Thank you for inviting me to participate in this first gathering of the International Organization of Supreme Audit Institutions’ (“INTOSAI”) Task Force on the Global Financial Crisis.
As noted in the introduction, I am a member of the U.S. Public Company Accounting Oversight Board (“PCAOB”) and, as a matter of policy, I should inform you that the views I express today are my own and do not necessarily reflect the views of other Board members or our staff.
Given your background as auditors, and your representation of Supreme Audit Institutions from around the world, I thought I would divide my opening remarks into three segments.
First – I will discuss briefly a few of the issues we are currently considering at the PCAOB that I think may be of interest to you.
Second – I will address the specific topic of the panel, which is “Reforms, Transparency, and Accountability” in the context of President Obama’s proposal for “Financial Regulatory Reform,” as outlined in the Administration’s white paper of June 16, 2009.
Third – I will discuss some of the transparency and accountability issues that have arisen for the auditing profession and the PCAOB.
As I think most of you may know, the PCAOB was established in late 2002, in the wake of the auditing failures of Enron and WorldCom. The Sarbanes-Oxley Act mandated our mission “… to oversee the audits of public companies … to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports ….”
The Act outlines four primary areas of responsibility for the PCAOB:
First, we are required to register all accounting firms that audit public companies whose stock is traded on any U.S. exchange.
Second, we are required to conduct periodic inspections of those registered accounting firms and report the results of those inspections.
Third, we are required to establish auditing and professional practice standards for the preparation and issuance of these audit reports by registered firms.
Fourth, if there is a suspected violation of the Board’s standards or other applicable rules, the law authorizes us to conduct investigations of, and disciplinary proceedings against, registered firms.
In short, the PCAOB registers the auditors, sets the rules for the auditors, “audits” and issues reports on the auditors, and, when necessary, disciplines the auditors. Under the Act, the SEC has ultimate control over each of these Board functions, as well as its membership and operations.
PCAOB Issues of Interest to INTOSAI
Issues we currently are addressing that may be of particular interest to you include the inspections of non-U.S. domiciled auditing firms that have registered with the PCAOB, as well as our standard-setting activities, including efforts to address audit quality concerns in the current economic crisis.
One significant challenge for the PCAOB is driven by our global mandate. As of June 16 of this year, the Board had registered 2,033 auditing firms, with 1,121 U.S. firms and the remaining 912 firms located in 86 other countries. Many of the foreign firms have issued audit reports on companies with securities registered with the U.S. Securities and Exchange Commission and, therefore, are subject to the PCAOB inspection requirements.
Because auditor regulation is new or nonexistent in some parts of the world, it can take time to negotiate agreements to allow the necessary inspections to take place in some foreign countries. To date, we have established relationships with foreign counterparts that have enabled us to conduct 140 inspections of non-U.S. firms in 26 foreign jurisdictions, including in Asia, the European Union, Israel, and Latin America. Still, there are close to 130 non-U.S. firms located in 42 jurisdictions that the Board has yet to inspect.
Perhaps most important to achieving robust auditor oversight is the fact that, over the past six years, many countries have taken steps to strengthen their regulation of public company auditors. We all recognize the role that independent auditors play in protecting investors and the public interest in transparent capital markets. The PCAOB has served as a model for many countries that have created or enhanced auditor oversight. And, by virtually all accounts, the PCAOB has improved audit quality in the United States.
In addition to our inspection program, U.S. audit quality has been improved by the PCAOB work in standard setting. The Board has issued six new auditing standards -- including the well-known standard for auditing internal controls -- and we currently have eight proposed standards on risk assessment and engagement quality review.
The PCAOB works closely with the U.S. accounting standard-setting body, the Financial Accounting Standards Board (“FASB”) and considers the potential impact of changes in accounting standards on auditing practices and procedures. For example, following the FASB’s recent amendments to accounting standards on fair value, disclosures, and other-than-temporary impairments of certain financial instruments, the PCAOB issued a Staff Audit Practice Alert to focus auditors’ attention on the impact of those accounting changes on their reviews of interim financial information, audits of financial statements, evaluations of disclosures, and preparation of audit reports.
Earlier, the PCAOB issued Alerts on audit considerations in the current economic environment and on matters related to auditing fair value measurements of financial instruments and the use of specialists. Beyond this, we continue to consider whether changes in PCAOB standards on auditing fair value measurements are necessary or appropriate.
In addition, we are reviewing the FASB’s draft standard on “going concern” issues. In light of recent economic conditions, the auditor's consideration of going concern is likely to be of heightened interest to investors, who are looking for warning signs about a company’s ability to continue to exist.
Of course, we also continue to closely monitor developments in the international standard-setting arena, as we establish our future standard-setting priorities and projects.
Reforms, Transparency, and Accountability – President Obama’s Proposal
All of this work we are doing at the PCAOB is to fulfill our mandate as dictated by the Sarbanes-Oxley Act. One of the principles underlying that Act and its mandate to the PCAOB is that healthy financial markets depend on the public’s ability to receive reliable information about events and transactions that affect companies’ finances and operations.
To achieve the transparency and investor confidence necessary to maintain effective securities markets, the U.S. Congress imposed requirements, not only on public companies, but also on the auditors who examine and issue reports on whether those companies’ financial statements fairly present the companies’ financial health and positions.
The PCAOB’s role as overseer of public company auditors – one of the most important gatekeepers to our markets – makes the PCAOB an important contributor to the ongoing regulatory reforms.
