I would like to join my fellow Board members in thanking the staff in the Chief Auditor's Office and the Office of General Counsel. As you do in all of the Board's standard setting projects, you received a lot of input from various members of the PCAOB Board and staff. However, I think this project presented particular challenges because of the breadth of the potential changes, the difficult issues involved, and the many views that were expressed during your outreach efforts over the last year. I believe the result of your hard work is a well-written and comprehensive concept release that fairly presents many important considerations relevant to changing what has been the standard auditor's report for many decades.
Call for Comments
That said, we know that the concept release does not address all of the considerations that should be explored in connection with expanding the auditor's report. Nor does it present all of the possible alternatives one could adopt to improve the auditor's report. So the most important message I have today is that we are interested in receiving robust comments in response to this release. We would like to hear from a broad range of investors of all sizes and types, as well as from investor representatives, audit committees, analysts and others. We need to understand what information auditors can provide that would be most meaningful to you; how it will be used; and how it will affect your decisions.
I am encouraged by the attention that members of the audit profession are giving this project and by their acknowledgment of the need for change. I look forward to their continued engagement on this important issue as well.
The Time for Change
I would like to take just a few minutes to expand on several issues discussed in the release:
While potential changes to the auditor's report have been discussed periodically over the years, I agree with my fellow Board members that the time has come to respond to the calls for change. Financial statements and their audits have become increasingly complex. We are moving away from "industrial age" accounting and moving toward "information age" models that are much less objective. Financial reporting involves an increasing use of estimates as well as judgments. Acceptable answers may fall into a wide range, resulting in a mixed attributes model where some numbers are "softer" than others. Coupled with innovative investment and business structures, interpreting financial results can be a challenge for even the most expert users of financial statements.
This new world became painfully real to many of us during the recent financial crisis, involving the failures or near-failures of systemically important entities that had received unqualified audit reports just months earlier. Important questions have been raised about whether more communication by auditors focusing on what they do, and what they think, could provide investors with important insight into the risks associated with their audit clients. Therefore, I support the Board's project and the issuance of the concept release.
The Auditor's Role
Some of the proposals discussed in the release inevitably require us to consider not just what is written in the auditor's report, but to think about the auditor's role in general. Certain disclosures described in the release could be made based on the work that auditors currently perform routinely. Other disclosures may require additional procedures to be performed. Either or both may be appropriate, and, as noted in the release, we look forward to receiving input on the usefulness of the various approaches.
However, as someone who performed audits for over thirty years, I would like to sound one note of caution: Auditors do a great deal of work and obtain important insights about the information that goes into their client's financial statements. They may be able to provide additional information about the audit work they performed and what it means, or about the risks of a material misstatement of the company's financial statements, or about the company's accounting policies and significant judgments and estimates. However, auditors are not analysts or investment advisers. They are not trained to evaluate and communicate the overall business and strategic risks of the companies they audit.
Education and Training
To the extent the Board ultimately decides to expand the role of auditors beyond attesting to the fairness of their clients' financial statements, the education and training of auditors would need to evolve. It would take time not only to introduce new requirements at the college level, but also to create an environment where practicing auditors can pass on their knowledge during the on-the-job training that is so fundamental to a good auditor's development. I believe that any audit standard proposed by the Board to increase the scope of auditor reporting must initially focus on the auditor's key area of expertise in the area of financial reporting risks rather than business, operational or strategic risks.
One important challenge for the Board will be how to structure any new requirements for the auditor's reports in a way that provides meaningful information to investors. Boilerplate language and check lists are of limited use, but we must also avoid the common pitfall of coping with difficult accounting models simply by increasing disclosure. I have heard complaints about "disclosure overload," "disclosure fatigue," and "accounting fatigue." We will have to be mindful that more disclosure is not always better disclosure. We will need to determine how to provide auditors with sufficient guidance about the nature and extent of information to include. What is the appropriate materiality or significance threshold auditors should use to determine whether to highlight certain transactions or judgments and estimates? How does the auditor decide which accounting considerations will be most relevant to investors?
Our experience in inspections is that many of our findings relate to the most subjective and difficult areas, including issues related to the valuation of investments. We understand that audit firms are putting significant resources into this area in an attempt to get it right. To the extent new requirements for the auditor's report require the disclosure of subjective information, firms will encounter similar difficulties. Likewise, subjective requirements will present challenges to PCAOB inspectors trying to determine compliance with such requirements.
In addition, to the extent new auditor disclosures involve their views and opinions on management predictions for the future, auditors also have valid concerns about potential increases in liability. For certain forward looking statements made by management in its "Management Discussion and Analysis," there are safe-harbor protections if the predictions do not come to pass. Should similar protections be implemented for auditors?
The Board also must consider carefully how to balance the potential benefits of increased auditor communications with the potential costs. Depending on the nature of the additional information to be included in the auditor's report, auditors may have to consider carefully what information to highlight for investors and how best to communicate that information. This will not be an insignificant effort. Writing clearly and concisely while communicating everything of importance to an investor will be a real challenge. It will require input from the most senior participants in the audit and from the firm's management. As I noted in my comments during the Board's open meeting on March 22 of this year, if this task is to be accomplished in a way that will provide meaningful information to investors — rather than vague boilerplate — this will not come cheap. There also may be other costs or unintended consequences that the Board should consider, and we hope to hear about those during the comment period. I expect that the Board will carefully review investors' comments about the type of information that will be most meaningful to them, in order to find an appropriate balance between the benefits and the potential costs of any proposed changes to the standard auditor's report.
Delivery of Audit Reports
One last issue I would like to raise today is how increased reporting by the auditor will affect the timing of delivery of audit reports. With filing dates as early as 60 days after year-end, increasing complexity and judgments in almost all accounting areas, the concentration of calendar year-end companies and no excess capacity in the audit profession, how will it all get done? Our goal is to improve audit transparency without negatively impacting audit quality, so I would be particularly interested in comments on how to address this issue as well.
I look forward to receiving robust, balanced and insightful comments on all of the relevant issues. Although there are challenges ahead, the need for change is clear. Investors demand — and deserve — a more effective, meaningful, and relevant auditor's report that better reflects the important work and expertise that auditors can provide.
In closing, let me thank the staff again for their hard work. More is yet to come, but I am confident that they will rise to the challenge.