Mr. Chairman, I commend you for taking on this issue of modernizing the auditor's report and support the timeline for consideration you have laid out.
Our mandate from the Sarbanes-Oxley Act 2002 is "…to protect the interest of investors… in the preparation of informative, [accurate and independent] audit reports…" and, I believe this project is an important step to the Board's fulfilling that directive.
Last Wednesday, at our PCAOB Investor Advisory Group (IAG) meeting, Professor Joe Carcello made, what I thought, was a compelling presentation for improving the auditor's report. Fellow IAG members Gus Sauter of Vanguard, Norman Harrison (formerly) of Breeden Capital, and Ann Yerger of the Council of Institutional Investors joined Professor Carcello in making this presentation. Also participating in the research and preparation of the presentation were Brandon Becker of TIAA-CREF, Michael Head of TD Ameritrade, Bonnie Hill of Icon Blue, Peter Nachtwey of Legg Mason, Anne Simpson of CalPERS, and Eric Vincent of Ospraie.
As part of their research, the group surveyed 300 leaders from investment banks, hedge funds, private equity funds, mutual funds, endowments and pension funds on the usefulness of the current auditor's report and suggestions for improvements that might better serve investors' needs. Responses to this survey represented well over eight trillion dollars under management. Some of the major points I took away from that presentation included the following:
- Most investors responding to the survey believe the current auditor's report does not provide valuable information that is integral to understanding the financial statements;
- Investors want auditors to discuss their assessment of management's estimates and judgments and how the auditors arrived at that assessment; and
- The majority of investors would also like more information regarding:
- areas of high financial statement and audit risk,
- unusual transactions, and
- the quality of an issuer's accounting practices and policies.
During the discussion that followed, I was struck by Anne Simpson's, of Calpers, depiction of the auditor's report for 2008, 2009, and 2010 for one of "the many companies that were the recipients of TARP [funds]." As she held copies of each year's report up for the people around the table to see, she described the reports as "word for word, exactly the same" with the 2008 report costing $119 million and the 2009 report costing $193 million. She went on to say, "I think [this example] really gives a sense of the urgency of tackling this issue."
Investor representatives point to the TARP recipients and a significant sampling of failed financial institutions during the financial crisis, where investors lost hundreds of billions of dollars, and wonder why virtually every one of them received unqualified opinions.
They ask why shouldn't auditors disclose to investors the same significant risks they disclose to audit committees? And, why shouldn't this information be disclosed to them directly instead of being funneled through management and audit committees.
As well, they ask whether auditors understand that under the law, they – as opposed to management or audit committees -- are the auditors' primary stakeholders.
As has been previously mentioned, questions about the usefulness of the auditor's report have been around for decades. For example, in 1978, the Cohen Commission studied the auditor's report and concluded that:
"For the largest corporations in the country, an audit may involve scores of auditors and tens of thousands of hours of work for which the client may pay millions of dollars. Nevertheless, the auditor's standard report compresses that considerable expenditure of skilled effort into relatively few words and paragraphs."
So, as far back as 1978, Manuel Cohen, was making essentially the same point as Anne Simpson made last week.
In a 2006 report, the CEO's of the six largest audit firms acknowledged that:
"…users of financial information may demand… to receive more finely nuanced opinions from auditors about the degree of a company's compliance with a given set of standards, or the relative conservatism of judgments compared to peer groups."
The CEO's went on to say,
"…investors even may want the auditor's views about the overall health and future prospects of the companies they audit."
So, even leaders of the profession foresaw the likely need and demand of investors for more information.
More recently, in 2008, the Treasury Department's Advisory Committee on the Auditing Profession urged the PCAOB to " undertake a standard-setting initiative to consider improvements to the auditor's standard reporting model."
As has been pointed out, dissatisfaction with the current auditor's reporting model is not limited to the United States. The European Commission has released a Green Paper calling for improvements in communication between auditors and investors. And the UK's Financial Reporting Council has issued new reporting proposals "…so that Annual Reports, including audited financial information, deliver greater value to investors and serve the public interest better."
Once again, I want to commend you, Mr. Chairman, former Chairman Goelzer, the Board, — and Marty and his team — for making this issue a priority for the Board and for an approach that includes a comprehensive outreach to solicit input from a wide variety of interested parties including — investors, issuers, audit committees and auditors.
As I mentioned at the outset, I support and look forward to meeting the timeline that has been laid out for our consideration of this issue,
I would be remiss if I did not recognize the efforts of Jennifer Rand, Dan Mutzig, Jessica Watts and Diane Jules from Marty's staff and Bob Burns and Nina Mojiri-Azad from the Office of General Counsel.