Public Company Accounting Oversight Board chairman James Doty told an audience of auditors that the public is expecting more from the audit profession and warned firms against skimping on audit quality.

He warned that for some firms, the independent audit has become a commodity to be contained with other costs.

“In the United States, large audit firms’ revenues from consulting are growing rapidly, at some firms more than 15 percent a year,” he said during an audit conference at Baruch College's Zicklin School of Business in New York on Thursday, co-sponsored by the NASBA Center for the Public Trust. “Audit fees have stagnated at, basically, the inflation rate. Thus, audit practices have shrunk in comparison to audit firms’ other client service lines. This, I think, threatens to weaken the strength of the audit practice in the firm overall.”

Doty said he wants to see an audit profession that attracts and retains top graduates who are committed to excellence in public service. He noted that investors have reawakened to the importance of the audit for corporate governance, and what people expect from auditors is expanding.

Doty also described the PCAOB’s standard-setting work. “At the PCAOB, we don’t rewrite standards just for the sake of change,” he said.

He and PCAOB deputy chief auditor Jennifer Rand, who spoke earlier in the day, noted that the PCAOB’s Auditing Standard No. 16 for improving auditor communications with audit committees has been submitted to the SEC for the necessary approval. Rand expects the SEC will approve the new standard, and Doty said he hopes it will become effective for audits of 2012 financial statements.

“No one relishes bringing home a bad report card,” he said. “It’s human nature. But of all groups, the audit profession ought to—and I believe does—understand the value of an honest dialogue about weaknesses: what’s been found to be wrong with the audit, what’s been problematic in the firm’s quality controls and what they’re doing to fix it. Auditors that help audit committees understand problems are in a better position to gain their support for the measures that are necessary to address the tough calls when those come along.”

He also discussed the PCAOB’s proposed new standards on related-party transactions and audit transparency. In the transparency proposal, the PCAOB has proposed requiring the name of the engagement partner as well as the participating firms in the audit.

Discussing the PCAOB’s inspection process, Doty noted that PCAOB inspectors come across some troubling marketing practices that conflict with audit quality.

“They find instructions issued to partners to inform clients when the firm provides services at a discount from their standard rates in anticipation of a long-term relationship. These instructions also instruct partners to provide for a termination fee if the hoped-for long-term relationship is not realized,” he said. “It is a tough subject. I recognize that for a profession known for character and esteemed for integrity, it is important to believe that character and integrity triumph. It is the rare case when an auditor is corrupted. That is not the issue. That is not the charge. An auditor need only look the other way, accept a well-annotated, well-expressed rationalization, focus on corroborating evidence to exclusion of other evidence. An auditor need only say, ‘I don’t object,’ ‘it’s a matter of judgment,’ ‘the literature is unclear.’ These are all the enemies of objectivity and skepticism.”

He warned that audit firms should not expect PCAOB inspectors to slow down or be easy touches. “The inspections will be stressful for the audit team,” he said. “But the public wants to know more about what’s in the PCAOB’s files.”

Doty noted that the PCAOB has engaged in a series of public meetings to discuss ways to enhance auditor independence, objectivity and professional skepticism, listening to suggestions from investors, senior executives, audit committee chairs, CEOs of audit firms, academicians and former regulators.

The European Union and its member states have also been considering some of the same questions, including term limits and mandatory firm rotation. Doty cautioned that the debate over such questions should not be rushed. However, he noted that auditors in the U.S. are increasingly affected by audit policy ideas that have been implemented in Europe and elsewhere.

After his speech, in a conversation with reporters, he discussed the status of the proposals for audit firm rotation, audit-only firms and other reforms in the European Union. He noted that it is presently before a committee of the Parliament and is also before the European Council. Afterwards, there will be a reconciliation process similar to the conference process that occurs in Congress when there are differences between legislation passed by the House and Senate. Doty declined to make predictions about what the final form of the audit firm reforms in the E.U. will be.

Doty also discussed the PCAOB’s efforts to conduct inspections of auditing abroad, including China. He noted that to date the PCAOB has conducted inspections in nearly 40 foreign jurisdictions, and one-quarter of their scheduled inspections are outside the U.S. The PCAOB has also entered into bilateral cooperative agreements with regulators in 14 other jurisdictions to conduct inspections jointly with the local regulator. However, China remains a problem. “I am disappointed that we still face resistance from some countries where there are registered firms we are required to inspect,” he said. “Since October 2010, we have not approved any applications for registration submitted by firms in jurisdictions that resist inspections. I am encouraged that Chinese authorities are at least continuing to talk with us about ways we might work together. We were invited to observe an inspection by Chinese authorities earlier this year. The exercise was helpful. It was educational, and it began to build working relationships among staff. But we have not been allowed to inspect any Chinese firms that are registered with us, notwithstanding the fact that those firms continue to issue audit reports that are filed with the SEC and relied on by U.S. investors.

“The current state is not sustainable,” he added. “We are coming to a crossroads where we will have to make some important decisions about how best to protect investors.”

He was asked by a Baruch College student if pushing the Chinese too hard might have negative political consequences, but he responded that it would be a miscalculation for a foreign firm to take that attitude. “No jurisdiction should think that we will not act because the political consequences are too great,” he said. “Congress can tell us that. The White House can tell us that. The one thing that the Supreme Court decision about FEF vs. PCAOB decided was that we are part of the executive branch and we’re subject to oversight by the White House, like the Treasury Department, and they can tell us to stop or pause.

“At some point we must inspect as part of our statutory duty,” he added. “Countries that are barring us on the grounds of national public policy, secrecy, whatever, should not count on political practices or politics to continue that situation. The firms, by the way, have gotten themselves into a pickle. The firms have rushed into China because it is an important market, and I really do understand the toughness of that situation.”

Doty also took some questions from reporters after his speech. He was asked about the PCAOB’s meeting on Wednesday in which the board approved its budget for next year and strategic plan for 2012-2016. The budget provides for a total accounting support fee in 2013 of $234 million. The accounting support fee will rise by about 9 percent next year for firms, but the amount will be staggered according to the size of the firm, with small firms paying far less than the larger firms.

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