PCAOB Looks to Improve, Expand Auditing Rules

Regulation of the auditing world is shifting gears, moving beyond the early, intense focus on internal controls to find new ways to improve auditing more broadly. Yet a pall of uncertainty remains over where that oversight of the profession should go next.

Conflicts in international law are confounding efforts to enforce U.S. audit rules, and a U.S. Supreme Court decision coming later this spring could unravel the existing regulatory framework. The Public Company Accounting Oversight Board is waiting for new appointees to form a new majority, and the financial crisis has placed significant new focus on how auditors should spot and address serious risks.

Goelzer

For Dan Goelzer, acting chairman of the PCAOB, it must be a little like driving a car in the dark, with no map.

Goelzer was a founding member of the PCAOB when the board was formed in 2002 as a result of the Sarbanes-Oxley Act. He became chairman last August when then-Chairman Mark Olson resigned. Goelzer has spent most of his career on the legal side of corporate and securities law, but did work as an auditor early in his career with Deloitte & Touche.

His job these days is to run a five-member board with one vacancy and two seats held by members who are lingering beyond their terms until the Securities and Exchange Commission gets around to naming their successors. The SEC appears to be in no hurry; a spokesman recently said the Commission has no public timeline for when it would name the new board members.

The SEC says the lag in naming new board members has nothing to do with the Supreme Court’s hearing of the Free Enterprise Fund vs. the PCAOB, a case brought by a small Nevada firm contending that the PCAOB has too much unchecked power in its regulation of auditing. The court will decide whether it’s appropriate for PCAOB board members to be appointed by the SEC, or whether they should be nominated by the president and approved by the Senate.

At last month’s national conference of the American Institute of Certified Public Accountants, Goelzer said the PCAOB faces a number of changes in 2010, not the least of which is enforcing its inspection mandate on overseas auditing firms that do work in U.S. capital markets. The board has 930 firms registered in 86 countries outside the United States, many of which are subject to regular inspections.

Aside from the cultural differences PCAOB inspectors are learning to navigate, the board is encountering obstacles where non-U.S. firms or their home governments cite privacy concerns and other local laws that conflict with U.S. requirements. Further, the board recently disclosed it is retooling its international inspections and struggling with how to finalize reports for inspections completed as far back as 2006. Some 86 reports are held up in an internal review process because the board recognized its own inspection work was not adequate. The board is exploring options on how to assure transparency to U.S. investors despite the cross-border headaches, including naming firms that have so far escaped inspection or requiring additional disclosures.

PCAOB 2010 GOALS

The following excerpt from PCAOB Acting Chairman Dan Goelzer’s speech before the AICPA outlines the Board’s goals and challenges:

What Challenges Does the PCAOB Face in 2010?

In some cases … we have had difficulty in reaching agreement with foreign counter-parts. For example, recently, we have experienced challenges with respect to our inspections in the European Union. The major obstacle is the Board’s inability to share inspections information, due to confidentiality provisions in the Sarbanes-Oxley Act. Both Houses of Congress are considering legislation that would correct this problem by permitting information-sharing with non-U.S. audit oversight bodies. However, we are currently unable to conduct further inspections in EU Member States. There are a handful of other countries in which similar issues have arisen.

This presents both the Board and the firms involved with something of a dilemma. We are required to conduct inspections of firms that audit U.S. companies according to a schedule. Firms are required to cooperate in those inspections. If we are unable to inspect certain registered firms because of prohibitions in local law or because local authorities will not permit us to do so, the Board will have to consider how to respond.

The Board has a range of options. We already disclose on our Web site the name of any firm that has not been inspected, despite the passage of four years since it became subject to inspection. One possibility would be to expand this disclosure to include the reason no inspection has occurred and possibly the firm’s U.S. public company audit clients. The Board could also require firms to include some sort of disclosure in their audit reports, in a communication to clients, or in the firms’ reports filed with the Board. Of course, the Board can also bring disciplinary proceedings against firms that fail to cooperate in the inspection process.

Multinational Audits and Global Networks

Some problems in multi-location audits that Board inspectors have already observed include:

U.S. engagement partners sometimes do not seem to have a sufficient basis to assess whether the non-U.S. personnel working on a U.S. engagement are qualified and familiar with U.S. GAAP, PCAOB standards, and SEC requirements.

Firms may fail to make available to their U.S. engagement partners relevant internal inspection information about foreign-affiliate firms and personnel. In some cases, the engagement partners fail to ask for this information, even if it is available.

Firms may not have set minimum levels of training on GAAP, PCAOB standards, or SEC requirements for the foreign-affiliate personnel who participate in U.S. issuer audits.

U.S. engagement teams sometimes fail to appropriately evaluate the results of a foreign affiliate’s work, or fail to adequately supervise and control the affiliate’s work.

Getting a handle on cross-border quality control is difficult, both for the Board’s inspection staff and, I suspect, for firms. The Board is enhancing its risk assessment and inspection methodology to better evaluate how global firms control their cross-border practices and the risks related multinational auditing. Developing an approach to quality control for these global networks will be one of the Board’s 2010 challenges.

