Speech by SEC Staff:
Remarks before the 2010 AICPA National Conference on Current SEC and PCAOB Developments
John F. Offenbacher
Senior Associate Chief Accountant, Office of the Chief Accountant
U.S. Securities and Exchange Commission
December 6, 2010
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 those of the Commission or of the author's colleagues upon the Staff of the Commission.
Good morning. I thought that I would spend my time addressing two matters that have recently required the attention of OCA’s Professional Practice Group.
Interim Commission Review
The first point that I would like to cover is one of the newer processes relative to the Commission’s role in overseeing the PCAOB. The Commission recently adopted Rule 140, Interim Commission Review of PCAOB Inspection Reports to implement Section 104(h) of SOX.1 This rule was effective September 7, 2010 and since that time, we have had some experience in applying the rule that may prove helpful to auditors that may one day request interim review.
It’s my hope that registered firms and the PCAOB will continue to resolve most matters regarding inspection findings without the need to involve the SEC. However, I believe that, in the limited situations where a firm’s concerns regarding PCAOB findings or determinations cannot be resolved between the registered firm and the PCAOB, this rule provides appropriate due process for seeking review by the SEC as allowed by SOX.
To put the Commission’s process in perspective, let me start by giving a bit of background on the PCAOB’s inspection report process as required by SOX. Section 104 of the Act requires the PCAOB to conduct a continuing program of inspections of registered public accounting firms. The same section directs the PCAOB to publish a written report of its findings for each inspection. Registered public accounting firms have an opportunity to review and respond to their draft inspection reports. According to SOX and PCAOB rules, the portion of the inspection report that relates to findings on specific audit engagements (which is commonly referred to as Part I of the report) is made public, along with the related response by the registered firm, upon Board approval of issuance. However, no portions of the inspection report that deal with the registered firm’s quality controls (commonly referred to as Part II of the report) are made public if the firm addresses the Board’s criticisms to the satisfaction of the Board not later than 12 months after the date of the inspection report.
So what does this mean for the Commission’s process? Well, Section 104(h) of the Act provides firms with the ability to seek what is called “interim review” of the PCAOB’s findings by the Commission. To facilitate the review required by the Act, the Commission recently adopted Rule 140. Rule 140 resides within Regulation P which contains rules related to the Commission’s oversight of the PCAOB. The Commission delegated authority to the Chief Accountant to perform the functions described in the rule.
Rule 140 provides that a firm can request interim review by the Commission within 30 days of either the receipt of its final inspection report or within 30 days of receiving notice of an unfavorable determination by the PCAOB regarding remediation of quality control deficiencies. The firm can request interim review with respect to any of the findings in the final inspection report, whether the finding is in Part I or Part II of the report, as long as the firm requests that review within 30 days of receiving the final inspection report. If the firm fails to request review of a specific finding at that time, it does not have another opportunity to request review of that finding in that particular inspection report. For example, when a firm requests review of an unfavorable determination by the PCAOB regarding the firm’s remediation of quality control findings, it cannot use that request as an opportunity to request review of any specific findings that it did not previously request the Commission to review. The only thing that can be reviewed at that time is the PCAOB’s unfavorable determination related to the firm’s remediation of Part 2 findings. In other words, the merits of the original quality control criticism or defect cannot be the subject of an interim review request at the time of the request for interim review on the unfavorable remediation determination.
Rule 140 provides specific direction regarding information that should be submitted to the Commission. Given our recent experience in performing interim reviews, I would advise any firm that is considering requesting interim review to spend time with those requirements and to satisfy themselves that they have complied with all aspects of the Rule prior to submitting the request. Under Rule 140, the Commission makes an initial determination as to whether the request should be granted or denied. Incomplete requests can hinder the ability to determine whether the review request should be granted. I would also draw auditors’ attention to a statement made by the Commission in its adopting release indicating that the Commission does not intend to routinely grant review requests absent some indication of concern. This statement, coupled with our recent experience in applying the rule, reinforces the importance of thorough documentation and complete compliance with the rule.
With regard to requests for interim review of unfavorable determinations regarding remediation of Part 2 findings, I would personally advise firms to make sure that they consider the points raised by the PCAOB in the report that the firm receives at the time that they are notified of the unfavorable determination relating to QC findings. This report is sometimes referred to as a “4009 report” which is a reference to the PCAOB’s rule 4009 that provides the requirements for addressing firm responses to quality control defects. The 4009 report provides details regarding the Board’s determination that may be helpful in understanding the Board’s reasoning. Our recent experience has shown that sometimes firms simply repeat their original submission to the PCAOB in their request for interim review without addressing the points raised by the PCAOB in its 4009 report to the firm. Such an approach can complicate the analysis as to whether review should be granted because it does not provide a thorough basis to understand why the firm disagrees with the PCAOB.
