Remarks Before the 2015 AICPA National Conference on Current SEC and PCAOB Developments
James V. Schnurr, Chief Accountant, Office of the Chief Accountant
Dec. 9, 2015
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues upon the staff of the Commission.
Good morning and thank you for the kind introduction. It is a pleasure to be with you for the second time in my role as the Chief Accountant of the SEC. Before I begin, let me remind you that the views expressed today are my own and not necessarily those of the Commission, the individual Commissioners, or other colleagues on the Commission Staff.
Now that I have been at the Commission for just more than a year, I would like to share some of my overall thoughts and perspectives on the accounting profession, including several key issues facing the profession; considerations about disclosure effectiveness; the role and communications of audit committees; and the importance of high-quality auditing standards.
State of the Profession
Before I get into these specific areas, let me start by making a broad observation: the accounting profession must remain focused on one overarching goal, which is to provide investors with high-quality, decision-useful information that allows for informed investment decisions and facilitates capital formation. While no single list of traits can describe “high-quality” financial information, I believe it begins with information that is relevant and credible. The information must be capable of making a difference in the decisions made by users and must faithfully represent what it purports to represent. Investors must also have confidence that the information is reliable when making those investment decisions. Each of us in the profession, including preparers, audit committees, auditors, standard setters, and regulators, plays a role in achieving this goal. It is important that we are all working together to achieve the high expectations that investors rightly set for us.
Preparation of relevant and credible financial reporting begins with management. Financial reporting often requires sophisticated decision-making and the application of informed judgment to the objectives and principles outlined in U.S. generally accepted accounting principles (GAAP) or IFRS. Management’s ability to fulfill its financial reporting responsibilities depends, in large part, on the design and effectiveness of internal control over financial reporting (ICFR). In simple terms, a company’s ICFR consists of the controls that are designed to provide reasonable assurance that the company’s financial statements are reliable and prepared in accordance with GAAP. While controls cannot replace the need for judgment or eliminate the variations in reporting inherent in situations in which a range of acceptable judgments is possible, well-designed controls support the process by which those accounting judgments are made and the resulting quality of the financial reporting.
The credibility of financial reporting also depends on thorough and objective audits performed by internal and external auditors. I was pleased to see that in a recent survey conducted by the Center for Audit Quality, U.S. investors expressed strong levels of confidence regarding the role and work of external auditors. We also have heard from some audit committee members that, in their opinion, the quality of independent audits has never been higher. Furthermore, mainly as a result of the PCAOB inspections of public accounting firms, many firms have shown some promising signs of improvement in compliance with the professional standards.
Such data points and observations are certainly encouraging, but they likely do not paint the full picture of audit quality and should not be a reason for complacency. The trend of improvement in audit quality is not universal among audit firms or even within a firm. Audit firms are at different points in the audit quality improvement process, and it is critical that further efforts to improve audit quality are undertaken. The firms also should anticipate and proactively respond to new and emerging risks to audit quality to ensure the gains achieved in recent years can be sustained in the future. This is particularly important in the case of audits of ICFR.
We are routinely reminded that investors view ICFR assessments, and independent auditors’ attestation on ICFR, as beneficial and important for investor protection. However, as you may be aware, deficiencies in ICFR audits continue to be one of the most frequent findings in PCAOB inspections of public accounting firms. These findings often question the sufficiency of auditing procedures performed to evaluate the adequacy of the design and effective operation of controls, including management review controls. However, I encourage all of you to take a broader view of the PCAOB inspection findings. As I recently noted in an address to audit committee members, the ICFR issues identified by the PCAOB may not be just a problem of audit execution. Rather, they may, at least in part, be indicative of deficiencies in management’s controls and assessments.
Therefore, both auditors and management as well as audit committees need to focus on the ongoing maintenance and assessment of ICFR. I encourage the three parties to engage in robust dialogue regarding ICFR design and assessment in the context of existing guidance from the SEC and the PCAOB. Brian Croteau, one of my Deputy Chief Accountants in OCA, will be speaking in more detail about ICFR matters and I will be moderating a panel at the conference later today that will be focused on the issues that preparers, auditors, and the PCAOB have been discussing related to ICFR.
As I indicated a moment ago, the independence of accountants who audit the financial statements included in filings with the Commission is essential to the credibility of financial reporting. Accordingly, auditor independence considerations remain of particular focus and attention for the Office of the Chief Accountant (OCA) and other staff throughout the SEC. One of the primary areas of focus is the growth of the accounting firms’ consulting practices. While the effects of this trend may not be all negative, it continues to raise independence concerns and has the potential to undermine investors’ confidence in the work of the external auditors. You will also be hearing more about some specific areas of auditor independence from Brian Croteau and Mike Husich, a senior OCA staff member, later today.
