Is the PCAOB doing enough?
In the wake of the Project on Government Oversight’s troubling report on the Public Company Accounting Oversight Board late last year, it has become clear that the board is not doing enough to hold accountable the third-party auditors on which investors rely to audit Wall Street’s largest public companies. Now, there is a bill languishing in Congress that could help, and lawmakers must take action.
On Sept. 5, 2019, POGO published an in-depth investigative report, “How an Agency You’ve Never Heard of is Leaving the Economy at Risk,” about the PCAOB’s enforcement activities since its creation in 2002. According to POGO’s report, in the more than 16 years since the PCAOB opened its doors, it has levied less than one-half of 1 percent of the fines that it could have imposed on the Big Four U.S. accounting firms based on its findings of defective audits. This amounts to a total of $6.5 million in fines, rather than the $1.6 billion that were warranted, a miniscule fraction of what PCAOB should have recovered from wrongdoers. It is also a miniscule fraction of revenue of this sector, which reported more than $154 billion in global revenue in 2019, alone. As one law professor put it, POGO’s report “suggests [PCAOB enforcement] is a toothless body of law.”
Congress created the PCAOB, which POGO calls a “watchdog over other watchdogs,” in 2002 in response to the Enron accounting scandal that led to the dissolution of what was then one of the five largest U.S. accounting firms, Arthur Andersen. According to POGO’s report, since the PCAOB began its oversight functions in 2003, it has identified 808 instances in which Big Four firms performed audits that were “so defective that the audit firms should not have vouched for a company’s financial statements, internal controls, or both.” But the PCAOB took enforcement action in only 21 of those instances. As to individual fines, which the PCAOB is empowered to levy on members of accounting firm management who fail to reasonably supervise lower-level employees who violate audit rules, the PCAOB imposed a total of only $410,000. As POGO notes, that is less money than one partner at a Big Four firm can earn in one year.
Among the roadblocks to effective oversight highlighted in the report is the lack of transparency surrounding the PCAOB. For example, the legislation that created the PCAOB requires that enforcement actions be conducted out of public view. As the report points out, this means that investors remain uninformed of potentially serious accounting violations unless and until the PCAOB enters into a settlement agreement, or proves its case in a court of law. It also enables accounting professionals to continue “business as usual” while an action remains pending, potentially leaving investors at risk of additional harm.
In contrast, enforcement actions brought by the Securities and Exchange Commission are made public as soon as they are filed, and the SEC runs a robust whistleblower award program, created by the Sarbanes-Oxley Act of 2002, that encourages individuals with knowledge of securities violations to report them to the commission. The lack of transparency surrounding PCAOB enforcement actions likely contributes to the general feeling that auditors “just don’t fear the PCAOB” the way they and other publicly traded companies fear the SEC.
Just two weeks after POGO published its report, Congress answered its call for increased transparency. On Sept. 19, 2019, the House of Representatives passed the PCAOB Whistleblower Protection Act of 2019, which incentivizes whistleblowers to report suspected violations of PCAOB rules, securities laws governing the preparation and issuance of audit reports, and the obligations and liabilities of the accountants who prepare and issue those reports, accounting professional standards, and the act itself. The act’s sponsor, Rep. Sylvia Garcia, D-Texas, expressly cited the POGO report in her House testimony, noting that the act would “implement a key recommendation that [POGO] made in a recent report” and calling the act “just one small tool in the toolbox of making sure that transparency and the investor faith it generates in this country continue.”
Specifically, the act prohibits employers from retaliating against individuals who report suspected violations directly to the Board, or who initiate, testify in, or assist in PCAOB investigations or enforcement proceedings. Like the SEC whistleblower award program, the act would also protect whistleblowers who report concerns internally to their supervisors, which encourages self-policing. Whistleblowers who experience retaliation could bring claims against their employers for reinstatement, double back pay, and attorney’s fees and costs.
Building on the success of the SEC’s whistleblower award program, under which 62 whistleblowers have been awarded approximately $381 million since 2003, the act also offers whistleblowers up to 30 percent of the fines collected from a successful enforcement action resulting from information that they provided to the PCAOB.
In language identical to that creating the SEC whistleblower program, the act exempts from eligibility for an award any whistleblowers who “gain the information through the performance of an audit of financial statements required under the securities laws and for whom such submission would be contrary to the requirements of section 10A of the Securities Exchange Act of 1934.” Although the independent auditors who are the primary subjects of this exemption might have the most intimate knowledge of the accounting wrongdoing at which the act is aimed, the exemption reflects Congress’s best attempt at encouraging whistleblowers to come forward without rewarding individuals — like independent auditors — who already are required by law to disclose relevant information.
Opponents of the act have criticized it as duplicative of the SEC whistleblower award program and its attendant workplace protections, which incentivize whistleblowers to report suspected violations of securities laws to the commission. But the act would go a long way toward fulfilling the unrealized promise of the PCAOB as a more specialized “watchdog over other watchdogs” by deploying the board’s unique accounting expertise to better protect our financial markets. Cognizant of the potential for overlapping enforcement actions, lawmakers included a provision to require coordination between the PCAOB and the SEC’s Office of the Whistleblower so as to improve efficiency, avoid duplicative efforts, and promote cost-sharing between the agencies, when possible.
The act, which is supported by the National Whistleblower Center, the Institute of Internal Auditors, and Public Citizen, would provide financial whistleblowers with another avenue for reporting their concerns of misconduct, as well as an opportunity to be compensated for the serious professional risk that those efforts entail. It is now under consideration by the Senate Committee on Banking, Housing, and Urban Affairs. Senators should take action to build on the success of the SEC whistleblower award program and pass this much-needed legislation in the new year.