Statement on Adoption of Rules to Require Disclosure of Engagement Partner and Other Firms Participating in an Audit

Mr. Chairman – Congratulations to you and all involved on bringing this initiative to a final vote this morning. Without your patience, persistence and leadership I do not believe this transparency project could have succeeded.

This issue has been before the Board, in one form or another, since at least 2009 following President George W. Bush's Treasury Advisory Committee on the Auditing Profession recommended that the engagement partner be required to sign the auditor's report.^[1]

This is now the Board's fifth open meeting on this subject and my views concerning this topic are reflected in my previous open meeting statements.^[2] The Board has heard from a number of constituencies, each of which has strongly held perspectives on the subject.

Investors and regulators alike do not believe that audit quality is where it should be.^[3] Investor representatives believe that requiring a signature on an audit report would increase an engagement partner's sense of accountability and responsibility, and hence prompt positive changes in his or her behavior, all in the service of improved audit quality.^[4]

I should add that the same reasoning compelled the drafters of the Sarbanes-Oxley Act to include a provision mandating a personally signed certification from the chief executive officer (CEO) and chief financial officer (CFO) with the quarterly and annual reports filed with the Securities and Exchange Commission (SEC or Commission) wherein the executives certify, as the auditor does in the audit opinion, that the financial statements conform to generally accepted accounting principles (GAAP) and fairly present the financial condition and results of operations of the company.^[5]

On the other hand, the audit profession believes that while an engagement partner is the member of the audit engagement team with final responsibility for the audit, the audit is the result of a group effort.^[6]

My position is well known. I see no reason why auditors should be treated any differently from other professionals—such as architects and engineers—who must sign off on their work product or, as mentioned, CEOs and CFOs who are similarly required to attest to their company's financial statements. I also agree with investors that engagement partners should be held individually accountable for the audit work and ultimate result of the audit engagements they are responsible for supervising.^[7]

Since 2009 this Board has heard a number of arguments against our signature proposal and related disclosure proposal which provided auditors with the option of placing their names in the auditor's report instead of signing it. The most persistent of these arguments is the assertion that engagement partners would have to contend with heightened liability concerns if their names appear in the auditor's report.

It is worth noting that all the liability arguments that we have heard have been premised on the idea that the engagement partner should not be liable for deficient audits that harm investors, even if those audits are carried out so recklessly as to meet the legal standard for fraud. But it is not clear, to me at least, why this should be the Board's goal. As Brandon Rees, Deputy Director of the Office of Investment for the AFL-CIO, stated in his comment letter:

Many audit firms have objected that requiring engagement partners to personally sign or disclose their names in audit reports may result in enhanced legal liability under Section 11 of the Securities Act of 1933. However, from the standpoint of investors, imposing Section 11 liability on auditors for material omissions or misstatements is beneficial. Auditors may limit their Section 11 liability by conducting audits with appropriate due diligence, and this will create an incentive for improved audit quality.^[8]

As Anne Simpson, Investment Director of CalPERS, succinctly put it in her comment letter:

The fact is that a signature alone would not increase liability. Liability is created when there is a problem with the audit, not when the auditor signs the audit report...When there is a high quality audit there is no fear of liability. If the audit falls short, investors should have adequate recourse.^[9]

Second, these arguments seem to assume that engagement partners today face no liability. But the SEC and PCAOB can and do pursue disciplinary actions against engagement partners who fail to carry out their responsibilities.^[10] And, while Janus^[11] and other Supreme Court decisions may have limited engagement partners' potential liability in private federal court actions, as James D. Cox, Brainerd Currie Professor of Law, Duke University School of Law, explained in his detailed comment letter, state law actions against an engagement partner, although "rare," can be maintained and in such an action –

that partner's signing or not signing the opinion letter is of no consequence in determining the auditor's or his/her firm's liability to a relying plaintiff. That is, changing audit procedures to require the engagement partner to sign or otherwise identify himself/herself will not change the contours of the auditor's liability under existing state law.^[12]

Finally, there are other, more practical reasons to think that engagement partner transparency will not significantly affect those partners' litigation risk. As others have noted, the primary reason why engagement members are not included as defendants in private civil litigation is due to the general perception that they do not have sufficient assets to satisfy any judgment, not because their identity is unknown or because legal theories of potential individual liability are absent.

The bottom line is that engagement partner disclosure will neither significantly change the liability landscape, nor create adverse, unwarranted consequences.

The last time this issue came before the board I mentioned that requiring the engagement partner's name to be disclosed in a new form, as opposed to the auditor's report, "would isolate the United States from an emerging global consensus on the manner in which the name of the engagement partner should be disclosed."^[13] This is not just a matter of opinion but a well-documented fact. 16 out of the 20 countries with the largest market capitalization (80 percent), including 7 European Union member states, already require disclosure of the name of the engagement partner in the auditor's report^[14] and I continue to believe that investors in the United States are entitled to the same.

For me, this issue has always been more about improving audit quality, which is not where it should be, by enhancing and influencing a leader's sense of individual accountability and acceptance of responsibility for a team effort he or she has led by signing his or her name to a most commonly reviewed report, as opposed to simply being identified in a newly developed form.

However, I understand that reasonable people may agree to disagree, which is why I support today's compromise which will result in the creation of a new standardized form – the Form AP, the "AP" standing for "Audit Participants."

As a result of this proposal, audit firms will now be required to identify the audit engagement partner for a particular audit on this form rather than the audit report, which is the primary vehicle by which the auditor communicates with investors about the audit. Furthermore, the audit report is available upon filing with the Commission while Form AP can be filed up to 35 days after it is included in a document filed with the Commission.