Another important gatekeeper in our financial reporting system is the audit committee. Keen oversight of the preparers and auditors by qualified, committed, independent, and tough-minded audit committees can further enhance the quality of financial reporting.
The important role of audit committees was recognized by the Sarbanes-Oxley Act of 2002 (SOX) and subsequent revisions to the Commission’s rules and exchange listing requirements. They were focused to a large degree on facilitating effective oversight by audit committees in their integral role with respect to investor protection. Based on my professional experience, both in my current position and in my previous life as an audit partner, these regulatory changes have resulted in a significant improvement in the quality and performance of many audit committees.
At the same time, over the past several years, many audit committees have assumed a number of responsibilities that extend beyond their specific regulatory obligations. For example, audit committees are often charged by the board with oversight of a host of major risks facing the company, including cybersecurity, emerging technologies, and compliance risks posed by government regulation. Because the financial reporting implications of such risks are naturally of interest to audit committees, it’s not surprising that some boards have sought to leverage these committees’ skills, knowledge, and involvement in these areas. However, in this environment of growing audit committee agendas, it is important not to lose sight of the key SEC and exchange listing requirements for audit committee performance.
While preparers, auditors, and audit committees together support an environment of active and participatory oversight over the financial reporting process, strong, independent standard setters also play a critical role. Investors must have confidence in how the accounting and auditing standards are set. Open due process, including thoughtfully and objectively considering the input and views of those who participate and play a role in our capital markets, is critical to the work of the standard setters.
Improving the quality of information provided to investors begins with establishing and, when necessary, improving the financial accounting and reporting standards. As I mentioned at this conference last year, Chair White asked me to make a recommendation to her as to what action, if any, the Commission should take regarding the further incorporation of IFRS into the U.S. capital markets. The staff will be in discussions with the Commissioners regarding certain regulatory changes that would facilitate the ability of domestic issuers to provide IFRS-based information as a supplement to U.S. GAAP financial statements.
In the near term, I encourage the FASB and IASB to continue to focus on converging the financial accounting standards. In my view, continued collaboration is the only realistic path to further the objective of a single set of high-quality, global accounting standards. This collaboration should include the FAF, IFRS Foundation, FASB, and IASB along with appropriate outreach to the various jurisdictions that use the accounting standards. The converged revenue recognition standard is a good example of where, through collaboration, we expect to see improved financial reporting. The transition from a reporting model that currently consists of industry specific and at times disparate models, to a single comprehensive model grounded in core concepts and clear principles is a shift that has the potential to benefit investors by providing more decision useful information. You will be hearing more about revenue recognition and other accounting standard setting activities from one of my deputies, Wes Bricker, later today.
While much has been done in recent years to strengthen the relevance and credibility of the accounting profession, it is important to continue on this path of improvement given the ever-evolving risks to reliable financial reporting, continuing evolution of the accounting frameworks, and the high expectations of investors and other users of the financial statements. I encourage the profession to maintain a mindset of continuous improvement, particularly around the quality of information provided to investors, controls over financial reporting, and the independent audit.
I also note the need for continuing professional education and making sure that accountants have the knowledge and skills necessary to meet the challenges of today’s financial reporting. With continued movement towards more principles-based accounting standards, of which the new revenue recognition standard is a good example, companies need to assess and continually reassess the impact to their existing accounting and financial reporting competencies and make adjustments, as appropriate, to their training, retention, and recruitment programs, and/or to the retention of qualified service providers.
Over the past year, financial reporting remained a key priority of the SEC’s Enforcement Division. It is worth noting that in addition to accounting or disclosure violations, enforcement actions have continued to be focused on internal control matters in line with the staff’s overall focus on ICFR. Furthermore, the Enforcement Division has paid close attention to the role and work of the gatekeepers, including external auditors and audit committee members. Enforcement cases brought this year against two large accounting firms (BDO and Grant Thornton) and their partners are examples of the Commission’s response when gatekeepers look the other way rather than satisfying their professional obligations. You’ll hear more about both cases from Enforcement Division Director Andrew Ceresney and staff, but I’ll briefly talk about the cases brought against BDO and five of its partners and Grant Thornton and two of its partners.
