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 Statement on Proposed Amendments to Improve Transparency Through Disclosure of Engagement Partner and Certain Other Participants in Audits 

DATE: Oct. 11, 2011 
SPEAKER: Jay D. Hanson, Board Member 
EVENT: PCAOB Open Board Meeting 
LOCATION: Washington, DC 

Introduction

The Board is issuing today proposed amendments to its standards to improve the transparency of audits, including by requiring firms to disclose the name of the engagement partner in the audit report and on the PCAOB's Annual Report Form, and by requiring firms to disclose in the audit report other persons and independent public accounting firms that took part in the audit.

I agree with my fellow Board members and the PCAOB staff that the proposed amendments would improve transparency and provide valuable information to investors and the public. As the Board described in its June 21 concept release on potential changes to the auditor's reporting model, investors have been clamoring for more information from auditors about what they do, how they do it, and what it means. We are continuing to gather input on the issues raised in the June concept release and will consider them carefully as we determine our next steps relating to the auditor's report. In the meantime, the amendments we are proposing today represent a positive step in the direction of enhancing the information provided to investors about audits and those involved in the audit process.

I want to turn first to the disclosure of other firms and accountants that participated in the audit.

Identification of Other Accountants and Firms

The Board is proposing amendments to PCAOB standards that would require firms to disclose in the audit report other independent public accounting firms and individual accountants not employed by the auditor that took part in the current-period audit, as well as their locations and certain information about the work performed by those other firms or accountants. Many investors have expressed strong interest in this information. Others may be unaware of the degree of involvement in audits by firms or accountants other than the firms issuing the opinions, and these investors may be surprised by the implications on both the audits themselves and our ability to inspect the firms participating in those audits. Because I believe the proposal serves important transparency interests and should not impose undue burdens on the firms, I support the proposal.

The disclosures we are proposing are particularly important in the context of audits of companies with multi-national operations. In such audits, the auditor issuing the audit report frequently refers certain audit procedures to firms or accountants located in other countries. Currently, investors have little or no information about whether other firms or accountants participate in such audits or about the identity or role of such other firms or accountants in conducting the audit procedures that ultimately support the opinion of the firm issuing the report. In some cases involving multi-national audits, the other audit firm is unrelated to the firm issuing the opinion. In other cases, the firm issuing the audit report and the other firm are members of an international network, which may subject both firms to similar governance and quality control procedures. Currently, investors have little or no insight into which of these scenarios applies.

Moreover, even where the other firm is a member of the international network of the firm issuing the audit report, the network affiliate firm may be subject to different, and potentially conflicting, legal and regulatory requirements that investors may want to consider in evaluating the overall audit.

Identifying in the audit report other firms or accountants that participated in the audit also will permit investors to consider other relevant information available about that auditor. This may include basic information such as the size of the firm or the expertise and experience of the firm or the accountant. Investors also may want to consider whether the firm is registered with the PCAOB, whether the firm is subject to PCAOB inspection, and, if so, whether the firm has been inspected, and its inspection results, information that is available on the PCAOB website.

Moreover, in light of the obstacles that have prevented PCAOB inspections of firms located in certain jurisdictions in Europe, China and Hong Kong, investors may be particularly interested in knowing when a firm that participated in the audit is located in one of these jurisdictions, and if so, the significance of that firm's role in the audit.

The proposed standards would require the firm issuing the audit report to disclose a measure of the significance of the work performed. No measure is perfect. We have chosen in this proposal to require disclosure of the percentage of total audit hours attributable to the respective firm where the auditor issuing the report supervises or takes responsibility for the work of the firm. Where the auditor issuing the audit opinion divides responsibility for the audit with another firm, the disclosures under the proposed amendments would not change from those currently required by our standards in AU section 543: The auditor issuing the opinion would have to disclose the magnitude of the portion of the financial statements audited by the other firm by stating the dollar amounts or percentages of assets, revenues, or other appropriate criteria.

These measures may not fully capture the actual importance of the other firm's or other accountant's role in the audit, as the measures do not perfectly correlate with audit risk or specific amounts reported in the financial statements. However, given that most auditors already track audit hours and routinely provide the information required by AU section 543 in situations of divided responsibility, I believe that it is reasonable to ask auditors to include this information in the audit report. The release notes that estimates may be necessary to complete the disclosure, which should make it easier for auditors to provide the necessary disclosures for work that was conducted close to the end of the audit.

On the other hand, providing more detailed information about the relevance and significance of the other firm's or accountant's work, potentially in narrative form, would present practical difficulties and could significantly increase the cost of compliance. I believe that the proposed measures will provide investors with important information about the level of involvement by the other firm or accountant in the audit, without imposing an undue burden or unjustified expense on the auditors involved. I am interested in hearing during the comment period whether we struck the right balance in this regard.

Engagement Partner Identification

We are also proposing today to require the disclosure of the identity of the engagement partner in the audit report and in the annual report filed by firms with the Board.

I support the issuance of this proposal for public comment because I believe the disclosure would provide investors with relevant information. However, I have significant reservations about whether naming the engagement partner in the audit report could increase the liability faced by engagement partners, which I believe could unreasonably increase the potential cost of compliance with the requirement and potentially outweigh its benefits. I believe the Board must thoroughly explore this issue before issuing a final standard.

