Helping Smaller Firms Start Off Right When Auditing Public Companies

Remarks as prepared for delivery 

Good morning. It is good to see all of you at this year’s forum. I look forward to what I hope will be a candid and interactive conversation with you today about the PCAOB and how we can do better. I have some ideas that I want to get your feedback on. My conversation has three parts. Part I will consist of prepared remarks. Part II will (hopefully) be interactive where I will discuss two ideas I have and then ask for your input. My second idea is much more provocative than my first idea. The last part will consist of the traditional Q&A where you ask me questions on any topic that comes to mind. 

I. Prepared Remarks

This is an eventful season in Denver, on the cusp of fall. Leaves in the mountain areas are turning golden. Professional sports begin again. The Denver Broncos played their first regular season game last Monday against the Kansas City Chiefs, and the Nuggets start their season next month. The skiing season begins in late October. But as we all know, the highlight of fall is the PCAOB’s forum for auditors of small businesses and broker-dealers. 

I used to work for the U.S. Mint which brought me to the Denver Mint a couple of times. I’ve always enjoyed coming here. Denver’s early days as a gold rush town are well known, but I recently learned that Colorado and Denver were pioneers in the accounting profession. A few “fun facts” for you. In 1907, Colorado became one of the first states to create a State Board of Accountancy and regulate public accountants.¹ The seventh person to become a CPA in Colorado was a woman. At that time, she was one of only seven female CPAs in the United States.² By 1924, Colorado had four female CPAs – more than 43 other states and the District of Columbia.³ One of those women was Emma Manns,⁴ who served as Treasurer, Secretary, and President of the Colorado State Board of Accountancy between 1924 and 1926.⁵ Miss Manns had her office in Denver⁶ like most Colorado CPAs in this early period.⁷

The history of the PCAOB is not nearly as old. Congress created the PCAOB in 2002 in part “to oversee the audit of companies that are subject to the securities laws . . . in order to protect the interests of investors.”⁸ In some ways, we are still fine-tuning how we regulate public accounting firms. Case in point, the PCAOB just approved amendments to our quality control standards known as “QC 1000.” The amendments, which are based on extensive stakeholder feedback, reduce regulatory burdens, afford firms greater flexibility, and align QC 1000 more closely with existing international standards. The PCAOB is also exploring making the interim inspection program related to audits of brokers and dealers permanent, which includes proposing amendments to existing rules. I anticipate that the PCAOB will publish the amendments for public comment later this year. 

As an audit regulator, the PCAOB has some flexibility in deciding whether to propose and adopt regulations. I would like to describe my 10 guidelines or principles to regulation. First, we must have clarity on the problem we are trying to solve. Second, we must have early stakeholder buy-in. I do not believe we need unanimous stakeholder buy-in, but if none or few of our stakeholders see a problem, then the PCAOB should perhaps hit the “pause” button. Third, if we clear the first two hurdles, then the PCAOB must consider how best to address the problem we are trying to solve. Do we start with a non-regulatory approach using staff guidance, practice aids, or Spotlights, or are regulations the right tool? Fourth, if we take a non-regulatory approach, we must make sure that we are inspecting for compliance with standards or rules, not guidance. To be clear, the PCAOB should never take shortcuts by requiring compliance with guidance. Fifth, if we determine that regulation is the best way to go, then the rulemaking must be proportionate to the problem we are trying to solve. We must not treat the rulemaking as a “Christmas tree” by adding a bunch of ornaments. Sixth, we must consider whether to take a one-size-fits-all approach or an approach that is scalable. Seventh, we must determine that the benefits outweigh the compliance costs, and try, if possible, to quantify the benefits and costs – which can be difficult. Eight, we must afford stakeholders a reasonable amount of time to comment on our proposed standard or rule. Ninth, we must give stakeholders sufficient time to comply once our standard or rule is final. Tenth, we must continuously engage with stakeholders to understand the challenges they face in implementing the standard or rule and provide timely guidance. 

One of my abiding beliefs, which I believe is true of my fellow Board members, is that we must seek the insights of stakeholders that include investors and those we regulate. Practitioners like you. This fits within my second and tenth principles. The PCAOB does this in several ways. One way is by establishing advisory and working groups. One such group is the Smaller Firm Resource Group, formed last year, which advises the PCAOB on the impact of our programs on smaller firms. This year, under the leadership of Chairman Logothetis, the PCAOB formed a small task force of outside experts, including practitioners, to help us improve our inspections program. The group is called the Inspection Modernization Council (IMC). What makes this group especially interesting is its focus and approach, which uses non-public meetings to encourage candid conversation and refine rough ideas. Materials used by the IMC are posted on the PCAOB’s website. My staff and I have observed this group in action, and what we’ve seen impresses me. 