The Commission charged BDO with violating multiple professional standards by dismissing obvious red flags throughout the audit; not resolving a material audit matter, despite it being elevated to the firm’s national office; and issuing an unqualified audit report without obtaining sufficient appropriate audit evidence. Interestingly, in the course of the audit, BDO asked numerous important questions and even issued a five-page letter to the company highlighting the conflicting information it received about a material financial statement account. In that letter, BDO also demanded an independent investigation of the matter by the audit committee.
Unfortunately, just days later, despite receiving no reasonable explanations from the company and without the requested investigation being performed, the engagement partner, the concurring reviewer, the regional technical director, the national director of accounting and risk management, and the national SEC practice director decided to withdraw the firm’s demands and the firm subsequently issued an unqualified opinion on the company’s financial statements. This case highlights the importance of professional skepticism and due professional care in auditors’ work and could indeed be used as a case study and reminder for public accountants at all stages in their professional careers. In addition to taking action against the auditors, the Commission also filed charges against the client company’s then-chairman of the board and other executives. From this perspective, the case is also a good example of the scope of the Commission’s enforcement efforts in the area of financial reporting and disclosure.
In the Grant Thornton case, the firm lacked the culture and the quality control processes to identify and appropriately remediate the deficient performance of an audit partner on numerous audit engagements as well as the lack of professional skepticism and performance of basic audit procedures when contradictory evidence existed. The case clearly highlights the responsibility the firm has to set the tone and culture of meeting their professional obligations to investors as well as the responsibility to have robust quality control systems in place to monitor and remediate poor performance of professionals.
Disclosure Effectiveness — Use of Accounting Judgments
Meeting the objective of high-quality financial statement disclosures requires the application of professional judgment. The core purpose of disclosure is to provide investors with the information they need to make informed investment and voting decisions. Judgments around financial statement disclosures should first and foremost be grounded in the objectives and principles of the relevant guidance, considering the utility of that information to users of the financial statements. In some instances, this application of judgment may suggest that the specific requirements, when applied to the entity’s facts and circumstances, would result in immaterial disclosures and therefore exclusion of the information would be appropriate. In other cases, it may suggest that disclosures beyond the specific requirements may be necessary to keep the disclosures from being misleading. Well-reasoned, practical judgments on financial statement disclosures are critical to providing high-quality and decision-useful information to investors.
The application of judgment to financial statement disclosures also requires appropriate processes and internal controls. Developing appropriate processes to enhance disclosures, including the judgments for deciding whether a disclosure may be immaterial, naturally requires coordination with management and the audit committee. Also critical to this process is to appropriately consider the perspective of a “reasonable investor.” Doing so may require input from others within the organization, including investor relations, and potentially outreach to users and analysts. As one final reminder, effective disclosures are not static. Rather, what is important to investors may change over time. As facts and circumstances change, you may need to re-evaluate whether existing disclosures continue to be relevant and applicable to your current situation.
While management, audit committees, and auditors apply the existing disclosure rules and requirements to their specific facts and circumstances, the SEC staff continues to work on a number of disclosure effectiveness initiatives to update and enhance those requirements. Later in the conference, you will hear more from our colleagues in the Division of Corporation Finance on efforts to update the existing requirements in Regulations S-K and S-X. OCA intends to coordinate with the FASB on ways to improve the effectiveness of financial statement disclosures and to minimize duplication with other existing disclosure requirements. OCA and the Division of Corporation Finance are actively working on potential recommendations for the Commission’s consideration for potential changes. In addition, the FASB recently issued a proposal aimed at potentially improving the effectiveness of financial statement disclosures. That proposal would, among other things, clarify that omitting a disclosure of immaterial information would not be an accounting error. I support recent efforts by the FASB to explore a disclosure framework that facilitates clear communication of the information material to users of a company’s financial statements and moving from a checklist model to a principles-based model. If designed and implemented appropriately, the quality of information provided to investors should improve. I look forward to constituent feedback on both the Commission and FASB requests for comment.
Audit Committee Oversight
At the beginning of my remarks, I mentioned the growing audit committee agendas and said that some audit committees may need to get back to basics in their oversight work. According to the SEC and exchange listing requirements, those “basics” include in particular:
- Appointment, compensation, and oversight of the independent auditor, including the required auditor communications;
- Preparation and disclosure of the audit committee charter; and
- Reporting by the audit committee to shareholders.
