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Remarks at 2016 Conference on Auditing and Capital Markets

Commissioner Michael S. Piwowar

U.S. Securities and Exchange Commission [1]

Washington, DC

Oct. 21, 2016

Good morning and thank you, Chairman Doty, for that kind introduction. Chairman Doty, Board Members Harris, Ferguson, Hanson, and Franzel, members of the Board staff, and distinguished guests, it is a privilege and a pleasure to be here at the Public Company Accounting Oversight Board (“PCAOB” or “Board”) 2016 Conference on Auditing and Capital Markets.

This conference draws an excellent mix of academics, practitioners, and regulators. I am particularly pleased to see so many high-quality economic research papers that provide valuable insights into topics that are relevant to the PCAOB’s standard-setting and oversight roles, such as the auditor’s report, auditor turnover, internal controls, and audit quality. I am also glad to see the international make-up of the authors and discussants of research on these topics, which reflects the fact that high quality audit standards are a global concern.

Next year will be the fifteenth anniversary since the creation of the Board. It is hard to believe that so much time has passed already.

I look back at 2002 as a watershed year. For me, it was the year that I joined the Securities and Exchange Commission for my first tour of duty as a visiting academic scholar on leave from Iowa State University. It was a big move from the small town-and-gown community of Ames, Iowa to the sprawling Washington, D.C. metroplex.

For the PCAOB, 2002 was the year of its founding. Financial reporting scandals and corporate malfeasance at Enron, WorldCom, Global Crossing, and Adelphia had rocked the markets. In March 2002, President George W. Bush laid out a 10-point plan to improve corporate responsibility and protect America’s investors.[2] Among the points included in the President’s plan were (1) investors should have complete confidence in the independence and integrity of companies’ auditors, and (2) an independent regulatory board should ensure that the accounting profession is held to the highest ethical standards.[3]

Congress responded, on an overwhelmingly bipartisan basis, with the Sarbanes-Oxley Act.[4] Sarbanes-Oxley was approved by the Senate unanimously, 99-0. In the House, the final bill was approved with only three members casting votes in opposition. President Bush signed the bill into law on July 30, 2002.

Title I of the Sarbanes-Oxley Act established the PCAOB to oversee public company audits in order to “protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports.”[5] This new organization would be “comprised of persons skilled and knowledgeable in issues” related to public company audits.[6]

To fulfill its mission, the Board was authorized by Congress to adopt auditing, quality control, and independence standards and rules.[7] Specifically, the Board was empowered to establish rules to the extent it determines may be necessary or appropriate in the public interest or for the protection of investors.[8] The scope of its authority is very broad. No less than the Supreme Court described it as follows:

[T]he Board is a Government-created, Government-appointed entity, with expansive powers to govern an entire industry. Every accounting firm – both foreign and domestic – that participates in auditing public companies must . . . comply with its rules and oversight. . . . To this end, the Board may regulate every detail of an accounting firm’s practice, including hiring and professional development, promotion, supervision of audit work, the acceptance of new business and the continuation of old, internal inspection procedures, professional ethics rules, and “such other requirements as the Board may prescribe.”[9]

Given this broad mandate, I was pleased that the Board established the Center for Economic Analysis two years ago to study and provide advice on the role audits play in capital formation and investor protection, as well as to consider how economic theory and analysis can further enhance the effectiveness of Board programs.[10]

For any regulatory body, high-quality economic analysis serves as the cornerstone for not only individual rulemakings, but for setting the rulemaking agenda as well. Economic analysis allows regulatory bodies to make decisions on a rational basis, not an emotional or speculative one. For that to happen, economists must be involved at the outset of any project, and not merely brought in at the end of a rulemaking in an attempt to provide post hoc justifications for decisions already made. The PCAOB recognized the important role of economic analysis when it stated that “economic analysis helps ensure that regulatory decisions, including whether to adopt new requirements and impose corresponding burdens, are informed by a rigorous review and analysis of the best information available.”[11]

High-quality economic analysis is not only necessary for the Board to satisfy its statutory obligations to find that a proposed rule serves the public interest and protects investors, but also a prerequisite for the Commission to satisfy its own oversight obligations. As previously discussed, the Sarbanes-Oxley Act authorizes the Board to adopt rules that govern professional practice standards for auditors that serve the public interest and protect investors. The Commission then has oversight responsibilities regarding rules of the Board. Without the presence of thorough economic analysis it would be impossible for the Commission to fully understand, review, and supervise the regulatory actions of the Board.