The information in Form AP will be available on our website, which will provide investors, audit committee members, and other interested parties with an opportunity to evaluate and compare the performance of individual engagement partners as well as other participants in the audit.

Some of the benefits of identifying the engagement partner on a standardized form include, over time:

• Providing investors with a means to determine whether certain engagement partners have been associated with adverse audit outcomes that could be attributed to deficiencies in their audit work or have been sanctioned by the PCAOB or SEC.

• Enabling investors to understand how much of the audit was performed by the firm issuing the report and how much was performed by other firms, including those practicing in jurisdictions where the PCAOB has been unable to conduct inspections.

• Revealing to investors for the first time situations in which the engagement partner has been replaced before rotation was required. And,

• Reinforcing the engagement partner's sense of professional responsibility and accountability for the quality of the audit through awareness that his or her name can be publicly associated with the audit that he or she supervised.

In addition:

• As the disclosed information is aggregated and analyzed in conjunction with other publicly available information, investors will gain valuable data about the conduct of engagement partners. And,

• Investors will be able to make more informed decisions when asked to ratify the company's independent auditor. Currently, investors are provided only with the name of the firm and fees paid to the auditor when asked to ratify the auditor. Following the adoption of the proposed rules, investors will also have the name of the engagement partner and information about the other participants in the audit prior to voting on whether to ratify the auditor.

In addition, I would like to believe that the identification of the engagement partner would serve to enhance the reputation of partners whose engagements are not associated with restatements or enforcement actions, thereby creating incentives that promote audit quality and investor protection.

I also support requiring audit firms to disclose the names and locations of any other firm that provides at least 5 percent of the total audit hours for any given audit report.

Currently, audit quality differs materially among various countries and this additional disclosure will, as Jeffrey Johanns of the University of Texas says, allow "users of financial statements to understand which public accounting firms are actually performing the audit work and where they are located, because many recent accounting fraud cases in the U.S. have involved poorly supervised foreign firms performing low quality audits."^[15]

Mr. Chairman, after more than six long years of contentious debate on this subject, I am glad we are now able to get this issue behind us and move forward to finalize other longstanding proposals such as:

• Modernizing the outdated audit reporting model. And,

• Improving auditor going concern reporting under Section 10A of the Securities Exchange Act of 1934.

Allow me to offer a brief word about each.

The auditor's reporting model remains a high priority of mine because it is the primary means by which investors and other stakeholders acquire information about the audit. In its current incarnation, the auditor's report conveys minimal information about the data obtained and evaluated by the auditor as part of the audit. The report has changed very little since the 1940s. Investors contend that it must be updated to provide additional information that will make it more relevant and useful to investors and other stakeholders – and I strongly agree.

As with the identification of the engagement partner, I would note that the United States lags behind much of the rest of the world in this area as well. I mentioned this as another top priority of mine upon first joining the Board in 2008. American capital markets are an international resource as well as a major force within the U.S. economy. The cornerstone of our capital markets has been our strong commitment to transparency and investor protection. Improving the audit reporting model would be in keeping with that commitment.

With respect to going concern, investors do not understand how so many large companies that were significantly affected by the events in the recent financial crisis received clean opinions from their auditors.

Nor do they understand how it is possible that out of the 25 largest issuer bankruptcies that occurred between fiscal years 2003-2012– representing a combined market capitalization of approximately $70 billion – only three received a going concern opinion in their most recent audit report before filing for bankruptcy protection^[16], which raises the question "where were the auditors?"

In August 2014, the Financial Accounting Standards Board (FASB) updated U.S. generally accepted accounting principles to establish new requirements for a management going concern assessment and related financial statement disclosures. ^[17] If the PCAOB were to follow FASB's threshold for "substantial doubt" in the auditing standards, it would result in auditors issuing even fewer going concern opinions; in other words, more clean opinions, notwithstanding the recent financial crisis.^[18]

The PCAOB, however, must adhere to a different obligation than the FASB. Section 10A of the Securities Exchange Act requires auditors to include "an evaluation of whether there is substantial doubt about the ability of the issuer to continue as a going concern during the ensuing fiscal year."^[19]

This provision was enacted into law in 1995 in response to the savings and loan crisis which cost the American taxpayer some $132 billion and was intended to give investors an "early warning" before a company's financial difficulties became severe.^[20]

Given the expectation of investors and the legislative history of Section 10A^[21], I feel strongly that the Board should take meaningful steps to improve auditor going concern reporting as soon as possible, including specifying what kind of early warning disclosure investors should expect from auditors in the future. This subject has been repeatedly discussed by the Board's Investor Advisory Group in 2011, 2012, 2014 and 2015.[22] And, this issue has been taken up internationally.^[23]

But, taking one step at a time, at this point I am pleased that we have at long last concluded this transparency project, and that investors will soon know the name of the engagement partner as well as the other participating firms on a particular audit.

As I mentioned at the outset, Mr. Chairman, without your leadership, I do not believe we would be finalizing this initiative today, and I commend you and my fellow Board members for bringing this to a vote this morning.

I would like to thank Marty Baumann, Jennifer Rand, Jessica Watts, Karen Wiedemann, and Lisa Calandriello from our Chief Auditor's office, Andres Vinelli and Morris Mitler from our Center of Economic Analysis, Gordon Seymour and Vince Meehan from our Office of General Counsel, Sarah Williams and Karl Heermann from the Division of Registration and Inspections, and Nirav Kapadia and Steve Raia from our Office of Information Technology for their tremendous work on this project. I look forward to a productive year of standard setting in 2016.