Responsibilities related to the oversight of the independent auditor have been vested in audit committees by SOX. That law is premised on the principle that audit committee members represent the interests of shareholders and, therefore, they are in the best position to select an auditor that will protect the interests of investors. In order to live up to this important tenet of our investor protection system, audit committee members should not act as management advocates. Rather, they should set the right tone for both the senior management and the independent auditor whom they oversee. As Chair White said last year, audit committees have an extraordinarily important role in creating a culture of compliance through their oversight of financial reporting. In that role, they should be asking probing questions about, for example, judgments made by management related to critical accounting estimates or important financial statement disclosures. They should require follow-up on their questions and corrective actions, where necessary. Similarly, when it comes to the independent audit, the company’s bottom-line or management’s preference should not drive the audit committee’s decision to hire or retain an auditor. Audit firms should compete for work on the basis of audit quality, keeping in mind that their responsibility is also to the shareholders rather than management of the company.
Regarding audit quality, I commend the PCAOB for its efforts related to audit quality indicators (AQIs), including publication earlier this year of a concept release on AQIs. As you all know, audit quality is hard to define and even harder to measure or predict. From that perspective, the PCAOB’s project on AQIs is particularly important. And while the work to develop a set of objective, reliable, and comparable audit quality indicators may never truly be complete given the need for the measures to evolve with the audit itself, I encourage all audit committee members to look at the PCAOB release for insights regarding factors they may find useful to consider when evaluating audit quality. I also encourage all of you to follow this project and provide your perspectives and insights to the PCAOB.
The other aspect of audit committees’ “basic” responsibilities that I wanted to touch upon today is the requirement for the audit committee to report to investors on its work and conclusions. A year ago, I spoke at this conference about the work that the SEC staff was undertaking to consider whether improvements could be made to the existing audit committee reporting requirements. The key questions that we set out to consider were: (a) whether investors are interested in hearing from audit committees on how (not just if) they have fulfilled their responsibilities; and (b) whether the Commission’s rules support such reporting. As a result of this work, on July 1st of this year, the Commission published a concept release to seek feedback on possible revisions to audit committee disclosures. Brian will touch on the feedback received which the SEC staff is carefully considering in advance of making any further recommendations to the Commission.
Last, but certainly not least, I would like to turn our attention to the PCAOB. Last year at this conference, I discussed the PCAOB’s standard setting projects. These are longstanding important projects, and the SEC, the staff from my office, and the PCAOB have engaged in a constructive dialogue about the status and content of the PCAOB’s standard setting. Overall, I am pleased with the PCAOB’s initial efforts with respect to enhancing its standard setting. Those efforts have included the Board retaining the services of an external consultant to take a fresh look at its overall standard setting process. I believe these efforts are reflective of the strong and cooperative relationship that we have had with the PCAOB over the years and the shared goals of both institutions that Chair White spoke of earlier today. And most importantly, such enhancements in this important area have strong potential to influence the quality of audits for the benefit of investors.
There is also positive news to report on the progress of the PCAOB’s transparency project. After years of much hard work and extensive deliberations, the Board is nearing completion of its transparency project with a vote and final rule expected next week. That project, which has been on the Board’s agenda since 2009 and attracted significant public attention, would result in disclosure of information about audit participants that investors have sought. I commend the PCAOB for their efforts in this area.
I also look forward to the PCAOB’s near term progress on some of its other standard setting initiatives. This includes the PCAOB’s project on possible revisions to the current auditor reporting model. OCA and other divisions and offices of the Commission remain committed to working closely with the PCAOB as it considers ways to enhance the informative value of the auditor’s report while preserving the level of assurance that the auditor’s opinion is expected to be based upon.
In addition to these auditor transparency and reporting initiatives, the Board has on its agenda a number of other important standard setting projects that directly address auditor performance. I continue to believe that updating auditor performance standards, using knowledge from PCAOB’s inspections and other available information, is the most effective way to improve audit quality. The PCAOB continues to play a critically important role in this regard, and this area deserves the priority it is being given. As recently emphasized by the Commission’s Chief Economist, Mark Flannery, although the performance standards of the PCAOB do not directly affect the content of an audit report, an efficient and rigorous audit process should enhance the confidence an investor can have in reported financial information. And even if no additional information is revealed by the audit report itself, procedures mandated by the PCAOB can affect how investors perceive the level of assurance obtained by auditors. While these effects on the market are indirect, they are quite important.
In summary, I look forward to the results of the PCAOB’s efforts to enhance its standard setting in releases that are expected to be published for comment in the next year. I encourage the Board to continue its focus on the standard setting process and projects. I remain committed to working together with the PCAOB as it seeks to produce further high-quality auditing standards that will improve auditors’ performance and ultimately increase investor protection — a core mission that both the PCAOB and the Commission share.
