Statement at Open Meeting to Approve PCAOB Budget
Commissioner Luis A. Aguilar
U.S. Securities and Exchange Commission
January 11, 2012
The Public Company Accounting Oversight Board is tasked by Congress to oversee the audits of public companies, and broker-dealers, in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports.1 Today we consider the resources the PCAOB requires to fulfill its mission.
The PCAOB Budget is Tied to Important Strategic Goals
Today’s action is the culmination of an interactive budget process. I want to acknowledge the cooperation shown by the PCAOB and its staff throughout the budget process. Our budget rule for the PCAOB requires the Board to align its budget request and justification to the accomplishment of the Board’s long-term strategic goals, and the fulfillment of its duties and responsibilities.2 In that regard, the Board has provided the Commission with a detailed, five-year strategic plan. I commend the Board for developing a strategic plan focused on the interests of investors.
The Audit Process Must Provide Investors with Decision-Useful Information
As reflected in the strategic plan, a central objective of the PCAOB is to improve the relevance and usefulness of the audit report.3 I am particularly interested in the efforts of the Board to improve communication between auditors and investors, and its efforts to foster an audit process that provides investors and other capital providers with the information they need to make good decisions.4
I was struck by data compiled by the PCAOB’s Office of Research and Analysis confirming that, of the ten largest bankruptcies during the financial crisis, eight of them received clean opinions from outside auditors on their most recent audited financial statements, prior to their bankruptcy filings.5 During the year leading up to such bankruptcies, the market capitalization of those eight companies fell 99%, destroying almost $75 billion in equity value.6 The failures of these firms, and others like them, contributed greatly to the pain that is still being felt from the recession throughout the real economy, as millions of Americans lost their jobs, and many had years of savings vanish, with little warning.
In the aftermath of such failures, many have asked how such companies received clean audit opinions just months before failing, and whether independent auditors could have done more to identify, and warn the public about, the increased levels of risk in the financial system.7 As the PCAOB has stated, many investors believe that “auditors are in a unique position to provide relevant and useful information” about audit risk and the quality of financial statements.8 As a recent PCAOB roundtable made clear, such investors believe that auditors should use their expertise to help provide investors with a clearer understanding of the financial statements they audit.9
Recently, the PCAOB issued an important concept release on possible changes to the reporting model used by auditors — with the hopes of improving communications between auditors and capital providers.10 I commend the PCAOB for initiating a dialogue on this important issue, and look forward to hearing how communications can be improved.
Serious Challenges to Audit Quality and Enforcement in Cross-Border Audits
On a separate note, I would like to discuss a serious challenge faced by the PCAOB in its efforts to protect investors by improving audit quality.
Many foreign issuers listed in the U.S. file audit opinions signed by foreign accounting firms, and domestic issuers may file audited financial statements for which a foreign accounting firm has performed audit work or other material services relied upon by the auditor of record. Often, the foreign accounting firm is held out as an affiliate of one of the “Big Four” global accounting networks and the auditor’s signature contains the familiar brand name of an accounting giant.
Under our laws, foreign accounting firms that audit or play a substantial role in the audit of U.S. issuers and broker-dealers are subject to oversight by the PCAOB. Currently, over 900 foreign accounting firms from 85 countries have registered with the PCAOB. Foreign-registered firms are subject to PCAOB inspections in the same manner as U.S. firms. In fact, the budget we consider today provides funding for the inspection of 90 firms based outside the U.S.
American investors have the right to expect that foreign auditors that sign audit opinions, or that perform material audit services on which the signing auditor relies, meet PCAOB standards for independence, objectivity, quality control, and ethics.
However, due to positions taken by a number of foreign authorities, the PCAOB has been prevented from inspecting the U.S. related audit work of registered auditing firms in various foreign countries.11 As a result, the Board has been unable to confirm whether PCAOB-registered firms in such jurisdictions comply with U.S. law and professional standards in connection with their audits of U.S. issuers.
I recognize that foreign inspections raise significant challenges, and I appreciate the efforts the Board has made to negotiate protocols with foreign authorities to facilitate inspections, but I am growing increasingly more concerned that the continuing gaps in oversight put U.S. investors at risk.
Without meaningful inspection rights, there can be no assurance that audit firms have the requisite independence and professional standards. Furthermore, U.S. investors may not be aware that the audit opinions on which they rely may be based on the work of firms that, while registered with the PCAOB, are outside the Board’s inspection regime.12
The question is, whether it is consistent with the goals of U.S. securities law and the protection of investors to allow firms that are beyond effective oversight to sign audit reports for U.S. public companies, or perform material services on which the signing audit firm relies. I think the answer is “no.”
