My little brother was always a much better athlete than me. This used to drive me absolutely crazy. No matter what the sport—football, basketball, baseball—he could always outrun, outshoot, and outswing me. This wasn’t because I had no game; it was simply because the little pipsqueak was tough as nails, athletically gifted, and imbued with a God-given desire to whip my butt.
When he inevitably outplayed me, I would be forced to lapse into “Older Brother Mode,” which typically involved pinning him down and cramming grass down his throat.
Either that, or I would change the rules of our sport on the fly, ensnaring him in some surprise regulatory obstacle (“That line is out of bounds!”) or some absurdly complicated statute (“That’s only a one-point shot because it touched the rim first and you didn’t call ‘swish’ and the sun is setting so I couldn’t really see and I slipped anyway so it’s my ball now with two free shots, so give it to me.”).
Those rule changes never ended well for me. They only fueled my brother’s desire to whip my butt … a craving that typically resulted in my embarrassment and defeat (and—if I could catch him—my brother eating more grass).
As older brothers the world over know well, changing the rules is the oldest trick in the book: If at first you don’t succeed, then simply move the goalposts.
The PCAOB knows all about this tactic.
The Public Company Accounting Oversight Board, as you likely know, is charged with—among other things—registering and inspecting accounting firms that audit public companies. The Board’s rules require that, at least once every three years, it must conduct an inspection of any audit firm that provides audit reports for 100 or fewer issuers. Firms that audit more than 100 companies must be inspected every year.
Unfortunately, the Board can’t keep up. It has been falling behind in its mandated auditor inspections, and has been falling behind for years. Back in February 2005, we reported that PCAOB inspections were sluggishly moving at a fraction of the pace needed to meet required levels. At the time, PCAOB spokeswoman Christi Harlan told Compliance Week that the number was low because it was the first full year of inspections during which there had been a learning curve for the regulators.
Apparently, it’s a steep curve, because the PCAOB has been falling farther and farther behind.
So, what does a regulator do when it can’t fulfill its mandate? Move the goalposts, of course.
On Oct. 16, the PCAOB eliminated the requirement that it regularly inspect each registered public accounting firm that plays a “substantial role” in audits but does not issue audit reports and eliminated the requirement that the Board inspect each registered public accounting firm that issues an audit report, even if the firm does not regularly issue audit reports.
You’ve got to laugh about this if you’re a public company executive (or else you’ll cry). First, the PCAOB botched its internal control standard and guidance so badly that it was forced to revamp them completely, and now the Board has acknowledged that it cannot fulfill its core mission of overseeing the auditing industry.
The Board is, of course, claiming that this change in the inspection cycle is a success of “risk-based” scoping, wherein the firms that conduct the most audits now get more attention. But that’s not entirely true; in fact, calling this a “risk-based” process is nothing but a PR spin. Rather, this is a manpower issue, pure and simple. PCAOB Chairman Mark Olson even acknowledged that the amended rule will limit “scarce inspection resources” to the approximately 800 firms that regularly act as principal auditor for an issuer.
Unfortunately, the PCAOB’s new inspection focus is inverted. It is not necessarily the largest of firms that need the extra focus: It’s the smallest ones. Just as the SEC spends considerable effort protecting the public markets from tiny entities and shell companies that present major risks to investors, so too should the PCAOB protect public issuers from the smallest and most dangerously neglectful of audit firms.
Ironically, the PCAOB’s own enforcement record proves this argument: All nine of the Board’s disciplinary proceedings have been against the smallest of audit firms that have only a handful of audit clients (or fewer). Apparently, small firms are a problem. So why lighten the inspection cycle?
I fully support the modification of rules to serve the public markets (i.e., the revision of the internal control provisions of SOX). But I don’t support the modification of rules simply to make a regulator’s life easier. The SEC hasn’t suddenly decided to stop regulating the pink sheets and bulletin boards because it’s too much effort, and the PCAOB shouldn’t either.
As I can attest from my experience with my brother, moving the goalposts usually comes back to haunt you. And I fear this decision will haunt the PCAOB as well.
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