection reports are non-public
Within-firm sharing of full reports is minimal More than half (~53%) of all PCAOB staff resources are in
Inspections whereas less than 8% are in Enforcement “Remediation” of audit deficiencies
Deficiencies not remedied within 12 months become public (posted on PCAOB’s website)
PCAOB’s remediation criterion is “good-faith effort” Frustrating yet effective
Critics want more transparency (e.g., to be able to see entire inspection reports) but “Audit quality” has likely improved compared to a “gotcha” regulatory approach
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PUBLIC INSPECTION-RELATED PUBLIC INSPECTION-RELATED DOCUMENTS DOCUMENTS
Visit: www.pcaobus.org/Inspections/index.aspx
Generalized findings (“4010” reports) Initial implementation of AS 2 Second-yr implementation of AS 2 Inspections-based observations on fraud Triennially-inspected firms Initial implementation of 12-mos remediation process
Other reports Statement on PCAOB’s approach to inspections Statement on issuance of inspection reports Process for Board determinations re: remediations Staff Audit Practice Alerts (4 to date)
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INTERNATIONAL INSPECTIONSINTERNATIONAL INSPECTIONS
SOX requires PCAOB registration of non-U.S. firms that audit U.S. issuers
SOX imposes the same requirements on them as for U.S. firms, i.e., Cooperation (what happens if a country says “No” to inspections?) Registration Inspections Enforcement
Creates challenges Conflicting laws
Initially, Board made several accommodations for registration Gave additional time to non-U.S. firms to register Non-U.S. firms may withhold information if legal conflict exists
(Rule 2105) Not specifically addressed in Board rules
Not-so-hypothetical question What if a country refuses to permit inspections?
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NON-U.S. REGISTERED FIRMSNON-U.S. REGISTERED FIRMS
1. China ……………… 97*2. United Kingdom .... 703. India ……………..... 574. Canada ……….…… 55 5. Australia ………..... 44
6. Germany…………… 437. France …………….. 358. Singapore ………… 219. Mexico ……………. 1910. Brazil.. …………….. 17
* Includes 47 Hong Kong firms____________As of 3.01.09
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INTERNATIONAL INSPECTIONS INTERNATIONAL INSPECTIONS
Degrees of reliance on non-U.S.
regulators are on sliding scale
Based on bilateral discussions Policy statement on “full reliance”
Issued for public comment (12.05.07) Joint inspections now in 6 countries
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INTERNATIONAL INSPECTIONSINTERNATIONAL INSPECTIONS COOPERATION & RELIANCE COOPERATION & RELIANCE
CRITERIA FOR DETERMINING DEGREES OF RELIANCE ON NON-U.S. REGULATORS
Overall adequacy, integrity, & rigor of a country’s regulatory system, including:
Staff capacity & sufficiency Independence from auditing profession, including funding Transparency Enforcement record (if any)
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STANDARD SETTINGSTANDARD SETTING
SOX directs PCAOB to establish standards for audits and related attestations of public companies (issuers) and for:
Quality control Ethics Independence
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PCAOB RULEMAKING ‘2-STEP’PCAOB RULEMAKING ‘2-STEP’
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AUDITING STANDARDS/RULES AUDITING STANDARDS/RULES MANDATED BY SOX MANDATED BY SOX
Internal Control Over Financial
Reporting (the infamous sec. 404(b)) Audit Documentation Engagement Quality Review (prev. 2nd-
Partner or Concurring Partner Review) Annual & Special Reporting Fraud – Oddly, is not mandated by SOX
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AUDITING STANDARDS ADOPTEDAUDITING STANDARDS ADOPTED
Interim Standards – Pre-existing audit standards “to be used on an initial, transitional basis”
PCAOB adopted existing auditing standards as its “Interim” standards on April 16, 2003
AS 1 – References in Auditors' Reports to the Standards of the PCAOB
AS 2 – [Internal Control] (superseded by AS 5) AS 3 – Audit Documentation AS 4 – Reporting on Whether a Previously Reported Material
Weakness Continues to Exist AS 5 – An Audit of Internal Control Over Financial Reporting
That is Integrated with an Audit of Financial Statements (supersedes AS 2)
AS 6 – Evaluating Consistency of Financial Statements
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STANDARDS-RELATED RULESSTANDARDS-RELATED RULES & AUDIT PRACTICE ALERTS & AUDIT PRACTICE ALERTS
Board Rules
Rule 3101 – Certain terms (“must” vs. “should”) Rules 3501-3525 – Ethics & independence (adopted by the Board 4.22.08 and pending
at SEC) 3526 Communication w/ Audit Committees re: independence
Effective Sept. 30, 2008 Tax Services for Persons in Financial Reporting Oversight Roles (amendment to
3523) Effective Aug. 22, 2008
Staff Audit Practice Alerts #1 Options Backdating – 7.28.06 #2 Fair Value (including use of specialists) – 12.10.07 #3 Auditing in the current economic environment – 12.05.08 #4 On Fair Value, OTTI, and disclosures – 4.21.09
For details on all PCAOB rules & standards, visit: www.pcaobus.org/Rules/Rules_of_the_Board/index.aspx
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OTHER STANDARD-SETTING OTHER STANDARD-SETTING PRIORITIES PRIORITIES
