Financial Statement Auditors – The Foot Soldiers of Integrity and A Pillar of the Capital Markets

Good evening. Thank you, Professor [Hal] Scott, for the warm introduction, and to the Program on International Financial Systems, Harvard Law School, and the China Development Research Foundation for the invitation to participate in the 22^nd annual U.S.-China Symposium. It is a pleasure to join you this evening, and it is an honor to share the stage with distinguished colleagues who help to contribute to this relationship, shape its legacy, and add my voice to a conversation that reaches far beyond these walls.

Since 1986, for nearly 40 years, the Program on International Financial Systems has served as a beacon for global financial dialogue, bringing together policymakers, academics, and representatives from industry to advance understanding, offer perspectives, and drive meaningful change in our capital markets.

It has been said that “It is Americans and Chinese—Silicon Valley, Shenzhen, Wall Street, and Beijing—that will determine what people everywhere will think and what they will buy. They are not the only two countries in the world that matter. Far from it. But if we don’t understand how the United States and China function and interact, then in large part, we won’t quite understand many of the biggest changes in the world.”¹

Before I continue, please know that my remarks this evening are provided in my official capacity as an individual PCAOB Board Member and do not necessarily reflect the views of the full Board, my fellow Board Members, or the PCAOB’s dedicated staff.

One glance at any given day’s news will underscore the importance of the capital markets to the overall U.S. and China relationship.

With this broader perspective in mind, my remarks this evening will delve into the following four areas: First, the importance of the limited liability corporation; second, the role of the financial statement auditor as the central pillar to investors and the capital markets; third, the evolution of regulation and the PCAOB’s mission; and finally, the imperative of global cooperation.

I believe each of these themes weaves together a tapestry that fosters confidence in the capital markets worldwide and why preserving and enhancing that confidence demands constant vigilance, transparency, and candid regulatory collaboration. The intent for my remarks this evening is to illustrate this.

I welcome your questions, thoughts, and perspectives on any of these topics.

The Importance of the Limited Liability Corporation 

Throughout history, we can pinpoint changes that helped to democratize investments and improve the lives of people around the world through the creation of robust capital markets. The foundational element of this system is the invention of the publicly owned joint stock company.

To understand why this creation was so pivotal to modern capital markets, I want to take us back to the 18^th century when intrepid entrepreneurs first pooled capital to forge modern markets.

During this time, trade routes stretched across the oceans. Entrepreneurs sought fortune in spices, textiles, furs, and uncharted territories or colonies. Yet most investors during this period carried a sword of Damocles—the ever-present threat of ruin hanging over you—namely unlimited liability. If your trading ship sank or your fur traders were lost to foreign lands, you risked more than goods; you risked your entire fortune. As a result, the pool of investors for these ventures was limited, often to those sponsored by monarchies and imperial dynasties.

That started to change, however, in the late 19^th century, with the rise of the modern limited liability corporation that issued shares of ownership to investors while protecting those investors from liability to creditors.

Suddenly, the cost of doing business no longer meant risking an investor’s entire life savings. Rather, an ownership share offered upside, while preserving the downside at the threshold of the owner’s initial investment. The corporation was also novel because it created a method of capital formation that was independent of the nation state, yet still deeply embedded within society.² The rise of the limited liability corporation transformed society as we know it.

In their book called, “The Company”, John Micklethwait and Adrian Wooldridge, two reporters from “The Economist”, argue that “The most important organization in the world is the company: the basis of the prosperity of the West and the best hope for the future of the rest of the world.”³

The authors go on to argue that the limited liability corporation’s introduction of shareholders brought massive benefits. It empowered individuals to invest their money in a business without being personally liable for losses and having to manage the day-to-day affairs of a company, while it enabled companies to raise large sums of money for capital intensive projects like never before.

New technologies such as steam engines and electricity clearly had the capacity to change the world, but the limited liability corporation provided the financing vehicle for this to occur and make it possible.⁴

With the backing of thousands of investors, companies around the world built railways across continents, and factories sprouted wherever labor and ambition met. Global trade networks expanded, and cities blossomed on the promise of shared risk and shared reward.

This new ownership structure, however, introduced a new challenge of aligning the interests of investors in a company and its management.⁵

This is commonly referred to as the “agency” problem. Over time, investors created mechanisms to provide oversight of company management.

The alignment of these two interests would not be possible without investors having accurate information about the financial performance of the company. Addressing this problem spurred yet another evolution in our capital markets - the introduction of financial statements audited by independent auditors.

The Auditor: The Central Pillar of Market Integrity  

As companies were growing and expanding around the world, so too was the need for financial statement audits. Audits became more than just a trustworthy statement—they opened the doors to raising capital from investors around the world.

