Statement on Concept Release on Requiring the Engagement Partner to Sign the Audit Report

Date:
Jul. 28, 2009
Speaker:
Steven B. Harris, Board Member
Event:
PCAOB Open Board Meeting
Location:
Washington, DC

The Concept Release we are considering today asks the public, and the profession, to comment on the pros and cons of requiring an engagement partner signature on the audit report.

The lead auditor — the firm's senior representative on the audit team — would sign his or her name, validating the work of the audit team and the opinion it reached.

I believe that requiring the engagement partner signature on the audit report is important — not only to bring within investors' reach a greater transparency and accountability in the auditing process but, also, to advance the Board's mission to protect the interests of investors and ensure the preparation of fair, informative and independent audit reports.

In developing this Concept Release, the Board considered not only the comments of investors but the recommendations of the U.S. Treasury's Advisory Committee on the Auditing Profession and the advice of the PCAOB's own Standing Advisory Group (SAG), as well as the opinions of a wide variety of other interested parties.

In addition, the Board reviewed international standards.

The Institute of Chartered Accountants in England and Wales may have said it best in its 2005 report on the subject: The engagement partner signature will "aid transparency and help to strengthen, in investors' views, independence and objectivity and confirm that the partner was not 'hiding behind' the name of the firm." [1]

Engagement Partner's Role

We are voting today on the issuance of this Concept Release to further public scrutiny and debate over the signature issue.

The engagement partner plays a significant role in the overall quality of every audit.

For investors — Adding the partner signature to the audit report acknowledges the engagement partner's key role in the overall quality of the audit and provides investors with another piece of relevant information about the audit.

For audit committees — This additional information can aid audit committees in their auditor appointment or retention decisions. Audit committees also might be encouraged to learn more about, and better understand, the expertise of the individual partners providing auditing services to them.

For auditors — Firms may be encouraged to improve the quality and expertise of some of their engagement partners.

Investor Group Support

For all these reasons, it is no surprise that investors and investor representatives from whom we have heard overwhelmingly support a signature requirement.

Here are a few sample comments:

  • Damon A. Silvers, Associate General Counsel, AFL-CIO:

    "To analogize to the SEC's world … when a 10-K or S1 [form] is filed with the SEC, a lawyer's name is on the cover page of that document. Not just a firm, but a name."

    He adds: "What investors are looking for here — and, I think, what we believe will … perhaps, drive audit quality -- is to make it a little bit easier to have [an] interaction with that partner."

  • Lynne Turner, former SEC Chief Accountant:

    "If [auditors] have a problem with [signing the audit], then, as an investor, I do want to know that, because that does give me informational content."

  • Kurt Schacht, Managing Director, CFA Institute Centre for Financial Market Integrity:

    "I think this is really about the truth of the balance sheet … [W]e support it , as an investor group."

  • Cynthia L. Richson, Director of Corporate Governance, Employees Retirement System of Texas:

    "It would incent greater accountability. It would be informative. It would help clarify which part of 'the firm' was involved in the engagement, in charge of it."

  • Janice Hester Amey, Portfolio Manager, California State Teachers Retirement System (CalSTRS):

    "The simple step of requiring the audit partner to sign the audit report will, we believe, increase ownership of the audit by the audit team, a concept that will certainly help investors gain confidence in the quality of audits."

  • Jeff Mahoney, General Counsel, Council of Institutional Investors:

    A number of Council members are on record in support of the signature requirement, he said, adding, "I was struck that one of them, at least, put this item at the top of his list of the things that he would do … that he thought would make an improvement."

Adding a Signature Requirement

The Board's current standard requires the firm itself to be the signatory on the audit report. This affirms the long-held view that the signature connotes the firm's responsibility to stand behind the quality of the audit.

It also recognizes that an audit often involves many firm employees, consultation with a firm's national office, and sometimes, outside specialists.

Nevertheless, as was pointed out in a recent BusinessWeek article, "audits are primarily human endeavors and audit firms are very dependent upon the quality of their professionals, including [their] competence and decision-making skills." [2]

The Concept Release recognizes the important role of the engagement partner in audit quality. Ultimately, it is his or her judgment, supervisory skill and professional opinion that show up in the audit report.

In the Board's discussions with the SAG, and in testimony heard before the Treasury's Advisory Committee, members of the profession, public companies and academics noted the psychological affects of putting your "John Hancock" on an official and public document.

  • Arnie Hanish, Chief Accounting Officer, Eli Lilly and Company, said:

    "I think the accountability issue is critical. I think having the individual sign their name as a partner of a particular firm … is probably most critical…. You get different behaviors when somebody has to put their name on something."

