by Ken Rankin
Washington -- The Public Company Accounting Oversight Board approved new rules requiring annual inspections of all major accounting firms with 100 or more audit clients.
The rules, which await approval by the Securities and Exchange Commission, subject smaller firms with fewer than 100 audit clients to regular inspections every three years.
Additionally, the PCAOB will be empowered by the new rules to undertake separate “special inspections” of firms at any time to “assess the degree of compliance with the Sarbanes-Oxley Act.” In explaining those provisions to board members during an early October meeting in Washington, PCAOB staff enforcement officials stressed that, while these special inspections may have a “more narrow focus” than the routine scheduled inspections, these proceedings will not be “tantamount to an investigation” of the firm.
In addition to giving final approval to the inspection rule, the five-member board also unanimously voted to propose two additional rules: one designed to define the terms used in auditing and related professional practice standards, and another establishing an auditing and related professional practice standard for the attestation to management’s assessment of internal control over financial reporting.
That second proposal is designed to implement Sarbanes-Oxley provisions that direct the PCAOB to establish professional standards governing the independent auditor’s attestation, and reporting on, management’s assessment of the effectiveness of internal controls.
The proposal has been received with some skepticism, however, as questions have arisen regarding exactly how critical an auditor can be of a client’s internal control systems, if that client had hired the firm.
Under the plan, “accelerated filers” (defined as “seasoned U.S. companies with public float exceeding $75 million”) will be required to comply with the new internal control reporting and disclosure requirements for fiscal years ending on, or after, June 15, 2004. Smaller companies, foreign private issuers and companies with only registered debt securities have until fiscal years ending on or after April 15, 2005, to comply.
The board is considering the possible effects on small and midsized companies, and board officials conceded that internal control is not a “one-size-fits-all” concept.
A blanket exemption for smaller filers, however, does not seem to be in the cards. In outlining the proposal during the October meeting, PCAOB chief auditor Douglas Carmichael told board members, “I don’t believe that any kind of exemption for small companies is warranted.”
Under the internal control attestation plan, the auditor would be expected to inform the audit committee in writing of all known “significant deficiencies and material weaknesses,” as well as any “internal control deficiencies.”
The proposed standard explicitly lists a series of circumstances that would be considered “significant deficiencies,” including:
● Ineffective oversight of the company’s external financial reporting and internal control over financial reporting by the company’s audit committee;
● Material misstatement in the financial statements not initially identified by the company’s internal controls; and,
● Significant deficiencies that have been communicated to management and the audit committee but that remain uncorrected after a reasonable period of time.
The new rules governing inspections of audit firms have raised concerns among foreign accountants, who warned that the board’s new requirements will create legal problems in their home countries.
In Germany, for example, accountants are subject to professional confidentiality obligations under legislation that “prevents our members from providing the PCAOB ... access to any or all facts and circumstances with which they are entrusted,” officials at the Institut Der Wirtschaftsprufer (the German Institute of Public Auditors) told the board.
The PCAOB’s plan to call persons to testify may also pose a problem for German accountants, the institute said. “An employer in Germany is unlikely to be able to force an employee to testify unless this matter has been specifically addressed in the contract of employment,” IDW officials explained.
As a result, the group argued, “even if the legal confidentiality requirements were to be circumvented in some way, it is likely that data security legislation will prevent German public accounting firms from making information and documents available to the PCAOB.”
The board’s plan for inspections also came under some criticism from some members of the U.S. accounting profession, who expressed concern that the proposal failed to protect the “due process” rights of accountants and their firms.
Accountants at Most Horowitz & Co., for example, had argued that the PCAOB’s rule “could result in reporting matters to the [Securities and Exchange Commission] and state licensing agencies that may not be violations” of SOX.
In comments raising those concerns to the PCAOB, the firm’s quality control director, Robert J. Sonnelitter Jr., said, “I believe that this proposed rule does not provide adequate due process” for accountants.
For their part, officials at the PCAOB offered little sympathy for the “due process” concerns voiced by accountants.
Among other things, they pointed out that criticisms of firms uncovered during inspections will not be made public if they are corrected within 12 months. Additionally, firms will have a right to review and comment on inspection reports before they are finalized. Audit firms will also be able to appeal the findings of inspectors, staff officials told the board.
“Sounds like due process to me,” PCAOB Chairman William McDonough said.
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