Corporations, investors, and curious members of the public may soon get a whole new glimpse into who works on and approves company audits, and the auditing firms are none too happy about it.
The Public Company Accounting Oversight Board has published a proposal that would require audit firms to include in each audit report the name of the engagement partner who oversaw the audit, as well as the names of any individuals or outside firms that contributed to the audit. The idea is to give investors a better sense of exactly who performed the work they rely on to make investing decisions.
Audit firms have generally opposed the requirement, but they won a small victory in the current proposal when the PCAOB retreated from an additional requirement that the engagement partner provide a signature on the audit report.
The board published a concept release in 2009 looking for views on whether to require engagement partners to take pen in hand and sign the audit report. Investors cheered the signature requirement, believing it would prod engagement partners to be more diligent and improve audit quality. Audit firms, however, argued that the signature would focus responsibility and liability for the audit on a single person, when a much larger firm effort leads to the ultimate audit opinions. The PCAOB decided to drop the requirement, reasoning that perhaps disclosure of the engagement partner's name is a compromise.
The additional disclosure requirements on audit reports are far from a done deal, however. The five members of the PCAOB have differing views on whether naming the engagement partner will affect audit quality or if it will add to auditor liability. And the PCAOB is bracing for—even inviting—plenty of debate in the 90-day comment period on the proposal.
One of the plan's top backers, PCAOB Chairman James Doty, said investors in many countries already have access to the names of audit engagement partners. “I fail to see why shareholders in BNP Paribas, listed on the Euronext Paris exchange, should be able to see the name of the engagement partner in the audit report, but shareholders in Citigroup, listed on the New York Stock Exchange, should not,” he said during an open meeting last week proposing the amendments.
Board member Steve Harris said he would have preferred to press forward with the signature requirement. “Nothing focuses the mind quite like putting one's individual signature on a document,” he said. “I see no compelling reason not to follow the same approach that is used for CEOs, CFOs, board members, and lawyers—and for that matter, by virtually all professionals—by having audit engagement partners sign their names to the reports that have been prepared under their supervision.”
Yet board member Dan Goelzer was not nearly as convinced. “Disclosure of the engagement partner's name could have an impact on his or her personal liability,” he said at the PCAOB meeting. Yes, that might give engagement partners an incentive to perform more diligently, he said, but it also could increase audit costs without increasing quality, or discourage “competent and careful practitioners” from accepting engagements on high-risk audits. “I do not believe that the board should adopt this proposal without understanding, to the fullest extent possible, how it would affect liability and weighing the liability effects as part of its decision.”
“It's about time. Whoever is responsible for the audit report ought to be clear and transparent. That's information that should be available to investors.”
—Gaylen Hansen,
Partner,
Ehrhardt Keefe Steiner & Hottman
Doug Carmichael, a member of the PCAOB's Standing Advisory Group and former chief auditor at the PCAOB, is hard-pressed to see how naming the engagement partner could increase liability. If a lawsuit is permitted to go forward to discovery, plaintiffs will learn the names of everyone on the engagement team, he says. “I don't see why the public disclosure would change the liability,” he says.
“It is a positive step as opposed to requiring the engagement partner to sign the opinion, but it still focuses on one person, which still could detract from the firm-wide approach,” says Cindy Fornelli, executive director at the Center for Audit Quality, an audit industry think tank. She adds, however, that she needs more time to study the proposal and consider the implications of disclosure compared with the signature requirement.
In addition to liability, auditors also worry about the business implications of naming engagement partners in the audit report. The board acknowledged that the requirement will enable investors to research which engagement partners are linked to problem audits or have faced disciplinary actions. Trent Gazzaway, managing partner at audit firm Grant Thornton, says engagement partners could face public scrutiny over audit opinions—for example whether a going-concern warning should have been issued against a company that subsequently fails—with no chance to defend their decisions. “There's a risk that the audit partner's name is going to get bandied about in the press and other places without an opportunity to present their side of the case,” he says.
JAMES DOTY STATEMENT
In the excerpt below, PCAOB Chairman James Doty speaks on the proposed amendments to improve transparency through disclosure of the engagement partner in audits:
The Sarbanes-Oxley Act of 2002 charged the PCAOB with protecting the interests of investors and furthering the public interest in the preparation of informative, accurate and independent audit reports. In furtherance of that mission, I support proposing to amend the standard auditor's report to include disclosure of the engagement partner assigned to the audit.