By offering investors everywhere a reliable view of a company’s performance, financial statement audits lowered perceived risk, expanded the investor base, and unlocked access to global capital.

This led to the emergence of accounting firms, who positioned themselves as those who would “protect…from the opportunists, frauds and other malefactors who sought to exploit the Industrial Revolution. In this role, accountants shared with teachers, doctors, lawyers, and priests responsibility to the wider community. They were the foot soldiers of integrity.”⁶

As a former financial statement auditor, I certainly agree with this sentiment. I consider auditing to be a noble profession, and honest, dependable auditors are indeed foot soldiers of integrity. I like to think of, and believe, that being a financial statement auditor is a calling. The value provided to our society is that great and important.

Auditors bring independence, professional skepticism, and a deep understanding of both a company’s operations and internal controls that undergird the transparency, accuracy, and reliability of financial statements. Skilled auditors are uniquely qualified to perform these tasks and stand as sentinels for investors and the capital markets.

It is a profound privilege that brings with it a profound responsibility—a responsibility—as I just noted, “to the wider community.”

The independent financial statement auditor can be thought of as the connective tissue that links investors, audit committee members, management, and the capital markets.

It is investors’ trust in the integrity of the audit that provides them with the confidence to make investment decisions based on information gleaned from audited financial statements, and society at large benefits from the efficient allocation of capital, and ultimately, confidence in our capital markets more broadly. It is this confidence that allows the formation of capital that propels entrepreneurs to develop and market new ideas and technologies.

Capital dictates which projects live or die, where markets move, and how whole industries pivot.⁷

Regulation, The PCAOB, and Lessons from Crisis

The emergence of financial statement audits and its importance to investors would necessitate further evolutions to help secure arguably the most important element of our capital markets—trust.  

The devastation from the U.S. stock market crashes of 1873, and then 1929, provided stark lessons to society of what happens when confidence vanishes from the marketplace. A period of unchecked speculation and opaque financial practices wreaked havoc on the global economy for years. 

Policymakers recognized that maximizing the benefits of the corporation for society would require some additional regulatory guardrails. American policymakers responded to the stock market crash of 1929 by passing the securities acts of the 1930s that require public companies to provide timely and accurate disclosures to protect investors and maintain market transparency.  

But disclosures alone were not enough to provide investors with the information they needed to make sound investment decisions, nor deter wrongdoing and prevent financial disasters. 

Fast forward to the turn of the millennium, when several well-known financial reporting and audit failures resulted in a loss of confidence in the audit profession and the U.S. capital markets more broadly. The downfall of Enron and WorldCom in the U.S. triggered significant economic fallouts, including the elimination of thousands of jobs, the loss of employee retirement savings, and a steep drop in shareholder value. 

I should also mention that a similar story played out in Europe around the same time with the collapse of Parmalat, further triggering the creation of independent audit regulators throughout the European Union.

So, against the backdrop of these auditing failures, the U.S. Congress passed the Sarbanes-Oxley Act, which established the PCAOB in 2002. The overarching mission of the PCAOB is to protect investors and further the public interest in the preparation of informative, accurate, and independent audit reports.

I would be remiss to not mention that at the time of the PCAOB’s founding, no other jurisdiction had established an audit oversight regime with this level of independence, authority, and reach.

Notably, Congress made explicit that the PCAOB’s powers extend to oversight of non-U.S. accounting firms.⁸ U.S. securities laws allow companies located anywhere in the world to raise capital in U.S. markets. As a result, companies’ auditors could also be located anywhere in the world. 

The authors of the Sarbanes-Oxley Act determined that non-U.S. auditors of companies listed on U.S. public exchanges should not be treated any differently than their U.S. counterparts because, “Otherwise, a significant loophole in the protection offered U.S. investors would be built into the statutory system.”⁹

The wisdom of this approach has proven itself over time.

Global Cooperation for Audit Oversight 

Today, the U.S. capital markets are the envy of the world, and U.S. equity markets now account for nearly half of global market capitalization—underscoring the need for cross-border cooperation and rigorous, independent audit oversight that reinforces investor confidence.¹⁰

Investors are drawn to the U.S. markets for one primary reason. A reason that was so often missing throughout the rise of the modern company—and that reason is trust.

Trust provides that the information available to investors and stakeholders is accurate and reliable, and ultimately, that the capital markets are stable and secure.

In the more than 20 years since its establishment, the PCAOB has, in my view, evolved into the model for effective audit oversight and an important factor in providing that trust.       

Through its global oversight activities, the PCAOB’s work has helped ensure that investors in U.S. markets can have confidence in the audits of financial statements of the public companies they invest in whether these companies are located in Boston, Berlin, or Beijing. 