On at least a pilot basis, I would like to see the PCAOB use small ad hoc working groups like the IMC, especially for standards we are writing, before we seek public comment on proposed standards. I would of course include at least one individual from a small firm in each working group. It could work as follows: our Office of the Chief Auditor would share draft standard or rule text with the group to discuss: (1) whether the text satisfactorily addresses the problem we are trying to solve; (2) whether a one-size-fits-all approach works or a scalable approach is more appropriate, especially for small firms; and (3) whether the benefits outweigh firm compliance costs. I believe this approach would enable the PCAOB to propose for public comment a better standard or rule – one that has already been vetted by a small stakeholder group and might, as a result, require fewer changes before adoption. By investing time on the front end with stakeholders, we might save time getting to the right result on the back end. 

Now, I would like to describe the two ideas I have and get your feedback. I will start with the less provocative idea. 

II. Ideas for Audience Input

A. PCAOB Training and Technical Assistance Program

By way of background, the PCAOB’s authority to set standards, inspect auditors and broker-dealers, and bring enforcement actions, gives us a mighty club. That club can be critical for improving audit quality and thereby protecting investors. But I believe the PCAOB needs to do more than just carry a club; it must also help firms succeed. Specifically, the PCAOB should find ways to help recently registered firms and inexperienced firms before they perform their first public company audit. So, my idea for making the PCAOB helpful is to establish a technical assistance or training program to help small, inexperienced firms become more ready to audit public companies. As you may know, SEC Chairman Atkins wants to “Make IPOS Great Again.” The PCAOB has a role to play here by helping to ensure that newly public companies can obtain the services of a responsible and affordable auditor. By establishing a technical assistance or training program, we might induce more firms to enter the public company audit marketplace. 

I see the potential benefits of a training program as high; namely, a reasonable likelihood that firms taking this training will produce higher quality audits than similarly situated firms that have not. I envision that PCAOB inspectors would conduct the training, because they have first-hand knowledge of where smaller firms may be falling short. Training could be webcast live so that participating firms can ask questions in real time, and recordings could be available to make the training more convenient. From a firm-cost perspective, I see the costs as low because the training would be free and voluntary. Of course, there may be an opportunity cost for firms in that time spent on training could mean less time conducting audits. That’s it in a nutshell.

Questions? Thoughts? Do you like this idea? Would you take such training? 

B. Change the Frequency of Inspections Based on Issuer Market Capitalization

Turning to my second idea. As I stated earlier, my second idea is provocative, but I believe it is worth discussing not only internally within the PCAOB but also with stakeholders. My second idea is for the PCAOB to consider changing the frequency of the PCAOB’s current annual and triennial general inspection cycle. As many of you know, registered firms that issued more than 100 issuer audit reports in the prior calendar year are annually inspected. Firms that issued 100 or fewer issuer audit reports are generally subject to a triennial or three-year inspection cycle. It may be time to reevaluate this annual and triennial approach by considering whether it remains fit for purpose, from an investor protection standpoint. 

Let me give you an example. Firm X issues 6 audit reports each year for 6 issuers with an aggregate market cap of $300 billion. Firm Y issues 6 audit reports each year for 6 issuers with an aggregate market cap of $30 million. Does it make sense for Firm X to be inspected as frequently as Firm Y? What if we changed the frequency of our general inspection cycle based on the aggregate market cap of the issuers the firm audited – the larger the aggregate market cap the more frequent the inspection. This could mean that some firms, like Firm X, could be inspected, say, biannually instead of triennially. To be even more provocative, an aggregate market cap approach could also result in a firm like Firm Y being inspected every four years instead of every three years. The theory behind this idea is for the PCAOB to more efficiently dedicate its inspection resources where inspections can provide the greatest incremental investor-protection benefit. The larger the market cap, the greater the potential losses for investors. This revised inspection cycle would still allow the PCAOB to inspect a firm more frequently when necessary – which we refer to today as a “special inspection.”

What do you think? Without getting into the appropriate market cap thresholds, does it make sense to set the frequency of inspections based on the aggregate market cap of the issuers audited? Is it viable to extend the inspection cycle from every three years to, let’s say, every four years when the aggregate market cap of the issuers audited falls below a certain level? 

Thank you for the feedback. Now I would like to hear your questions. How can the PCAOB be helpful to you? How can we do better?