Editor's Note: The Public Interest Section of the American Accounting Association is pleased to publish the following blog post by Steve Mintz, Professor Emeritus, Cal Poly, San Luis Obispo. Please contact lawrence.chui@stthomas.edu with questions, comments, or suggestions about our blog, or to express interest in our organization. Disclaimer: When you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
Is the PCAOB Obsolete?
The SEC removed William Duhnke as chairman of the Public Company Accounting Oversight Board, the U.S. audit watchdog, on June 4, 2021. This raises serious questions about the relevance of the PCAOB today and whether it has been operating as intended. In other words, is it protecting the public interest against deficient audits? The SEC removed Duhnke and took steps to replace its entire board, as the SEC’s new leader, Garry Gensler, begins to shape the regulator.
A
recently issued report slammed the PCAOB as being too lenient with the Big Four
accounting firms over audit deficiencies, resulting in only $6.5 million in
fines during its tenure, according to a new report.
The
Project on Government Oversight (POGO), an independent watchdog, said its
analysis of PCAOB annual inspection reports showed the board has in key respects
been doing “a feeble job” policing the Big Four.
“It
has taken disciplinary action over only a tiny fraction of the apparent
violations its staff has identified,” the report said. “Meanwhile, the
financial penalties it has imposed pale into insignificance compared to the
fines it apparently could have imposed.”
In
the 808 cases in which the Big Four performed audits that were so defective
that the audit firms should not have vouched for a company’s financial
statements, internal controls, or both, only 18 resulted in PCAOB enforcement
actions, POGO found.
PCAOB,
moreover, could have fined the audit firms more than $1.6 billion but has fined
them a total of just $6.5 million, while penalties against individuals at Big
Four firms totaled $410,000 — “less money than one partner at a big accounting
firm can make in one year.”
According
to Reuters,
the POGO report “could increase pressure on the [PCAOB], which in recent years
has been criticized for being too close to the industry it oversees and slow to
ensure the industry performed its job.”
“It’s
unacceptable that the agency is taking such a light-handed approach in holding
these large audit firms accountable,” POGO’s executive director, Danielle
Brian, said in a news release, adding, “By failing to hold the Big Four
accountable, the board is putting all Americans’ financial futures in
jeopardy.”
The
report recommends reforms including requiring the PCAOB to clearly identify
companies referenced in inspection reports and the individual auditors
responsible for alleged audit deficiencies.
Holding
individuals responsible for alleged audit deficiencies is risky business. After
all, quite a few auditors review the financial statements, accounting and
reporting, and audit report before they are issued. The firms should be held
responsible because it’s their job to make sure deficiencies do not exist in
audits.
The
criticism of the PCAOB boils down to the fact that it does not appear to be
making a discernible difference in moving audit firms to reduce audit deficiencies.
But the real reason may be the scandal that erupted on January 22, 2018, when a
former PCAOB staffer, Brian Sweet, who was hired by KPMG in 2015, leaked
confidential information about PCAOB's plans to audit the company. Most of the
leaked information concerned which audit engagements the PCAOB planned to
inspect, the criteria it was using to select engagements for inspection, and on
what these inspections would focus.
The
motivation for KPMG in hiring Sweet was the high audit deficiency rate at KPMG
when compared to the other Big Four firms. The average audit deficiency rate
has ranged between 30-to-40 percent since the program started. The rate for
Big-4 firms has gotten as low as 21 percent (Deloitte) and gone as high as 54
percent (KPMG). In the case of KPMG, it was determined that the firm too often
failed to gather enough supporting evidence before signing off on a company's
financial statements and internal controls.
It
is time for Congress to investigate the accounting profession for a lack of
independence and high rate of audit deficiencies. These are the two most
prominent failures of the PCAOB during its twenty-year tenure. Independence
violations are up and the audit deficiency rate, while declining recently, is
still too high. In my view, the public is not being protected and we may be
just one scandal away from having another meltdown of corporate financial
reporting like we saw in 2008-2009.