The Public Company Accounting Oversight Board has proposed for a second time the idea of requiring auditor reports to disclose the names of the lead partner on an audit engagement and some of the other individuals and firms who participated in audits of public companies, brokers and dealers.
The amendments would require disclosure in the auditor’s report of the name of the engagement partner who led the audit for the most recent period, along with the names, locations and extent of participation—as a percentage of the total audit hours—of other public accounting firms that took part in the audit, and the locations and extent of participation of any other individuals or companies not employed by the auditor who also performed procedures on the audit.
The PCAOB is asking for public comment on the “reproposal,” which represents a second try at a proposal first issued in 2011 after a July 2009 concept release suggested requiring the engagement partner to sign his or her own name on the audit report. After the PCAOB heard objections from firms concerned about auditor liability, the board issued a proposal in October 2011 that, among other things, would have required disclosure of the name of the engagement partner, but without requiring a signature, as well as disclosure of other participants in the audit. The PCAOB is pressing ahead with further modifications in the latest version in an effort to improve transparency and audit quality.
“Identifying the engagement partner and providing additional information about the other participants in the audit will increase the usefulness of the auditor's report for investors when making their investment decisions, as well as when voting on the ratification of a company’s choice of accounting firm as its auditor,” said PCAOB chairman James R. Doty in a statement. “Knowing the name of the engagement partner on an audit, and the various other firms that participate in a global audit, may help the investing public identify and judge quality, leading to better auditing.”
The PCAOB pointed out that in many audits today, only the name of the firm that issued the auditor’s report is disclosed. Therefore, information about any other firms and people that participated in the audit is unknown to investors and other users of audit reports.
In many audit engagements, particularly audits of companies with multiple locations and international operations, the primary auditing firm may perform only a portion of the audit. The rest of the work may be done by other affiliated accounting firms, non-affiliated accounting firms, or other persons not employed by the auditor, such as consulting firms and individual accountants.
“Over time, investors will benefit from knowing the identity of the engagement partner and being able to obtain an understanding of an engagement partner’s history when evaluating the audit,” said PCAOB chief auditor and director of professional standards Martin F. Baumann. “Further, it will be very useful for investors to know what other firms participated in an audit and the extent of their participation, as different firms participating in the audit may have very different inspection results or may be located in a jurisdiction where the PCAOB is prevented from performing inspections.”
Aside from the disclosure obligations, the reproposed amendments would not change the performance obligations of the auditor in conducting the audit.
“The disclosure would require no new work by the auditor,” said Doty. “Yet as with previous accountability reforms like it—such as Sarbanes-Oxley’s requirement that CEOs and CFOs personally certify their company’s financial statements and internal controls—it holds the promise of improving audit quality by sharpening the mind and reminding auditors of their responsibility to the public. The capital markets know that audit quality is not all equal, and they are willing to pay more for reliable audits, in the form of reduced financing costs for companies that obtain such audits. The corollary is also true: markets demand a premium cost of capital from companies that present an audit report that is perceived to be less reliable. This proposal is a way to use the motivating power of our markets to incentivize higher-quality audits. But to do so, the markets need information. If the public knew about partner history, and the relative extent of involvement of other firms that have their own records of good or poor auditing, the market could react by appropriately pricing the cost of capital.”
Skepticism and Support
Another PCAOB board member, Jeanette Franzel, registered some objections to the proposals during the board’s meeting Wednesday. “The key questions surrounding this proposal are whether and how additional transparency about the identities of engagement partners and other participants in audits would solve a particular need or problem, serve appropriate policy objectives, achieve certain benefits, and impose compliance or other costs,” she said. “Frankly, it is surprising that we are at this point in the standard-setting process with such basic questions still unanswered. Today’s release does not explain why the board has changed its objectives for the reproposal from accountability to disclosure of useful information for investment decisions (as names are collected over time and combined with other unspecified information). And, with those changed objectives, the board is now in a position to surmise how, or hope that, such information may be compiled and made useful over time. I’m starting to think that naming the audit engagement partner in the auditor’s report is a solution in search of a problem.”