On June 17th, President Obama said, “… we’re proposing a set of reforms to require regulators to look not only at the safety and soundness of individual institutions, but also – for the first time – at the stability of the financial system as a whole.” He added, “Consumers will be provided information that is simple, transparent, and accurate.”
The President’s remarks reaffirm the PCAOB’s mission and the importance of promoting and preserving a stable financial system that produces understandable and useful information for investors.
One of the keys to maintaining a stable financial system that includes transparent financial reporting is the quality of its auditing profession. The profession must be dedicated and strong enough to perform rigorous and independent audits; to withstand the pressures from some clients; and to issue unbiased reports that build public trust in the accuracy of the audited financial statements that are the foundation of investment and policy decisions.
In my view, assuring the viability of a high quality auditing profession requires that the PCAOB consider, not only the audit practices of the firms, but also the firms’ financial conditions. If another major audit firm were to fail, for any reason, the stability of the financial reporting system as a whole might very well suffer a shock, and investors’ faith in the quality and integrity of the information that fuels our securities markets could take another blow.
It seems incumbent on the PCAOB and our fellow auditor oversight bodies around the world to be on the watch for risk indicators of such a failure, and, if a failure occurs, be ready to take precise and sure action to respond in the best interests of investors.
This is directly related to issues of concentration and competition within the auditing profession. If the time comes when action is needed to address these issues, the Board should be in the position to be able to make decisions that are based on facts and hard evidence. To date, however, the PCAOB has not required the firms to provide the Board or the public with more than minimal data about their financial condition or their exposure to significant contingent liabilities. I believe we need to begin now to consider how to collect the information that we may need down the road.
Transparency and Accountability Issues at the PCAOB
The Board could achieve many of these goals I have been discussing, and those of the Administration’s regulatory reform plans, by encouraging the type of transparency and accountability that would help ensure a more stable financial system. For our part, as overseers of auditors, I support the PCAOB considering the following measures.
First, auditing firms in the United States should disclose key financial information about their businesses.
As most of you may know, in accordance with Article 40 of the E.U.’s Eighth Directive, E.U. statutory auditors are required to produce what are called transparency reports. In the United Kingdom, similar reports include audited financial statements. No such disclosures are required in the United States, in strange contrast to the auditors’ primary role of policing the financial disclosures of public companies. It is, at best, ironic that auditing firms in the United States, whose business is providing transparency, resist publicly providing their own financial statements.
Last year, an advisory committee on the auditing profession, sponsored by the U.S. Department of the Treasury, thoroughly considered issues affecting the sustainability of a strong and vibrant U.S. auditing profession. That committee recommended, among other things, that larger auditing firms submit confidential audited financial statements to the PCAOB. The co-chairs of that committee went farther, recommending that at least the largest auditing firms make their audited financial statements available to the public.
I believe that a regulator’s access to the firms’ financial information would allow the regulator to evaluate and better foresee the threats to the financial stability of the firms. This, in turn, would allow the PCAOB to anticipate the potential impact of any such threats on the operation of our financial system. Also, the PCAOB and other regulators, should the need arise, would be in a position to take appropriate steps to assure the continual flow of vital information and some certainty to the markets.
Second, I support consideration of a requirement that the firm partner with primary responsibility for an audit sign the audit report. The partner signature requirement is another practice that is common in the European Union and one that the U.S. Treasury Advisory Committee recommended for use in the United States. Supporters of this requirement believe that it fosters increased accountability, transparency, and audit quality. As a result, I believe that the PCAOB should consider whether to adopt it as a requirement.
In addition to placing new requirements on the firms, I believe that there are measures the PCAOB can take to improve its own accountability and transparency to the benefit of investors.
I would like to see the Board consider alternative methods to measure the quality of audits performed by registered firms. For example, U.S. bank regulatory agencies use what is known as the “CAMELS” rating system in evaluating a bank’s financial condition. The acronym stands for Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to market risk. Bank examiners assign a numerical rating of one to five for each of these categories and then assign an overall rating of the bank’s financial condition. Although the ratings are not public, they are used in making supervisory and regulatory decisions regarding a bank.
While the CAMELS criteria used by bank examiners would not be appropriately applied to auditing firms, it may be possible to define comparable factors for audit firms. A numerical rating system connected with those factors might provide the PCAOB and auditing firms with clearer communication of inspection results and more measureable remediation efforts. Even if the ratings were nonpublic, they could help PCAOB inspection teams document trends in firm practices and characteristics, which might become the subject of PCAOB profession-wide summary reports that are made public.
Further, the PCAOB has been evaluating how to better inform the public about the firms that fail to satisfactorily remediate deficiencies in their quality control systems. For example, we have been considering how to prominently note such firms on our Web site.
- The Board also has been studying how to clarify for investors, audit committees, and other interested parties which registered firms have been through a PCAOB inspection. I think it is fair to assume that most investors do not realize that, while the PCAOB has a little over 2,000 registered firms, we only inspect about half of those firms (a little over 1,000). Registered firms may not be inspected for a number of reasons but, regardless of the reason, the public should be able to distinguish easily between those that have participated in our rigorous inspection regime and those that have not.
- Finally, and perhaps most importantly, I believe that the decision-making process at a number of our governmental agencies should be more transparent. Too often, regulators hear overwhelmingly from the institutions they regulate. I believe that broad public participation -- including investor and consumer group representation -- should be institutionalized as part of the regulatory decision-making process, both here in the United States and internationally.
All of these recommendations you have heard me talk about today are variations on the themes espoused by the new U.S. Administration: transparency and accountability. I am pleased to report that the PCAOB is considering moving forward on a number of them.
Thank you again for inviting me to participate on the panel today.