The final point that I will make regarding Rule 140 is that the standard of review is an “arbitrary and capricious” standard. There is a body of case law that helps to define what an “arbitrary and capricious” standard of review is and, I think fortunate for all of us, I don’t have time to get into that today. The point that I will make is that the “arbitrary and capricious” standard of review is, generally a more limited standard, in contrast to what my attorney friends call a “de novo” review that would result in the Commission reconsidering the matter anew. The Commission, in its adopting release for Rule 140, states that “an arbitrary and capricious standard of review creates an incentive for the firm to fully address and pursue areas of concern in the inspection report with the PCAOB, under its rules, prior to requesting review by the Commission.”2 The staff fully expects the firm to address all matters through the PCAOB’s process prior to requesting interim review. The firm should consider fully explaining the process that it undertook with the PCAOB as part of its request for interim review. I would also point out that nothing about the Commission’s interim review process changes the auditor’s responsibility to consider and address all of the PCAOB’s findings in accordance with PCAOB standards.3 For example, a firm should not use the interim review process as a means to simply delay consideration of the impact of additional facts or potentially omitted procedures in accordance with AU 390/561.
It is my hope that one outcome of this rule is that it helps to promote important understandings between registered firms and the PCAOB about issues that are contained in inspection reports, whether that occurs without the need to seek interim review or as a result of that process.
Broker-Dealer Auditor Compliance
Another topic that the Professional Practice Group has spent a considerable amount of time discussing relates to the intersection of the Dodd-Frank Act4 and the PCAOB. One of the provisions of the Dodd-Frank Act that will have an effect on the accounting profession is Section 982 granting the PCAOB explicit oversight authority over the auditors of brokers and dealers. SOX required auditors of broker-dealers to register with the PCAOB, but was not as explicit regarding the authority of the PCAOB to write audit standards for, inspect the audits performed by, and enforce violations of its rules by auditors of broker-dealers. The Dodd-Frank Act clarified the PCAOB’s authority over broker-dealer auditors in these areas.
Both the SEC and the PCAOB will be taking steps to implement the PCAOB’s authority over broker-dealer auditors. To avoid any possible confusion regarding the standards that apply to such audits while both the SEC and PCAOB are considering the next steps, the Commission recently provided transitional guidance with respect to its existing rules regarding non-issuer broker-dealers.5 Specifically, references in Commission rules and staff guidance and in the federal securities laws related to GAAS or to specific standards under GAAS, as they relate to non-issuer broker-dealers, should continue to be understood to mean auditing standards generally accepted in the United States, plus any applicable rules of the Commission, that is, AICPA and not PCAOB standards.
In addition, a rulemaking project is being considered to update the audit and related attestation requirements for broker-dealers under the federal securities laws. The Commission noted in its transitional guidance that it intends to revisit the guidance that I just mentioned as part of its rulemaking project. If the proposed rulemaking progresses to the point where the Commission issues a proposal, I would encourage you to review the proposal and provide constructive feedback on how the Commission might be able to further customer protections in the broker-dealer space.
The PCAOB also must promulgate certain new rules and make changes to certain of its existing rules in response to the Dodd-Frank Act. The rules that the PCAOB adopts related to broker-dealer auditors, like all other rules of the PCAOB, are not effective until they are approved by the Commission. I believe that the PCAOB staff will discuss some of their proposed rulemaking projects later in the conference.
While all of this rulemaking is being considered, I want to take this opportunity to remind auditors of their responsibility to comply with existing securities laws and professional standards relating to broker-dealer audits. Pursuant to Rule 17a-5 and Exchange Act Section 17(e), broker-dealers must file a registered independent public accountant’s report covering the annual financial statements and supporting schedules. Today, the accountant’s audit must be conducted in accordance with GAAS. Again, per the Commission’s transitional guidance that is AICPA standards. In addition to the financial statement audit, the broker-dealer’s auditor also must perform a review of the accounting system, the internal accounting control, and procedures for safeguarding securities. Rule 17a-5 states that the “scope of the audit and review…shall be sufficient to provide reasonable assurance that any material inadequacies existing at the date of the examination…would be disclosed.”
Both the annual financial statement audit and the examination procedures performed by the auditor are critical compliance elements of the Commission’s regulatory oversight of broker-dealers. Auditors currently planning or performing audits of broker-dealers should ensure that they do so in a manner that is in conformity with the requirements of the applicable rules and professional standards, including the requirement to obtain reasonable assurance to support their reporting. The Chief Accountant and the Director of the Division of Trading and Markets recently issued a joint letter to the AICPA’s Stockbrokerage and Investment Banking Expert Panel regarding these matters. I encourage all interested parties to read that letter which is available on the SEC’s website. You can find it from OCA’s page under the Staff Letters to Industry link.6
Both of these are just examples of a couple of the significant projects in the Professional Practice Group that are directly related to our coordination of the Commission’s oversight of the PCAOB. Hopefully I was able to provide a little insight into what we do along with some information that may be helpful. Thank you for your time and enjoy the rest of the conference.
1 Sarbanes-Oxley Act of 2002
2 See Release No. 34-62575 (July 26, 2010)
3 See AU 390, Consideration of Omitted Procedures After the Report Date and AU 561, Subsequent Discovery of Facts Existing at the Date of Auditor’s Report
4 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (July 21, 2010)
5 See Release No. 34-62991 (September 24, 2010)
6 See http://sec.gov/info/accountants/staffletters/aicpa111810.pdf