Given the importance of economic analysis to its work, I commend the Board for adopting formal guidance on the subject. Like the SEC’s own internal guidance on conducting economic analysis,[12] the PCAOB’s guidance on rulemaking recognizes four main elements: (1) the need for the rule, (2) the baseline for measuring the rule impacts, (3) the alternatives considered, and (4) the economic impacts of the rule and alternatives. With respect to the last point, there are consequences when rules are adopted – some intended, others not. It is the latter set of consequences, the unintended consequences, for which a robust economic analysis can particularly helpful.

The PCAOB guidance notes the role played by economists in developing a clear understanding of the need for regulatory action. One key part of this role is evaluating any research or data available on the particular issue. Indeed, due to Commission efforts to make data about public companies more widely available and in formats more useful to analysis, such as through our XBRL and interactive data efforts, investors, academics, and regulators have access to more data than ever before.

Economists also play an integral role in the threshold question frequently posed to regulators: is a new rule even needed? Economic analysis can help identify whether there are more effective or efficient ways of addressing the underlying issue outside of rulemaking, such as through better communications, targeted inspections, or an enforcement action. Early involvement by economists not only helps identify alternative approaches to addressing a given issue, but also the costs and benefits of each alternative at the outset, prior to the staff locking in on a particular solution. There are always trade-offs when choosing a course of regulatory action, including the costs of waiting to address an issue as well as the opportunity costs of deciding to initiate a full rulemaking proceeding. These trade-offs cannot be fully evaluated without the assistance of rigorous economic analysis.

Now that I have made the case for why high-quality economic analysis is an essential part of regulatory processes, I will discuss some of the common myths and misconceptions about the process.

Myth 1: “Economic analysis” and “cost-benefit analysis” are the same thing

The first myth is that economic analysis and cost-benefit analysis are the same thing. They are not, even though many mistakenly use the terms interchangeably. Cost-benefit analysis is one component of a regulatory impact analysis. Economic analysis, on the other hand, is much broader. In 2007, former SEC chief economist Chester Spatt gave a speech explaining how economic analysis and cost-benefit analysis are complements, not substitutes.[13] Dr. Spatt noted that within the regulatory community, economics had been boiled down to a simple cost-benefit analysis consisting of numerical counting exercises for estimates that were quantifiable. As a staff economist at the SEC during this period, I can readily attest to this practice when it came to Commission rulemaking.

Dr. Spatt argued instead that regulators should “use economic principles to ascertain the qualitative as well as quantitative impacts upon behavior, even when those effects do not lend themselves to easy quantification.”[14] In this fashion, economic analysis complements cost-benefit analysis, because it provides a more complete view of the trade-offs and consequences of alternative approaches, thereby providing the tools for “thinking through” the cost-benefit analysis.

Fast-forward nearly ten years and look how far we have come. Both the SEC and PCAOB guidance call for a thorough economic analysis and specifically reject solely relying on a limited cost-benefit analysis that is constrained to what is quantifiable. Today, particularly when I have seen the economic analysis or, in some cases, the lack of analysis, from other financial regulators, the Commission is second to none when it comes to considering the economic effects of a proposed course of action. I am pleased that the Board has decided to follow a similar course.

Myth 2: Economic analysis in rulemaking just slows down the rulemaking process

The second myth is that rigorous economic analysis is simply a device used by opponents of regulation to slow down the rulemaking process. Before directly addressing this myth, think about what those critics really want. Do they really want regulatory agencies to make ill-advised regulatory policy based on ill-informed decisions and without consideration of the consequences?

Far from slowing down the rulemaking process, effective economic analysis actually speeds up the rulemaking process. Many of you are familiar with the typical path of a rulemaking: a proposal is published, the public is given an opportunity to comment, the regulator considers those comments, and a final rule is adopted. Is that the end of the process? No, it is actually only the beginning.

Both the regulator and those affected by the regulation will need to start complying with the rule. The compliance process means understanding what the rule means and how it applies in real life, not the hypothetical situations that may have been considered during the notice and comment period. Rigorous economic analysis makes it less likely the regulator and market participants will need to deal with unintended consequences, which could delay implementation, because the regulator will have previously spent time thinking about possible unintended consequences and designing the rule to minimize such effects.

More importantly, rigorous economic analysis makes a rule less likely to be challenged, and potentially overturned, by the courts. The Commission has unfortunately learned this lesson the hard way. In matters ranging from governance by mutual fund directors[15] to equity indexed annuities[16] to proxy access[17] to resource extraction,[18] time and time again when the Commission attempted to take a “short cut” and not engage in a rigorous economic analysis, our rules were overturned by the courts. Given the vast amount of additional time and resources that it takes to litigate a matter through the courts, lose the case, and then repropose a new rule that complies with the court decision, it makes a lot more sense to get it done properly – the first time.