The benefits have not just accrued to U.S. investors; they have also improved audit quality¹¹ and capital formation globally.¹² But the need for continued global audit oversight collaboration remains, and the stakes could not be higher.

Investors from around the world flock to American markets because participation carries a simple, non-negotiable condition: adherence to our rules. Protecting and strengthening these rules and applying them with consistency and without favor, safeguards hardworking investors, fuels job creation, and sustains the prosperity that defines our nation. By insisting on the same standards for all U.S. listed public companies and their auditors, we reinforce confidence in every corner of the global economy.

However, audit oversight does not end at our borders.

For oversight to be effective, regulators around the globe need to work together if we are to indeed advance a common goal to provide transparency, protect investors, and foster market integrity. 

Working effectively with audit oversight authorities around the world is crucial for the PCAOB to fulfill its statutory mandate. For more than a decade, the PCAOB engaged in negotiations to secure consistent access across all jurisdictions to the audit work performed for public companies listed on U.S. capital markets and to establish an international standard for cross border collaboration, including in China.

After years of persistent diplomacy and negotiations, PCAOB access in China remained stymied. 

Congress passed the Holding Foreign Companies Accountable Act (HFCAA) in 2020 to create a level playing field and to ensure all PCAOB-registered accounting firms, no matter where they are located, are subject to the same level of oversight and that their audits of U.S. listed public companies meet the same high standards.  

The law provides that where positions taken by other authorities impede the PCAOB’s access to completely inspect or investigate accounting firms, the companies audited by those firms can no longer trade on U.S. markets.

The PCAOB subsequently signed a Statement of Protocol (SOP) with the China Securities Regulatory Commission (CSRC) and the Ministry of Finance of the People’s Republic of China in 2022 that is designed to facilitate the access we need to completely inspect and investigate. 

We are currently in our fourth year of inspecting registered accounting firms in China and Hong Kong and have reported critical findings at each one because the firms did not meet our audit standards. Where inspection findings indicate a weakness in the firm’s system of quality control, which is foundational to audit quality, then the firm has 12 months to correct those quality control deficiencies through our remediation process.

Over time, through our continued inspections and ongoing engagement with the firms, we are hopeful this oversight will have a meaningful impact on the work of auditors in China and Hong Kong and improve how audits are conducted there and ultimately, lead to higher audit quality.

To date, for as long as the PCAOB can inspect and investigate completely in China, China-based companies continue to access the benefits of our capital markets.

In fact, so far this year, there have been approximately 70 initial public offerings (or IPOs) in the U.S. from companies based in mainland China. In a majority of cases, these companies are being audited by firms located outside of China. This is an area we will be scrutinizing closely based on several risk factors that we apply across all firms.

Since the 2022 agreement, the PCAOB has also brought and settled disciplinary matters involving audit firms located in mainland China and Hong Kong for violating the PCAOB’s rules and standards. These are serious violations that put investors at risk, and these oversight results—conducted with the same access and scrutiny as the PCAOB exercises with all firms, no matter where located—improve audit quality for investors. 

Vibrant and efficient capital markets cannot function without transparency and consistently accurate financial reporting backed up by high quality audits. The PCAOB’s oversight promotes high quality auditing which facilitates investor confidence in the markets.

Conclusion

This evening, we have journeyed together from the birth of limited liability corporations through the rise of auditing as the bedrock of market transparency, to the PCAOB and our role in protecting investors and maintaining trust in the markets, and finally, to the frontlines of global audit cooperation. Looking back, we can see that each of these changes represents an effort to recalibrate the system to align the interests of entrepreneurs, investors, and, finally, the public good.

As we look ahead, this evolution continues. We are the beneficiaries and inheritors of a system that has largely succeeded in democratizing investments and unleashing human ingenuity to benefit the lives of people across the globe.

But there are challenges before us: the expansion of the private markets, the integration of digital assets into the global financial system, and the widespread adoption of AI. In the coming years, each will likely test the financial reporting ecosystem.

I want to invite all of you to join me in continuing this conversation today and into the future. While there are many topics worthy of discussion, a few of the most pressing to me include identifying ways in which regulatory cooperation can be strengthened for the benefit of investors; understanding the impact that private equity investments and related accounting firm restructuring may pose to audit quality; recognizing how new technologies may introduce new risks; and finally, considering how innovations in technology can be harnessed to improve risk detection and possibly advance audit quality to unprecedented levels.

At the center of these global economic currents lies the financial statement auditor—the foot soldier of integrity—working every day to uphold their time-honored responsibilities to investors and the capital markets.

In conclusion, our shared mission must be to adapt, collaborate, and continue to earn and keep the confidence of investors who count on transparent, reliable financial information.

Thank you for your attention. I welcome your questions and comments.