Engagement Quality Review (previously Concurring Partner Review) Re-proposed; comment period ended 4.20.09
Risk Assessment (including fraud risk) 120-day comment period ended 2.18.09
Related Parties Confirmations
Concept release, 4.14.09 for 45 days
Use of Specialists
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ADDITIONAL STANDARDS- ADDITIONAL STANDARDS- RELATED ACTIVITIES RELATED ACTIVITIES
Review of PCAOB Interim Standards Harmonization/convergence of
auditing standards (international) Coordination w/ other standards-setters
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INVESTIGATON, ENFORCEMENT, INVESTIGATON, ENFORCEMENT, & DISCIPLINE & DISCIPLINE
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WHEN PRUDENTIAL WHEN PRUDENTIAL SUPERVISON FAILS SUPERVISON FAILS
Board can use formidable investigative and enforcement powers
e.g., failure to conduct audits with sufficient care & competence
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BOARD’S BROAD JURISDICTIONBOARD’S BROAD JURISDICTION
The Board may investigate possible violations by registered public accounting firms or their associated persons of: any provision of the Sarbanes-Oxley 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
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SOURCES OF INVESTIGATIONSSOURCES OF INVESTIGATIONS
Issuer disclosures (e.g., public SEC filings) Auditor changes Restatements
Media Tips (from the public) Other regulators PCAOB (i.e., internally)
Inspections Office of Research & Analysis
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WIDE RANGE OF SANCTIONS WIDE RANGE OF SANCTIONS
Censure firm or associate of firm Require professional training Bar from association w/ registered firms Civil monetary penalties:
<$900,000 per person (each violation) <$17,800,000 per firm (each violation)
Two fines to date (1 firm + 1 assoc. person) - $1m+ Monetary penalties go for scholarships
De-registration of firm (“nuclear bomb”) “… any other appropriate sanction…”
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INVESTIGATIONSINVESTIGATIONS (cont'd)(cont'd)
SOX requires confidentiality of information (similar to inspections data)
PCAOB can share investigative information with the SEC, Justice, & other federal agencies enumerated in SOX, and with
state accountancy boards
May not share info w/ non-U.S. regulators (also true w/ respect to Inspection reports)
Unintended flaw in SOX Investigations are only made public at their conclusion and then only if disciplinary proceeding results in a settlement, or litigation (including appeals) is completed and results in sanctions
Can create perverse incentives
Coordination with SEC’s Division of Enforcement is standard practice
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GENERAL TYPES OFGENERAL TYPES OF INVESTIGATIONS INVESTIGATIONS
Violations of professional standards
Audit failure/“bust” The auditor should have detected that
issuer's financial statements are not in accord with GAAP &/or are materially misstated
Major GAAP departures
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UNLIKELY!UNLIKELY!
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CURRENT/EMERGING ISSUESCURRENT/EMERGING ISSUES
Inspections of audits of non-issuer broker-dealers Because of a legislative drafting glitch, auditors must now be registered w/
PCAOB,* but PCAOB cannot inspect their audits!
“Corrective” legislation is pending in Congress
CIFiR & Treasury advisory committee recommendations (selected) Signature of engagement partners Fraud Center Indicators of audit quality
Departures of founding Board members
Is PCAOB constitutional?
______* Estimate additional 1,200 firms will be registered
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UPSHOT of SOX & PCAOB for UPSHOT of SOX & PCAOB for AUDITING PROFESSION AUDITING PROFESSION
Oversight of auditors of U.S. issuers has been federalized
PCAOB is the “new sheriff in town” Congress viewed AICPA peer reviews as a sham “Tough [prudential] love” needed – PCAOB ex-Chair Bill
McDonough
A sea change for audit firms At times a rocky adjustment, but firms survived
(some say prospered) and may be the better for it over time
The key question: Are investors better off?
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PUBLIC POLICY QUESTIONS PUBLIC POLICY QUESTIONS
What are the responsibilities of being a public company (and the implications for auditors of public companies)?
Are they less merely because of company size? Should investors in small companies be afforded less
protection than investors of large companies? End exemption from 404(b)?
Would it matter (toothpaste theory)? What is the societal B:C of SOX/PCAOB? Where, if anywhere, does PCAOB fit in the forthcoming financial regulatory scheme? Should SOX be amended?
Be careful what you ask for!
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POLICY QUESTIONS POLICY QUESTIONS (continued)(continued)
What are the implications & influence of SOX outside the sphere of public companies?
Government Non-profits Private companies
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REMEMBER THIS QUESTIONREMEMBER THIS QUESTION
QUESTION
Which is/are flat-out wrong?
1. Public Company
2. Accounting
3. Oversight Board