Standards-Setting in a Multi-Standard Environment

[A]s a corollary to the globalization of auditing, the Board needs to take into account that it is not the world’s only setter of auditing standards. The International Auditing and Assurance Standards Board promulgates the International Standards on Auditing—the ISAs—and practitioners with an international clientele must be familiar with the applicable standards in the countries in which they operate. Further, U.S. auditors with both a public company and a private company practice must be able to apply both PCAOB standards and the standards issued by the Auditing Standards Board. While this multi-standard environment imposes burdens, there are some good reasons for the differences—beginning with the fact that PCAOB standards envision an integrated audit of the financial statements and of internal control.

Expanding Responsibilities

In the case of broker-dealer auditors, legislation under consideration in both the House and Senate would close the gap by giving the Board full oversight authority. If this legislation is enacted, the Board will need to develop an inspection methodology, including appropriate risk analyses, and hire and train additional staff with experience related to broker-dealer audits. We may also be required to adjust our funding system so that broker-dealers, like public companies, pay part of the cost of overseeing their auditors.

Another area where some have suggested a broader role for the Board is firm governance and transparency. For example, last year, the U.S. Treasury’s Advisory Committee on the Auditing Profession issued a report with a number of recommendations aimed at the Board, including that we should require the larger auditing firms to produce a public annual report and to file on a confidential basis audited financial statements with the Board. These ideas would take us in new directions in the nature of our oversight of the major firms. To date, the Board’s focus has been on how firms perform public company audits and on improving audit quality. In contrast, transparency requirements would respond to the view that the large accounting firms are public interest entities that owe a level of disclosure because of the key role they play in our financial system. Whether to go down that road is one of the tough issues the Board will face next year.

Source

Dan Goelzer Speech at AICPA Conference (Dec. 7, 2009).

Even inside the United States, inspectors encounter problems stemming from foreign audit work—where, for example, a mistake in India or Italy could affect U.S. investors, said Goelzer. (A fact that investors in Satyam, the Indian outsourcing firm that collapsed in fraud last year, know all too well.) “The board needs to make sure that it is addressing that risk,” he said.

The PCAOB also is wrestling with suggestions that it should pay more attention to audit standards in other countries when writing standards for the United States, a concept not entirely accepted by existing board members. Allison Patti, a professional accounting fellow at the SEC, said at the same AICPA conference that momentum for international convergence in auditing is building and “market forces continue to support the collaborative development of national and international standards.”

Goelzer said the U.S. requirement for an audit of internal control over financial reporting is one prominent reason that U.S. standards can’t fully converge with International Standards on Auditing written by the International Auditing and Assurance Standards Board or with private-company rules written by the AICPA’s Auditing Standards Board, since those bodies don’t require such an audit. He does support, however, eliminating unnecessary differences, he said.

Niemeier

The board has just pushed forward on seven new standards that would instruct auditors on how to assess and respond to risk of misstatement or fraud. In publishing the revised package, first proposed in October 2008 and revised last month based on public comment, board member Charles Niemeier said he found the effort to compare the U.S. standards with international rules a “distraction” from the more important objective of simply making them better than existing U.S. standards.

In the past, much of the board’s focus was devoted to meeting the requirements of Sarbanes-Oxley, most notably the audit of internal control over financial reporting, Niemeier noted. Now, he said, the PCAOB seems preoccupied with focusing on how its standards compare with other auditing rulebooks. “Our time would be better spent identifying our own issues,” he said.

A focus on identifying and assessing risk is certainly a timely topic, given that the financial crisis was precipitated by companies and auditors alike ignoring or glossing over risk. The seven proposed standards address audit risk; audit planning and supervision; consideration of materiality in planning and performing an audit; identifying and assessing risks of material misstatement; how the auditor should responds to risks of misstatement; evaluating audit results; and audit evidence.

Baumann

If approved, the seven new standards will more than double the number of standards the board has written in its seven-year history. While it’s been treated as one project, “in fact, it is several projects wrapped into one,” Niemeier said. Chief Auditor Marty Baumann said the standards are expected to be effective for audits beginning after Dec. 15, 2010.

Still, the new standards themselves are not a clear path forward for the regulation of auditing or the auditing profession. “The board faces challenges because its mission is something of a moving target,” Goelzer said.

Ideas continue to percolate in the wake of economic crisis for how the PCAOB’s role might change. Maybe it should regulate auditors of broker-dealers, as is now being considered in both houses of Congress; maybe it should regulate governance and transparency of the audit firms themselves, as suggested by the U.S. Treasury Advisory Committee on the Auditing Profession.

Under its existing mandate, the board has tussled with the SEC for several years in a row over its need for more funding to achieve what it’s already required to do. This year, the board submitted a budget to the SEC asking for a 16 percent increase in funding to add more staff. The SEC has not yet acted on that request.

Whatever is ahead for auditors and their regulators, it will involve some significant changes in 2010, Goelzer said. How right he is.