In summary, from my perspective, the participants in the various roles of the profession, as well as the profession as a whole, have improved their performance in meeting their responsibilities to investors. However, there is considerable variation in the performance of the participants as well as within the participant groups and, therefore, the need for all involved in the profession to continue to improve their performance.
I appreciate the opportunity to share my remarks with you today at this important conference. Thank you for your attention.
 Statement of Financial Accounting Concepts No. 8, Chapter 3 Qualitative Characteristics of Useful Financial Information (September 2010), available at http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176157498129&acceptedDisclaimer=true.
 International Financial Reporting Standards.
 Release Nos. 33-8810, 34-55929, Commission Guidance Regarding Management’s Report on Internal Control Over Financial Reporting Under Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (June 27, 2007) available at: http://www.sec.gov/rules/interp/2007/33-8810.pdf.
 The Center for Audit Quality Guide to Internal Control Over Financial Reporting available at: http://www.thecaq.org/docs/reports-and-publications/caq_icfr_042513.pdf?sfvrsn=2.
 See The CAQ’s Ninth Annual Main Street Investor Survey, Investor of the Future (September 2015) available at: http://www.thecaq.org/docs/default-source/reports-and-publications/caq2015mainstreetinvestorsurvey.pdf?sfvrsn=2.
 Public Company Accounting Oversight Board.
 See James Schnurr, Remarks Before the UCI Audit Committee Summit (October 23, 2015), available at: http://www.sec.gov/news/speech/schnurr-speech-uci-audit-committee-summit.html.
 See Release Nos. 33-8810, 34-55929, Commission Guidance Regarding Management’s Report on Internal Control Over Financial Reporting Under Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (June 27, 2007), note 3, supra and PCAOB Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting.
 Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees, published by the New York Stock Exchange and National Association of Securities Dealers (1999) available at: http://www.chugachelectric.com/pdfs/agenda/fcagenda_051403_ixd.pdf.
 See James Schnurr, Remarks before the 2014 AICPA National Conference on Current SEC and PCAOB Developments (Dec. 8, 2014), available at: http://www.sec.gov/News/Speech/Detail/Speech/1370543609306.
 Financial Accounting Standards Board.
 International Accounting Standards Board.
 Financial Accounting Foundation.
 See Wesley R. Bricker, Remarks at the Bloomberg BNA Conference on Revenue Recognition (September 17, 2015) available at: http://www.sec.gov/news/speech/wesley-bricker-remarks-bloomberg-bna-conf-revenue-recognition.html.
 See SEC Press Release No. 2015-184, SEC Charges BDO and Five Partners in Connection with False and Misleading Audit Opinions (Sept. 9, 2015), available at: www.sec.gov/news/pressrelease/2015-184.html.
 See SEC Press Release No. 2015-272, SEC: Grant Thornton Ignored Red Flags in Audits (Dec. 2, 2015), available at: http://www.sec.gov/news/pressrelease/2015-272.html.
 See remarks by Chair Mary Jo White to the National Association of Corporate Directors, The Path Forward on Disclosure (Oct. 15, 2013), available at: http://www.sec.gov/News/Speech/Detail/Speech/1370539878806.
 See SEC Press Release No. 2013-269, SEC Issues Staff Report on Public Company Disclosure (Dec. 20, 2013), available at: http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540530982.
 Proposed Accounting Standards Update Assessing Whether Disclosures Are Material and Proposed Accounting Standards Update Chapter 3: Qualitative Characteristics of Useful Financial Information. See http://www.fasb.org/cs/ContentServer?c=FASBContent_C&pagename=FASB%2FFASBContent_C%2FNewsPage&cid=1176166401832.
 See Section 10A(m)(2) of the Securities Exchange Act of 1934.
 See Item 407(d) of Regulation S-K.
 See Mary Jo White, Remarks Before the Stanford University Rock Center for Corporate Governance — Twentieth Annual Stanford Directors’ College (June 23, 2014), available at: https://www.sec.gov/News/Speech/Detail/Speech/1370542148863.
 PCAOB Release No. 2015-005, Concept Release on Audit Quality Indicators (July 1, 2015), available at: http://pcaobus.org/Rules/Rulemaking/Docket%20041/Release_2015_005.pdf.
 See Mark Flannery, Keynote Address at the Public Company Accounting Oversight Board’s Center for Economic Analysis 2015 Conference on Auditing and Capital Markets (Oct. 22, 2015), available at: https://www.sec.gov/news/speech/keynote-address-pcaob-missions-of-sec-and-pcaob.html.