I know the PCAOB is proactively working to resolve the inspection issue, and I ask the Board to do so as soon as possible.
In conclusion, I am pleased to support the Board’s 2012 budget and accounting support fee. It is important that the PCAOB have the resources to fulfill its mission.
I would like to thank Chairman Doty, and the members and staff of the PCAOB, as well as SEC staff from the Office of the Chief Accountant and the Office of Financial Management, for their hard work throughout the budget process, as well as the time spent with myself and my staff to respond to my questions and concerns. I appreciate your dedication, and the important work you do to protect investors.
1 Section 101(a), Sarbanes-Oxley Act of 2002, as amended, 15 U.S.C.A. §§ 7201-7266.
2 Securities and Exchange Commission Regulation P, 17 C.F.R. §202.190 (2011).
3 Public Company Accounting Oversight Board, 2011–2015 Strategic Plan: Improving the Relevance and Quality of the Audit for the Protection and Benefit of Investors (November 30, 2011), at p. 18 (Goal 2, Objective A).
4 See, PCAOB Release No. 2011-003, “Concept Release on Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements and Related Amendments to PCAOB Standards, Notice of Roundtable” (June 21, 2011) (hereafter, “PCAOB Concept Release”). See, generally, PCAOB Docket Matter No. 34, available at http://pcaobus.org/Rules/rulemaking/Pages/docket034.aspx.
5 Steven B. Harris, PCAOB Board Member, “Statement on Concept Release on Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements” (June 21, 2011), citing “PCAOB Office of Research and Analysis; Standard & Poor's; Reuters; FactSet”. In addition, two of the ten companies analyzed failed to receive a clean opinion as to the effectiveness of internal control over financial reporting, including one of the eight companies that otherwise had a clean audit opinion.
7 See, “The Role of the Accounting Profession in Preventing Another Financial Crisis,” hearing before the United States Senate Committee on Banking, Housing, and Urban Affairs (April 6, 2011). Archive webcast available at http://banking.senate.gov/public/index.cfm?FuseAction=Hearings.Hearing&Hearing_ID=0f533e5b-dc43-4fc2-a415-5df2ae8806da. (At the hearing, Sen. Jack Reed (D-R.I.) asked, "Why were there no timely warnings about companies that failed within months of an unqualified report?" and questioned the possibility of “systemic weaknesses in the audit system”. Dow Jones International News (April 6, 2011)).
8 PCAOB Concept Release, at p. 7
9 See, e.g., comment of Ann Yerger, PCAOB Roundtable on Auditor's Reporting Model (September 15, 2011), unofficial transcript available at http://pcaobus.org/Rules/Rulemaking/Docket034/09152011_Roundtable_Transcript.pdf (hereafter, “PCAOB Roundtable”), at p. 20 (“The bottom line is that investors want more information from the outside auditors.”) Mary Hartman Morris of CalPERS, another roundtable participant, described four key areas in which investors are looking for more information: “… key financial statement and audit risk the auditor has considered when conducting the audit…;  … auditor’s assessment of the key estimates and judgments made by management….  … [t]he quality of the accounting policies and practices adopted by management….  … unusual transactions and significant changes to accounting policies….”, PCAOB Roundtable, pp 150-155. See, also, comment of Damon Silvers, PCAOB Standing Advisory Group Meeting (November 10, 2011), pp 114-118, unofficial transcript available at http://pcaobus.org/Rules/Rulemaking/Docket034/11102011_SAG_Transcript.pdf.
10 PCAOB Concept Release.
11 In 2011, the PCAOB executed separate Statements of Protocol with the audit regulators in the United Kingdom, Switzerland, and Norway.
12 James R. Doty, Chairman, “Statement on Proposed Amendments to Improve Transparency Through Disclosure of Engagement Partner and Certain Other Participants in Audits” (October 11, 2011), available at http://pcaobus.org/News/Speech/Pages/10112011_DotyStatement.aspx. I note that the PCAOB publishes a list identifying issuers whose PCAOB-registered auditor is located in a jurisdiction where “obstacles to PCAOB inspections exist”. See, “Issuer Audit Clients of Non-U.S. Registered Firms in Jurisdictions where the PCAOB is Denied Access to Conduct Inspections,” available at http://pcaobus.org/International/Inspections/Pages/IssuerClientsWithoutAccess.aspx. However, neither the availability of such a list, nor proposed amendments to PCAOB standards requiring disclosure of audit participants, addresses the underlying issue.