In 2009, the Board issued a concept release to solicit comment on whether the Board should require the signatures of audit engagement partners on the audit report. In response, we received comments supporting such a requirement as well as comments in opposition. I agree with those commenters who pointed out that engagement partners already feel a great deal of responsibility for the audits they perform, even in the absence of a requirement that they personally sign the audit report. In my experience, most engagement partners understand their public interest obligations and take seriously the responsibility they assume when they allow an audit report to be issued by their firm.. The work of engagement partners is governed by auditing standards as well as their firm's respective quality control policies and procedures. They perform their duties knowing that their work will be reviewed by an engagement quality reviewer and will be subject to internal firm and external PCAOB inspections. They also understand that their firm's reputation is on the line, and that the issuance by the firm of an opinion on financial statements later determined to be misstated could risk the financial well-being of the firm's partners and employees in the event of litigation. Ultimately, those individuals who stray from their obligations despite all of these incentives may face the specter of regulatory enforcement proceedings and the subsequent loss of their ability to practice in their profession.

I believe we should respond to the needs of investors, who have told us that the identity of the engagement partner is valuable information that would aid their understanding of and ability to evaluate the audit. Providing that information by identifying the engagement partner in the audit report and in the firm's annual report filed with the Board should not, in my view, cause any fundamental changes in the role of the engagement partner or diminish the important role played the firm and its management and quality control processes in the audit process. Therefore, with one important caveat, I support the proposal to require the identification of the engagement partner in the audit report and in the firm's annual report filed with the PCAOB.

As I noted above, I am concerned about whether identifying the engagement partner in the audit report could increase the individual liability of engagement partners in civil litigation. We have heard a variety of views on this issue, and it appears that there is uncertainty about the extent of increased engagement partner liability the proposed disclosure would create.

I agree with the 2008 recommendation made by the Advisory Committee on the Auditing Profession to the U.S. Department of the Treasury that Board action in this regard should not impose on the engagement partner "any duties, obligations or liability that are greater than the duties, obligations and liability imposed on such person as a member of an auditing firm."[1]

As the ACAP report noted, the SEC in 2003 issued rules relating to the disclosure by companies of their audit committee financial experts pursuant to Section 407 of the Sarbanes-Oxley Act. In connection with its decision to create a safe harbor from liability for individuals who are designated as the audit committee financial experts, the SEC pointed out that directors of public companies bear significant responsibilities and face potential liability in connection with their obligations to shareholders.[2] The SEC stated:

We . . . believe that it would adversely affect the operation of the audit committee and its vital role in our financial reporting and public disclosure system, and systems of corporate governance more generally, if courts were to conclude that the designation and public identification of an audit committee financial expert affected such person's duties, obligations or liability as an audit committee member or board member. We find that it would be adverse to the interests of investors and to the operation of markets and therefore would not be in the public interest, if the designation and identification affected the duties, obligations or liabilities to which any member of the company's audit committee or board is subject.

I believe that the same considerations apply in the present case. As I noted above, many incentives exist for engagement partners to perform at the highest levels. They already face potential liability, at the firm and individual level, in private litigation or in connection with PCAOB and SEC enforcement actions. Nothing in our proposal today is intended to create any fundamental changes in the existing role or responsibilities of the engagement partner. We do not have the authority to issue a safe harbor from liability for engagement partners; we also should not exercise any authority that would have the opposite effect by creating new liabilities.

I am therefore particularly interested in comments about whether the proposed requirement is likely to increase the potential liability of engagement partners. Ultimately, whether I support a final standard requiring disclosure of the identity of the engagement partner in the audit report will depend in large part on the input received and clarity about the extent of any increase in engagement partner liability as a result of our actions.

I am also interested in comments about our proposal to require disclosure of the identity of engagement partners in the firms' annual reports filed with the Board. Because the concerns about an increase in potential liability for engagement partners do not appear to apply to regulatory filings with the Board, one option for the Board may be to adopt this requirement alone. Would investors benefit from this disclosure, in the absence of the disclosure of the engagement partner in the audit report? Are there any potential unintended consequences should the Board decide to do so?

In closing, I would like to add my appreciation to that already expressed by my fellow Board members for the hard work on this project by members of the Office of the Chief Auditor and the Office of General Counsel. You frequently find yourselves on the receiving end of strongly held views and, occasionally, conflicting requests, in response to your recommendations. As always, you have responded to our myriad comments by crafting a well-balanced and carefully considered document that I anticipate will spark thoughtful comments for the Board's consideration.

I would also like to thank the staff of the SEC who took time to provide input as we considered the provisions of the proposed amendments.

Finally, I would like to thank all of those who provided comments on the engagement partner signature concept release, and I encourage all of you to continue to participate in this important dialog.


[1] U.S. Department of the Treasury, Final Report of the Advisory Committee on the Auditing Profession to the U.S. Department of the Treasury, VII:19, VII:20 (2008).

[2] See SEC, Final Rule: Disclosure Required by Sections 406 and 407 of the Sarbanes-Oxley Act of 2002, Release No. 33-8177 (Jan. 23, 2003).

 

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