But, finally and perhaps most satisfying, is the fact that some of the most vocal opponents of economic analysis – those outside groups that thought economic analysis was an impediment to regulatory efforts – have invoked economic analysis arguments to justify their positions in comment letters and court filings related to rulemakings.[19] If imitation is the best source of flattery, then we economists are positively gushing.

Myth 3: Economic analysis is a partisan political issue

The third myth is that economic analysis is a partisan political issue. In fact, presidents from both political parties have consistently tried to improve regulatory rulemaking efforts by the federal government through the use of economic analysis.

Executive Order 12866, signed by President Clinton, directs federal regulatory agencies in the Executive Branch to follow certain principles, including adopting a regulation only upon a reasoned determination that the benefits of the intended regulation justify its costs.[20] OMB Circular A-4, approved by President Bush, provides guidance to agencies on the regulatory analysis required in Executive Order 12866.[21]

Executive Order 13563, signed by President Obama, affirms the principles in President Clinton’s Executive Order and supplements it with additional principles, such as retrospective analysis of existing rules.[22] Executive Order 13579, also signed by President Obama, directs independent federal regulatory agencies, like the Commission, to comply with the provisions in the previous executive orders.[23]

Solid economic analysis is therefore something that both political parties can agree upon. The PCAOB guidance provides a good description of the ideal economic analysis – it should be “framed neutrally, be internally consistent, and evaluate costs and benefits even-handedly and candidly, without unsupported, self-serving statements or opportunistic or selective use of evidence or studies.”

Myth 4: Economic analysis is only relevant to rulemaking

The fourth myth is that economic analysis is only relevant to rulemaking. At the Commission, our economists play an essential part in nearly every activity that we do in support of our core mission. For instance, they provide support to exams conducted by our Office of Compliance Inspections and Examination and to investigations conducted by our Division of Enforcement.

Our litigation support team rivals the best economic consulting firms hired by leading law firms, and our economists often testify at trial as expert witnesses. In the enforcement context, early participation by our economists can help determine materiality, harm to investors (if any), ill-gotten gains (if any), whether the benefits of pursuing a particular enforcement action outweigh the costs, and whether it would be prudent to pursue alternatives to enforcement.

The Ph.D. economists who come to work for the Commission also conduct high-quality, independent, and cutting-edge research. The Commission has a longstanding tradition of bringing in top academic researchers as visiting economists to provide their expertise on a number of issues relevant to the Commission. SEC staff economists are not only engaging with top academic researchers, they are conducting path-breaking research themselves. Our staff’s research has been published in a wide range of academic journals, conference volumes, and scholarly books.[24]

Myth 5: Economic analysis is only a fad

The final myth that I will address is that economic analysis is only a fad that will disappear. This is simply not the case either at the Commission, or at other regulators. One of the reasons for why that will not happen is the intense scrutiny placed on the Commission and its processes, and the flow-through effect that attention has on the broader administrative state. In recent years, we have seen increasing Congressional interest in the Commission’s rulemaking, overall agenda, and internal activities. Congress has also shown strong support for the efforts of the Commission to both improve, and extend the application of, its economic analysis. For example, the fiscal 2014 omnibus appropriations bill included a provision to expand our Division of Economic and Risk Analysis and to increase the number of economists. As Congress continues to push the Commission to expand our number of economists and their role in our internal processes, quality economic analysis will become more and more ingrained in the overall regulatory system.

There is also continued judicial scrutiny of the Commission’s actions. As I mentioned earlier, the Commission has been repeatedly admonished by the D.C. Circuit when it has short-changed the economic analysis. As a result of the expansion of authority in the Dodd-Frank Act, there is more public focus on the effects of regulation, not only on regulated entities, but on the overall economy. Given the stakes, I do not expect the judicial challenges from persons affected by financial regulation to abate.

The good news is that, within the Commission, the non-economist staff members are some of the biggest fans of the economists. The staff understands that inherent in the SEC’s three-part core mission – protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation – there are tradeoffs. Economics provides the best set of tools to evaluate those tradeoffs. And thus economic analysis has become part of the SEC’s DNA. It may take a little time, but I have no doubt that economic analysis will become part of the PCAOB’s DNA, too.

*  *  *

In closing, I commend the Board for including, as part of its strategic plan, the use of economic analysis tools in conducting post-implementation review of new standards. Post-implementation review is an important component of high-quality economic analysis of regulatory decision-making. The Center for Economic Analysis is well suited to conduct these reviews for the PCAOB.

I hope the Board is more effective at post-implementation review than the Commission. In fact, I hope the Board is so successful in its post-implementation review efforts that the Commission can learn from them. While the Commission has made great progress in incorporating economic analysis into our regulatory, compliance, and enforcement processes – and as you can tell, I am quite proud of that progress – there is still room for improvement in the way we apply this type of analysis after our actions have taken effect.

