The Public Company Accounting Oversight Board is taking a close look at the nearly 1,000 accounting firms that have registered with the PCAOB although they do not audit public companies or broker-dealers, and may decide to drop many of them.
“Currently 923 firms are registered with the PCAOB even though they do not conduct audits that would subject them to mandatory PCAOB registration,” said PCAOB member Jeanette Franzel in a speech at the Association of Government Accountants’ Annual Professional Development Conference in Dallas on Wednesday. “The board is examining the extent of this practice and the risks that may arise from gaps in expectations about what a PCAOB registration may signify.”
She noted that the Sarbanes-Oxley Act and PCAOB rules require all U.S. and non-U.S. accounting firms to register with the board if they prepare or issue audit reports or play a substantial role in preparing or issuing audit reports of issuers, brokers or dealers. Currently, approximately 2,360 firms are registered with the PCAOB, including about 915 non-U.S. firms located in 85 jurisdictions.
Not all PCAOB-registered firms regularly issue audit reports for issuers, but the PCAOB inspects those that do, approximately 714 firms, including more than 240 non-U.S. firms. In addition, approximately 118 registered firms do not regularly issue audit reports for issuers. However, they report that they play a substantial role in the audits of issuers, Franzel noted.
“Together, these firms audit or play a substantial role in the audits of the previously mentioned more than 9,755 U.S. issuer companies that have approximately $26.4 trillion in global market capitalization,” she said.
Based on 2012 year-end data, the four largest registered public accounting firms and their global affiliates audited more than 98 percent of the global market capitalization of U.S. issuers, she observed. “The next three firms and their global affiliates audited another 1.1 percent of this market capitalization,” Franzel added. “This level of concentration, which has increased significantly since the 1980s, has been studied extensively. The dynamics of this market provide complexities for the board’s oversight programs and present challenges within the market for choice among audit firms."
The PCAOB has issued a concept release proposing the possibility of requiring mandatory audit firm rotation, but the concept has attracted little support among either the auditing firms or the businesses they service. Congress has also gotten involved, with the House passing legislation last week by an overwhelming 321-62 margin that would prohibit the PCAOB from imposing mandatory firm rotation (see House Approves Bill Banning Mandatory Audit Firm Rotation).
However, the PCAOB hopes to address the problems it is seeing among audit firms. "For the large firms, the number of serious audit performance deficiencies we reported spiked in our 2010 inspections, and remained high overall for the large firms in the 2011 inspections,” Franzel pointed out. “We are starting to see some limited improvements in the 2012 and 2013 inspections. I am hopeful that with the significant audit quality and compliance efforts many firms are putting forth, we will start to see sustainable improvements in inspection results in the next year or so."
She told the audience that if the PCAOB sees significant improvements in the level of compliance with PCAOB professional standards on audits, the board will have an opportunity to consider adjusting its inspection approach and methodology to take advantage of firms’ more effective compliance approaches. She pointed out that the board is currently working on a project to develop measures of audit quality that could provide “useful context” for any new approaches.
“To the extent board inspections find improvements in firms’ ability to design and effectively implement quality control systems that provide reasonable assurance of compliance with PCAOB professional standards, the board may have an opportunity to adjust its inspection approach and methodology to take advantage of those improvements in the future,” Franzel added.
In the aftermath of the financial crisis and the problems found with Ponzi schemer Bernard Madoff’s cozy relationship with his longtime auditing firm, the PCAOB has also been performing inspections in recent years of the auditors of broker-dealers under the Dodd-Frank Act of 2010.
Franzel noted that on the broker-dealer auditor front, approximately 825 registered firms reported that they audited brokers and dealers in 2012, including approximately 511 that reported that they do not audit issuers. The PCAOB plans to issue a summary report next month on its most recent inspections of broker-dealer audits.
A preliminary report was issued last year based on the board's initial inspections of 10 audit firms and 23 of their audits of securities brokers and dealers, outlining a number of concerns (see PCAOB Finds Problems with Audits of Broker-Dealers). “Unfortunately, we continue to find significant problems of a similar nature with these audits,” said Franzel.
She argued that a strong enforcement function is essential to the board's fulfillment of its investor protection mission, and in response, the PCAOB has developed an active enforcement program that seeks to identify potential cases of serious auditor misconduct, investigate them thoroughly and promptly and, where appropriate, institute disciplinary actions.
“The overriding goal is to ensure that auditors who commit serious violations of our auditing standards face appropriate and real consequences,” said Franzel. “The board is empowered to impose a range of remedial and disciplinary sanctions against registered accounting firms and associated persons who violate applicable laws, rules, and professional standards.”
She noted that the PCAOB’s Enforcement Division currently has about 90 open informal inquiries, formal investigations, and litigated disciplinary proceedings in process. All of them are nonpublic under conditions imposed in the Sarbanes-Oxley Act. However, the PCAOB hopes to make the disciplinary proceedings public so that they don’t drag on for years with no indication to the public of problems with particular auditing firms or their corporate clients. Senators Jack Reed, D-R.I., and Charles Grassley, R-Iowa, re-introduced legislation in April to amend the Sarbanes-Oxley Act to make the disciplinary proceedings public (see Senators Re-introduce Bill to Make PCAOB Disciplinary Proceedings Public).