The inadvertent disclosure of an investigation by the Public Company Accounting Oversight Board into Deloitte & Touche’s 2003 audit of truck maker Navistar International Corp. raised eyebrows recently as the first formal probe of a Big Four firm by the Board. But the probe should be of interest to public companies for another reason: It raises an important issue regarding the disclosure of PCAOB investigations by auditors to their public company clients.
News of the Board’s investigation surfaced in a Bloomberg report earlier this month, after the Securities and Exchange Commission—which oversees the PCAOB—inadvertently disclosed the probe when a confidential document ended up in a public file.
As promulgated by Section 104 of The Sarbanes-Oxley Act of 2002, the PCAOB is required to inspect registered public accounting firms on a regular basis. Part of the Board’s inspection process includes the review of selected audit engagements.
However, the PCAOB doesn’t disclose which issuer files are pulled during its inspections of accounting firms, and auditors aren’t required to inform a client that its file was pulled.
But under the Board’s rules, auditors aren’t barred from telling clients that their files were pulled, either. That raises the question of whether auditors should inform public companies if their audit is being looked at, and if so, at what point?
“Up To The Auditor”
When asked why the PCAOB doesn’t require that a company be notified if their audit is being looked at during an inspection, Christi Harlan, the Board’s director of public affairs, told Compliance Week, “The fact that the Board selected an engagement to look at carries no significance. There’s no one particular reason for any audit to be pulled [during a board inspection]. Audit selection could be for a variety of reasons.”
Harlan said the rules provide for an informational filing with the SEC in the event that the Board authorizes an investigation—which is apparently the document that Bloomberg found in the case of the Navistar probe. But such filings are normally confidential. Harlan could not confirm or deny that the PCAOB sent anything related to an investigation to the SEC.
But Harlan emphasizes that each accounting firm needs to determine whether its clients should be aware of a PCAOB review of their audit. “If there is a problem with an audit, the inspection team talks with the auditors,” said Harlan. “It’s up to the auditors to decide whether the information should go to the client.”
Grunfeld
Raphael Grunfeld, a partner with New York-based law firm Carter, Ledyard & Milburn, noted that since the PCAOB has the authority to interview both the auditor and a company’s audit committee in connection with an engagement, the auditor may want to inform its client of an issue before the board does.
“If, during an inspection, the PCAOB raises an issue with a certain accounting approach or the way accounting principles were applied, the auditor may want to pick up the phone to the audit committee and tell them that they may get a call from the PCAOB, and tell them to cooperate,” said Grunfeld.
A Matter Of Prudence
But that isn’t to say that the auditor should notify every client whose file gets pulled for review during an inspection, says Grunfeld. Like many SEC investigations, a significant portion of PCAOB inspections are expected to fall under the category of “not material.”
However, if the audit review appears to escalate, Grunfeld says it would be wise to inform the client. That’s particularly the case when there are disagreement between the auditor and the PCAOB, or if the board “expressed dissatisfaction with an engagement and it seems likely that they would like to speak to the company about it,” said Grunfeld. “Tell the client to tell the truth, to hide nothing,” he adds. “Tell them that’s a routine PCAOB inspection.”
Still, Grunfeld notes that auditors don’t need to ring the alarm bells simply because the PCAOB took a different position than the accounting firm. “There are a lot of gray areas where the Board can take one position, and an accounting firm can take another,” he says.
Romanek
Others disagree, arguing that public companies should insist on being informed of any inspection of their independent accounting firm that relates to their audit. One such person is former SEC staffer Broc Romanek.
“I believe companies should be demanding that their independent auditors inform audit committees when the PCAOB is reviewing a company's file during a PCAOB inspection of the auditor,” wrote Romanek in a recent ‘blog entry that he maintains as editor of TheCorporateCounsel.net.
Romanek went so far as to imply that corporate directors may be obligated to seek that information. “Some might argue that a board might even have a duty to be at least asking for this type of information as part of its duty of care, as it should be aware if a regulator is questioning its application of the auditing standards,” wrote Romanek.
According to Romanek, at least one company has included language in the engagement letter with its auditor requesting to be informed of such PCAOB reviews (see sample wording at left).
Fletcher
However, Vinson & Elkins partner Scott Fletcher doesn’t necessarily agree with the position outlined by Romanek. “I don’t think audit committees or boards ought to be under any duty to demand this information from auditors,” said Fletcher. “If it’s a serious matter, the client ought to be informed, but I’m not sure they have to be informed of every routine inspection—it strikes me that it would create a lot of make work that isn’t necessary.”
Instead, he thinks the decision to inform clients should be made on a case-by-case basis. “If it turned into a formal [PCAOB] investigation, as a matter of prudence, the auditor would want to let the client know at that point, just as the client would let the auditor know if they are the subject of formal investigation by the SEC,” said Fletcher.
The original Bloomberg article on Navistar, as well as related coverage from Compliance Week and the relevant PCAOB rules, is available from the box above, right.
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