PCAOB Set to Expand Under New Mandates
An Interview With Chairman James R. Doty
PCAOB Chairman James R. Doty sees the audit profession as being at a turning point, not just in the U.S., but globally. “One of the fundamental advantages of our society has always been the audit. We believed we could believe in the numbers and that the numbers would be right. It’s the role of the [PCAOB], the mission of the board, to protect investors by being sure that that tradition and that assumption is a safe one and exists here.”
For Doty, a securities lawyer and a former SEC general counsel who took the helm of the PCAOB in February, his mission is clear.
“I want to consider the independence and the integrity of the profession at the level that will assure the protection of investors and the importance that auditors have in our society, and in our economic system,” Doty said in an April interview with the JofA.
He said the greatest surprise he’s encountered in his new role is “the heightened self-awareness [auditors] have that the world is changing.”
“I don’t see any firm that I have looked at and met with or heard from that doesn’t appreciate that, in fact, they’re in the middle of a process that can’t be reversed.”
He said there’s heightened awareness by firms that they’re going to have to make changes to preserve the relevance of the audit and respect for the role auditors are accustomed to having. A large part of this involves attracting, mentoring and developing auditor talent.
As to the PCAOB’s future as the profession’s regulator, Doty, who led the team that represented the board before the Supreme Court in last year’s constitutional challenge (see, Free Enterprise Fund v. PCAOB, Supreme Court docket no. 08-861 (2010)), said the court’s opinion made it clear that the board’s existence and its powers and responsibilities are not in question.
AUDIT REPORT CHANGES
The auditor’s report on the fairness of a public company’s financial statements has been largely the same for almost 70 years, according to Doty. He said the PCAOB has sought opinions from many constituencies about the auditor’s reporting model.
He said constituents want the audit report to go beyond the traditional binary report of either clean or qualified. “There’s a view that more information is sought by investors, that auditors have more information, and that they should be able to speak beyond ‘pass/fail’ to what they have seen and done in the audit. At the same time, we have heard that the responsibility for creating information should remain with management, that we should not transpose to the auditors the act of creating the financial and reported results and information,” he said.
Doty believes there is “a substantial realization [within the audit profession] that it’s important for the relevance for the audit report and the audit … that there be an intelligent and thoughtful expansion of the auditor’s reporting model.”
In response to the concern that changes to the auditor’s report could increase costs, he said many of the new things that are being talked about for the audit report would not be based on additional work. “They would reflect statements that the auditor makes about the work that auditors have always done in the audits.”
He also acknowledged a view that, if auditors must go on the record and comment on their work in the reporting process, they will require more time and attention to do it, and that will increase the cost of the audit. “Whatever we do … every step is going to involve an evaluation of the costs and benefits of changing the content of the report or not changing it.”
Doty contended that it’s difficult to quantify the benefit of audit quality. “In our society, it’s like knowing that the lights will go on when you turn the switch or that the roads will be repaired … and, therefore, it may be that the things, although not necessarily quantifiable, will be instantly recognizable.”
Doty said he anticipates a proposal by the end of this year, following the publication of a staff concept release.
INSPECTING BROKER-DEALERS’ AUDITORS
On the board’s new authority under the Dodd-Frank Wall Street Reform and Consumer Protection Act to oversee the audits of broker-dealers, including the authority to determine whether to inspect the auditors of any or all introducing brokers (those who do not maintain custody of client assets), Doty said the purpose of the board’s interim inspection program is to gather facts.
“We’re going to get as much factual data as we can to tell us whether there’s some meaningful basis for including, or for excluding, given categories of broker-dealers from the permanent inspection program.”
AUDIT FEES
On the issue of whether competitive pressure to reduce audit fees could weaken audit quality, he said, “We’re not the economic regulator of the profession, but we are concerned with audit quality because of shareholder and investor protection.”
He emphasized that audit committees’ responsibility goes beyond ensuring they’re not opinion shopping, which is illegal. Rather, audit committees have a fiduciary responsibility “to think about what they’re getting in terms of service and their auditors.”
REGULATOR, NOT CHEERLEADER
Doty said he’s aware that many auditors feel they do good work, but he said audit firms should not expect accolades from the PCAOB. “That’s not our mission and our role, and I don’t think we’re going to do that.”
One of the PCAOB’s current priorities in its inspection program, he said, is to achieve consistency of quality and approach so that the firms understand what the PCAOB is doing.
The whole discussion with the profession, he said, is about the importance of auditors seeing themselves as responsible ultimately to the public and to the investor. “[They need to bring] to the audit process real objectivity, resisting any pressure from management and asserting themselves if they believe either management or board members are in danger of creating financial reporting that is fictional.”
INTERNATIONAL INSPECTIONS
One of Doty’s greatest priorities is gaining access to China to conduct inspections of PCAOB-registered firms. He said that meaningful progress was made at the May 9 U.S.-China Strategic and Economic Dialogue that took place in Washington. “Both sides have agreed to accelerate efforts, including undertaking a process for negotiations and engaging in technical assistance activities, to reach a bilateral agreement governing cross-border audit oversight,” he said. “The hope and expectation is that the PCAOB’s discussions with the Chinese authorities in the coming months will provide the framework for a definitive bilateral agreement later this year.”
He said it is in China’s interest as an economic power and a participant in the world economy to have the assurance that joint inspections bring to the markets.
The PCAOB’s negotiations in Europe appear to be going better. “[European Commissioner for Internal Market and Services Michel] Barnier has written me and has pointed out that they find our inspection regime acceptable and that we are invited to deal with each member state to arrange these inspections. That is now beginning to happen.”
The PCAOB has agreements in place for joint inspections with the United Kingdom and Switzerland (not a member of the EU). “I would expect that, by the end of the year, the list of EU nations … in which we’re doing inspections will be substantial.”
Elaborating on previous comments he has made about the need for more oversight of audit firm networks, Doty said this work will be conducted through joint inspections with the PCAOB’s foreign counterparts.
“Joint inspections will provide assurance that the issues that we find in an audit can’t be characterized as being remote from the network firm’s control or from the firm’s knowledge base. We’ll project transparency into audits that are performed across the world and inform investors more about those audits.”
Photo by Sean McCormick/Sean McCormick Photography
Matthew G. Lamoreaux is a JofA senior editor. To comment on this article or to suggest an idea for another article, contact him at mlamoreaux@aicpa.org or 919-402-4435.
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