  • Donald T. Nicolaisen, Treasury's Advisory Committee Co-Chair, and former SEC Chief Accountant, said:

    "[I feel strongly that] an audit partner should sign his or her own name to an audit opinion. … I believe the investor should have the opportunity to know who it is who ultimately is accepting responsibility on behalf of the accounting firm to make sure that all the pieces came together." [3]

  • Paul G. Haaga, Jr., Vice Chairman, Capital Research and Management Company, observed that a signature requirement "could increase the sense of accountability and improve quality, similar to the requirement for CEOs and CFOs signing 10Ks and internal control representations." [4]

I would note that CEOs and CFOs must certify that their financial statements are fairly presented, as mandated in Section 302 of the Sarbanes-Oxley Act. A recent research study found that practicing auditors said that those signature requirements had a positive effect on the integrity of financial reports. [5]

Similarly, a letter to the PCAOB from four distinguished academics, who also are members of the Auditing Section of the American Accounting Association, made this point: "While the academic literature does not directly address the issue of partner sign-off, research … shows that accountability (which would likely result from having to provide a personal signature on the audit report) reduces auditors' biases in information processing and enhances auditors' consensus and effort." [6]

Based upon this and other opinion that the Board has reviewed, I believe that an engagement partner signature requirement would increase the auditor's sense of accountability and responsibility for the audit report. It also would increase the transparency of the audit process for investors.

Liability Issue

I say this, recognizing that some auditors are concerned that such a requirement would somehow increase their personal liability on the job.

I would note that this issue was reviewed by the Treasury's Advisory Committee, and by the European Parliament -- in its consideration of the E.U. Eighth Directive, Article 28, Audit Reporting -- and neither found the issue unmanageable in this context.

Conclusion

Mr. Chairman, I look forward to carefully reading all the comments we receive on this Concept Release and hope to hear from all parties, including audit practitioners, public companies, financial statement users and, most importantly, investors -- who supply the needed capital to these companies, and whose interests are paramount to the Board.

I believe that this is an important initiative, and I thank you, Mr. Chairman, for bringing it before the Board for a vote this morning. I would also like to thank our staff, Jake Lesser, Bella Rivshin and Mary Peters for all their excellent work on this release.

Chairman Mark W. Olson

Finally, since this is likely to be our last Open Meeting, Mark, with you as our Chairman, I just wanted to say how much I have appreciated your friendship over the years and the opportunity to work with you. Your time and leadership at the PCAOB is apparent in the many achievements during your tenure, not least of which is taking the PCAOB from a start-up to a steady-state operation.

Some others include: completing a well-regarded internal controls standard (AS No. 5); overseeing a risk-based approach to inspections; expanding the Office of Research and Analysis to better support those inspections; attracting experienced, top talent to the PCAOB; establishing the Board's first five-year strategic plan; and enhancing PCAOB coordination with our international counterparts. I thank you, congratulate you on your accomplishments, and wish you the very best in the future.

* * *

During a question and answer session at the end of the Open Board Meeting, Mr. Harris made additional comments.

Further Discussion on Liability Issue

I appreciate that there is a genuine complex debate over the auditor liability issues associated with the engagement partner signing the audit report. These issues were discussed by commentators to the Treasury's Advisory Committee and at our SAG meetings, and they are further reviewed in this Concept Release.

It is important to note that in all of those discussions, no one has suggested that having the engagement partner sign the audit report would increase the firm's liability in any respect. The previous discussions also note that the lead engagement partner already may be held responsible today in proceedings brought by the SEC and PCAOB, as well as in some types of private litigation for seriously deficient audits that harm investors.

Since the engagement partner is designated by the auditing standards as the person with "final responsibility" for the audit, some investors may be surprised to learn that there could be any situations today in which a firm can be found liable in private litigation for an audit, but the lead engagement partner for that audit faces little or no personal legal responsibility. I look forward to hearing commentators' views on these issues.

More generally, the PCAOB's mission is to promote high professional standards, to improve audit quality, and to further the public interest in the preparation of informative, fair and independent audit reports. In considering standards related to the preparation of audit reports, the critical question is how well the standard will advance those objectives.

In some cases, standards that advance those objectives in important respects may pose some prospect of liability that did not previously exist. I believe that we should not approach standard setting as if we may pursue our mission only in ways that avoid any potential for any new liability. In any event, I am not yet persuaded that the concepts we are discussing today would do so in any significant way and, again, I look forward to reading the comment letters regarding these issues.

[1] Institute of Chartered Accountants in England and Wales, Audit Quality Forum, Working party policy paper, Shareholder involvement — Identifying the audit partner, (March 2005), 15; available from
http://www.icaew.com/index.cfm/route/155603/icaew_ga/en/Technical_and_Business_Topics/Thought_leadership/
Audit_Quality_Forum/Shareholder_Involvement/Audit_Quality_Forum_Shareholder_involvement.

[2] Bedard, Jean C., Johnstone, Karla M., and Smith, Ed, "How Good Is Your Audit Firm?" BusinessWeek, (June 26, 2009); available from
http://www.businessweek.com/managing/content/jun2009/ca20090626_764988.htm.

[3] Nicolaisen, Donald T., U.S. Treasury's Advisory Committee on the Auditing Profession (ACAP), Record of Proceedings, (Mar. 13, 2008), 228-230.

[4] Haaga, Jr., Paul G., U.S. Treasury's Advisory Committee on the Auditing Profession (ACAP), Record of Proceedings, (Feb. 4, 2008), 2.

[5] Cohen, Jeffrey R., Krishnamoorthy, Ganesh, and Wright, Arnold, Corporate Governance in the Post Sarbanes-Oxley Era: Auditor Experiences, working paper, (June 5, 2009). Available from http://ssrn.com/abstract=1014029.

[6] Carcello, Joseph, DeZoort, Todd, Hermanson, Dana, and Gramling, Audrey letter to PCAOB Board Members, (June 3, 2009).