Remarks as prepared for delivery
We’re here today to consider updates to PCAOB rules, so they match what investors already expect: that when an associated person’s negligence directly and substantially contributes to firm violations that can put investors at risk, the PCAOB has tools to hold them accountable.
To do this, we are proposing amendments to PCAOB Rule 3502, Responsibility Not to Knowingly or Recklessly Contribute to Violations.
First, the proposal strengthens accountability for associated persons, including individuals and firms, who put investors at risk by updating the threshold for liability from recklessness to negligence – allowing the PCAOB to hold auditors accountable for failing to exercise the same standard of reasonable care and competence they are already required to exercise anytime they are executing their professional duties.
Second, it clarifies that associated persons of any registered firm can be held liable for contributing to the violations of any registered firm – not only a firm with which they are associated – as long as their conduct at least negligently contributes to the firm’s violation.
While instances where auditors negligently, directly, and substantially contribute to the violations of firms with which they are not associated could be rare, arrangements among firms are becoming more and more complex every day. This clarification will ensure more complex firm arrangements, including some that we may not be able to contemplate today, cannot be used to evade accountability in the future.
It is important to understand, auditors are already required to exercise reasonable care or competence anytime they perform an audit – meaning they are prohibited from being negligent today. Similarly, the U.S. Securities and Exchange Commission already has the ability to seek penalties in enforcement actions against associated persons when they negligently cause firm violations.
So, there is no reason this proposal should cost auditors significant time, resources, or money.
Simply put, if you are doing what you are already supposed to be doing, this proposal won’t affect you. If you are not, there may be consequences.
I also want to be clear; these updates are not intended to ensnare junior professionals or other auditors who are responsibly executing their duties. Again, to be held liable under the proposal, not only do associated persons have to act negligently, this proposal also maintains the current requirement that their negligence must have contributed to the firm’s violation both “directly and substantially.” That does not include auditors whose conduct is remote from, or tangential to, the firm’s violation.
Like many of the standards this Board has voted to modernize, Rule 3502 is nearly 20 years old. Things have changed since it was first adopted in 2005.
The SEC now has the ability to seek civil money penalties in enforcement actions against associated persons when they negligently cause firm violations. The way that firms operate has changed. And the expert staff at the PCAOB who have seen how Rule 3502 plays out in the real world are recommending this update.
We have both the benefit of experience and the responsibility to investors to ensure Rule 3502 is fit for purpose in today’s world.
That purpose is to ensure there are consequences when associated persons of PCAOB-registered firms contribute to violations committed by registered firms, which can put investors at risk.
Let’s look at current quality control standards, for example, which impose obligations on firms, not individuals. Quality control is fundamental to firms consistently performing high-quality audits. And when firms violate the PCAOB’s quality control standards, the consequences for investors can be significant.
Quality control failures impact everything from client acceptance and continuance, to independence, to the execution of audit engagements, to supervision and review.
But the firms are not making the decisions and taking the actions that result in quality control failures on their own – people are making these decisions and taking these actions.
Similarly, some PCAOB independence violations can only be directly committed by firms, including violations that undermine the audit process and can put investors at risk, like failing to obtain audit committee pre-approval for audit or non-audit services, or providing services for an audit client for a contingent fee or commission.
Again, firms don’t make the decisions or take the actions that lead to these violations on their own. People participate in these decisions and actions.
Those people are auditors – highly trained professionals, with specialized skills and ethical duties who are licensed and paid to carry out duties solely entrusted to them. When they fail to exercise the reasonable care or competence entrusted to their profession, and that failure directly and substantially contributes to a violation by a firm, investors expect there to be consequences. Investors deserve accountability.
The two changes we are proposing today will ensure Rule 3502 lives up to those expectations with the accountability investors deserve.
I encourage all our stakeholders to read the proposal and provide your perspectives.
I would like to express my gratitude to those individuals who have significantly contributed to this proposal. Specifically, I would like to thank in the Office of General Counsel: James Cappoli, Connor Raso, Damon Andrews, Drew Dropkin, and Vince Meehan; in the Office of Economic and Risk Analysis: Federico Garcia and John Cook, with support from Tian Liang, Michael Gurbutt, and Martin Schmalz; and in the Division of Enforcement and Investigations, Bob Rice, Bill Ryan, John Abell, and Mike Davis.
I would also like to thank my fellow Board members and their staff for their contributions to this proposal. In addition, I would like to recognize the support provided by the Office of Communications and Engagement.
Finally, I would like to thank the SEC’s staff for their support and assistance.