The names of key management executives, not to mention corporate board members, have long been disclosed. The names of audit engagement partners are also disclosed in many countries, but to this point not in the United States.
I fail to see why shareholders in BNP Paribas, listed on the Euronext Paris exchange, should be able to see the name of the engagement partner in the audit report, but shareholders in Citigroup, listed on the New York Stock Exchange should not. Indeed, the names of engagement partners for some European companies that are listed on the NYSE are disclosed in U.S. filings. Why are shareholders in France Telecom to be favored over shareholders in AT&T?
The project has come a long way since the Board first tabled questions, in the form of the July 2009 concept release, on whether the PCAOB should require an engagement partner to sign his or her name on the audit report.
I understand the objections we received to requiring engagement partner signature, most notably that the change could unintentionally imply a reduction in the firm's overall responsibility for the audit and the audit opinion. Our audit standards set forth the responsibilities of the auditor. This proposal does not change the responsibilities of the audit firm or the engagement partner. In the view of thoughtful commenters, a signature requirement could detract, to the public's view, from the responsibility of the audit firm.
This leads to the second part of today's proposal, to provide investors disclosure about other accounting firms and certain other participants in the audit. On large, multi-national audits, multiple partners in multiple offices, and even multiple firms, may participate and share responsibility for various aspects of the audit.
For many large, multi-national companies, a significant portion of the audit may be conducted abroad—even half or more of the total audit hours. In theory, when a networked firm signs the opinion, the audit is supposed to be seamless and of consistently high quality. In practice, that may or may not be the case. Shining a light on the composition of the multi-national audit should reward consistent high quality where delivered.
I am concerned about investor awareness. I have been surprised to encounter many savvy business people and senior policy makers who are unaware of the fact that an audit report that is signed by a large U.S. firm may be based, in large part, on the work of affiliated firms. Such firms are generally completely separate legal entities in other countries.
Enhanced transparency into the composition of cross-border audits should help investors gain a better understanding of how an audit was conducted and make more informed decisions about how to use the audit report.
Source: PCAOB Chairman James Doty Statement.
As for enhancing audit quality by giving engagement partners an increased sense of duty, Gazzaway says engagement partners already know that every audit will or could be subject to the engagement quality review process, internal inspections, PCAOB inspections, Securities and Exchange Commission reviews, and even discovery as part of litigation. “Every partner knows their career is on the line every time they sign an audit opinion,” he says. “Someone at some point in time is going to look over their shoulder.” He says it's not clear how naming the engagement partner in the audit report will increase that sense of duty, but he's open to the dialogue.
Pulling Back the Curtain
In addition to naming the engagement partner, the PCAOB proposal would also require audit firms to list any outside individuals or firms that contributed in any meaningful way to the audit effort. The PCAOB wants to pull back the curtain on audit firms it can't currently reach through its registration and inspection process, especially overseas firms where the PCAOB has been barred from performing inspections. Disclosing those other audit firms would give investors a better sense of how much of an audit is being done by people or firms beyond the PCAOB's regulatory scrutiny.
The PCAOB has learned through its inspection process that many large audit firms sub-contract significant portions of an audit for global companies, especially when most of the client company's operations are outside the United States. Through its staff alerts, the PCAOB has already warned audit firms that they need to do a better job of scrutinizing that overseas work that they fold into their audit opinions.
“In theory, when a networked firm signs the opinion, the audit is supposed to be seamless and of consistently high quality,” Doty said. “In practice, that may or may not be the case. Shining a light on the composition of the multinational audit should reward consistent high quality where delivered.” Doty says he's been surprised to encounter savvy business people and senior policy makers who were unaware that audit reports signed by large U.S. audit firms might be based largely on the work of affiliated firms.
Gaylen Hansen, a partner with regional audit firm Ehrhardt Keefe Steiner & Hottman, says he supports such a requirement. “It's about time,” he says. “Whoever is responsible for the audit report ought to be clear and transparent. That's information that should be available to investors.”
Lynn Turner, former chief accountant at the SEC, says identifying outside participants in the audit report will give audit firms an incentive to supervise their work more closely. “Once they are identified, I believe they will feel more risk of being held accountable for sub-standard work, which they should be,” he says.
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