In February 2015, I spoke to a group of securities lawyers and told them that a retrospective analysis of our rules would help us identify which if any of our current rules should be modified, streamlined, expanded, or repealed for the purpose of making our regulatory regime more effective and less burdensome.[25] I pointed out that even though President Obama had signed an Executive Order requiring such a retrospective analysis more than three years ago, the Commission had not yet undertaken a serious effort to conduct this type of analysis of our existing rules.[26] Now another eighteen months have passed and I have yet to see any progress.

I will continue to champion this issue in any way that I can. Recently, one such avenue arose through the Regulatory Flexibility Act, which requires the Commission to perform a periodic review of rules that have or will have a significant economic impact upon a substantial number of small entities within ten years of the publication of such rules as final rules “to determine whether such rules should be continued without change, or should be amended or rescinded.”[27] To fulfill that obligation, the Commission publishes a list of rules scheduled for review during the upcoming year. Unfortunately, the Commission typically receives little or no public comment on these reviews.

Last month, in connection with the release of the most recent list, I issued a public statement calling attention to this oft-forgotten method of review.[28] This year’s rule list includes Regulation NMS, which imposed, among other provisions, the order protection rule and the market access rule.[29] There have been substantial changes in technology, economic conditions, and other factors since Regulation NMS was adopted in 2005. Given these changes in equity market structure and significant attention to this issue in the popular press, including changes that may have resulted as a consequence of the imposition of Regulation NMS, I cannot think of a more worthy rule to retrospectively review. As we seek to undertake a review of Regulation NMS, and other rules under various mandates, I hope to engage in a healthy dialogue with the PCAOB to discuss our experiences.

Thank you for letting me share some thoughts on why high-quality, independent economic analysis is an essential part of all regulatory processes, dispel some myths about economic analysis, and explain why the PCAOB’s post-implementation review efforts could potentially serve as a model to the Commission and other regulators. I hope this conference has been insightful and thought-provoking.


[1] The views expressed today are my own and do not necessarily reflect the views of the Securities and Exchange Commission or my fellow commissioners.

[2] George W. Bush, Remarks by the President at Malcolm Baldrige National Quality Award Ceremony (Mar. 7, 2002), available at

[4] Pub. L. No. 107-204, 116 Stat. 745 (2002).

[5] Section 101 of the Sarbanes-Oxley Act.

[6] H. Rep. No. 107-414, at 16-17 (2002).

[7] Section 103 of Sarbanes-Oxley Act.

[8] Id.

[9] Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477, 485 (2010).

[11] Public Company Accounting Oversight Board, Staff Guidance on Economic Analysis in PCAOB Standard Setting (Feb. 14, 2014), available at

[12] Staff of the U.S. Securities and Exchange Commission, Current Guidance on Economic Analysis in SEC Rulemakings (Mar. 16, 2012) available at

[13] Chester S. Spatt, Economic Analysis and Cost-Benefit Analysis: Substitutes or Complements? (Mar. 15, 2007), available at

[14] Id.

[15] Chamber of Commerce v. Securities and Exchange Commission, 412 F.3d 133 (D.C. Cir. 2005); Chamber of Commerce v. Securities and Exchange Commission, 443 F.3d 890 (D.C. Cir. 2006).

[16] American Equity Investment Life Insurance Co. v. Securities and Exchange Commission, 613 F.3d 166 (D.C. Cir. 2010).

[17] Business Roundtable v. Securities and Exchange Commission, 647 F.3d 1144 (D.C. Cir. 2011).

[18] American Petroleum Institute v. Securities and Exchange Commission, 953 F.Supp.2d 5 (D.D.C. 2013).

[19] See, e.g., letter from Better Markets (Sept. 17, 2013), available at; letter from Americans for Financial Reform (July 22, 2016), available at

[20] 58 FR 51735 (Oct. 4, 1993).

[22] 76 FR 3821 (Jan. 21, 2011).

[23] 76 FR 41587 (Jul. 14, 2011).

[25] Michael S. Piwowar, Remarks at the “SEC Speaks” Conference 2015: A Fair, Orderly, and Efficient SEC (Feb. 20, 2015), available at

[26] See Executive Order 13579 – Regulation and Independent Regulatory Agencies (July 11, 2011); see also M-11-28 – Memorandum for the Heads of Independent Regulatory Agencies (July 22, 2011).

[27] 5 U.S.C. 610.

[28] Michael S. Piwowar, Statement Regarding Publication of List of Rules to be Reviewed Pursuant to the Regulatory Flexibility Act (Sept. 15, 2016), available at

[29] 17 CFR Part 242.600 et seq.

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