Another PCAOB member, Jay Hanson, also voiced skepticism. “While I support gathering additional feedback on our possible courses of action, I do have strong reservations about today’s proposal and take exception to a number of generalizations in the release about what the board believes,” he said. “I cannot say today that I would support the ultimate adoption of the reproposal as currently drafted. As is the case with all of our regulatory activities, there is a balance we must achieve. We must weigh the potential benefits of our actions, determining the degree to which they have a positive effect on investor protection, and we must consider the anticipated costs to those we regulate and the capital markets at large. We strive to base this consideration on the best evidence available. In some cases, the scale tips easily and the board unanimously supports a new standard. In other cases, it is a much closer call, and this is one of those situations.”
One of the PCAOB’s key advisors, Cindy Fornelli, executive director of the Center for Audit Quality, expressed her reservations in a statement issued Wednesday by her organization. “The CAQ supports the PCAOB’s efforts to respond to calls for further transparency into the audit,” said Fornelli. “However, given that we do not see a nexus to audit quality or accountability, we do not believe the auditor's report is the appropriate place to identify the engagement partner. It is important to note that engagement partners already are held accountable to multiple parties including their firms, audit committees, regulators and investors. There are also important contributions to the audit made by many others beyond the engagement partner, including the firms’ comprehensive quality control systems. The CAQ looks forward to commenting on various aspects of today’s PCAOB proposal, including exploring alternatives for communicating partner identification to investors.”
Nevertheless, the proposal does have its proponents within the PCAOB. “Engagement partner and other audit firm identification have been before the board, in one form or another, since at least 2008,” said PCAOB member Steve Harris. “I have stated my strong belief at past meetings, in 2009 and 2011, that this rule would significantly advance the board’s mission, by increasing both transparency and accountability. So, I support its reproposal, with the understanding that the board will vote on a final standard in the first half of 2014.”
Another board member, Lewis Ferguson, voiced his support. “I support issuance of these reproposed amendments to AU 508 on reports on audited financial statements,” he said. “Many investors and users of financial statements have told the board in roundtable discussions, meetings of our Standing Advisory Group and Investor Advisory Group, and comment letters that they would like to know more about the participants in the audit.”
Ferguson said he believes that the PCAOB should promote disclosure and increase the transparency of participants in the audit for the benefit of the investing public, and that doing so would enhance the operation of capital markets.
“Today, the standard auditor’s report tells readers of the report nothing about the identity of the participants in the audit beyond the name of the principal audit firm,” he added. “Allowing users of financial statements to determine the identity of at least some of the participants in the audit may enhance their ability to assess the reliability of the audit report, and to be better informed when voting on whether to approve the selection of auditors.”
Comments on the reproposed amendments are due by Feb. 3, 2014. A fact sheet on the reproposal is available online, along with an archive of the webcast and a podcast of the board meeting on the PCAOB’s Web site.
Broker-Dealer Amendments for Dodd-Frank
In addition to deciding to repropose the disclosures on auditor reports, the PCAOB also spent part of its meeting on Wednesday voting to approve a set of amendments, updates and clarifications aimed at conforming some of its rules for audits of broker-dealers to the requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The Dodd-Frank Act of 2010 amended the Sarbanes-Oxley Act of 2002 to, among other things, give the PCAOB oversight authority for audits of brokers-dealers registered with the SEC. The PCAOB initially proposed the conforming amendments in February 2012. The amendments insert references to audits and auditors of broker-dealers in relevant board rules, and call for broker-dealer audit client information on the board’s registration, withdrawal and reporting forms (PCAOB Forms 1, 1-WD, 2, 3, and 4).
The amendments also require that PCAOB-registered firms that audit broker-dealers comply with certain of the board’s professional practice standards, update a number of board rules and forms based on the PCAOB’s experience administering and enforcing its own rules, and make certain updates to the board's ethics and independence requirements.
“Today’s vote to conform the PCAOB’s rules to Dodd-Frank’s expansion of the board’s authority represents another step in the board’s implementation of our responsibility to oversee registered firms that audit brokers and dealers,” said Doty.
If approved by the SEC, the amendments to the PCAOB’s rules, Ethics Code, and membership requirements of the American Institute of CPAs’ SEC Practice Section would take effect on June 1, 2014. The amendments to Forms 1, 1-WD, 3, and 4 would take effect on July 1, 2014. The amendments to Form 2 would take effect April 1, 2015.
The final amendments and board statements from the open meeting are available on the PCAOB’s Web site under Rulemaking Docket No. 039, along with an archive of the webcast and a podcast of the meeting on the site.