Impact of Accounting/Auditing Profession in Corporate Governance

Remarks as prepared for delivery

Thank you, Frank for that kind introduction.

It is a pleasure to be here with you today. As some of you might know already, I am originally from Macau. It is therefore a great honor for me to share my perspectives in front of this audience.

Before I share some of my thoughts about the impact of the accounting profession in corporate governance, I want to make clear that the views I express today are my own and do not necessarily reflect the views of the U.S. Public Company Accounting Oversight Board (PCAOB), other PCAOB Board Members, or PCAOB staff.

This year is the 22nd anniversary of the Sarbanes-Oxley Act of 2002, affectionately known as “SOX.” You may recall that the birth of SOX started with egregious corporate scandals in the U.S. The first was Enron, a corporation that appeared to be a reputable energy company at the time. The company’s leadership created fictitious holdings, used special purpose entities to hide their debt and toxic assets, and falsified accounting records. When news of this became public, Enron filed for bankruptcy in 2001, where its share price tumbled from its peak US$90.75 to a mere US$.26 cents.¹ This scandal spurred not only the demise of the company but also its auditor, Arthur Andersen, and eradicated the life savings of numerous hardworking employees and investors who had the utmost confidence in the company’s financial position.

Following suit in 2002 was another large accounting scandal, resulting in the bankruptcy of WorldCom, the 2nd largest long-distance telephone company in the U.S. at the time.² Both Enron and WorldCom intentionally “cooked the books,” and again, Arthur Andersen turned a blind eye at WorldCom for inflating profits.

Given these extensive financial scandals and in order to restore trust in our capital markets, the U.S. federal government implemented sweeping reform by enacting SOX with bipartisan congressional support. Looking back, it is fair to say that Congress’ intent to restore public trust in auditors of public companies has made a real difference. The U.S. capital markets have continued to grow, from a market cap of approximately US$11T in 2002 to over US$50T as of the end of last year. With the enactment of SOX came the beginning of the PCAOB and the end of more than 100 years of self-regulation by the accounting profession. As a newly formed independent regulatory and oversight body, the PCAOB had its growing pains during the initial years and has evolved in maturing its programs throughout the past 22 years. 

The PCAOB regulates the audits of public companies and SEC-registered brokers and dealers in order to protect investors of U.S. listed companies and further the public interest in the preparation of informative, accurate, and independent audit reports. In short, we audit the auditors of U.S. listed companies. And we use three key tools to do so:

1. We set the auditing standards;
2. We inspect registered audit firms to determine if those standards are followed; and
3. We take enforcement actions where appropriate.
   

All with the goal of protecting investors. In a global economy, our work sometimes extends beyond the U.S. borders. The PCAOB regularly conducts inspections in more than 50 jurisdictions around the world.

I understand that many of you are familiar with SOX and have been involved with SOX-related projects. Today I am focusing on our Inspection program which is our largest program and would like to highlight briefly some high-level trends of our inspection results, common deficiencies from our recent inspections, and future priorities.

I want to recommend two resources for you: 1) Spotlight of Staff Update and Preview of Annual Inspection Observations³, and 2) Spotlight of staff inspection priorities.⁴ These Spotlights are published annually on our website and provide a great summary of the inspection results as well as upcoming inspection plans.

To provide historical context, we could take a look at some high-level trends of the deficiency rates for both the U.S. and Non-U.S. Global Network Firms since the inception of our Inspection program. When I use the term Global Network Firms or GNFs, I am referring to public accounting firms that are registered with the PCAOB and who are members of networks through which they affiliate with other firms in other countries for various business and client service purposes.⁵ For example, a U.S. GNF is a firm headquartered in the U.S. and a member of a global network. There are currently 6 U.S. GNFs.⁶ When I use the term “deficiency rate,” I am referring to the ratio of audits with inspection findings relative to the total number of audits (with and without findings) reviewed by the PCAOB Inspections division. Although it is not a holistic measurement of audit quality at a given point in time, it provides us with some insights on trends over a period of time. The deficiency rate for U.S. GNFs in 2004 was about 18%, which trended downward through 2007 to about 10%, rising to over 40% at the peak in 2013, then settled back down to about 16% in 2020, but started to rise again in 2021 to 21% and 30% in 2022.⁷

For Non-U.S. GNFs, the trending is similar, starting at about a 25% deficiency rate in 2005, slightly down to below 25% in 2008, up again to nearly 50% in 2013, then landing at about 33% in 2022.⁸

I think that the key takeaway from these historical trends is that audit quality is not a destination, but a journey that requires ongoing focus, vigilance, and proactiveness. Based on the data, I could observe three distinct cycles that spanned the past 22 years:

• Early Implementation - the first eight years (2002-2010) reflect the initial cycle of audit quality effort under the new regulated environment. The most significant event of this cycle was obviously the implementation of the landmark law SOX and unsurprisingly showed higher deficiency rates initially which then started to trend downward. This trend is also consistent with our inspection results of PCAOB registered firms outside of the U.S. When PCAOB started inspecting a new jurisdiction, it often followed this trend;
• Internal Control over Financial Reporting (ICFR) and Global Financial Crisis - The second cycle covered approximately a decade (2010-2020). The most significant events of this period were the implementation of the ICFR Auditing Standard (AS 5) adopted in 2007⁹ and the global financial crisis which began in 2008. Although SOX was implemented years earlier, the PCAOB had to amend its initial auditing standard on ICFR (AS 2) due to the public outcry of its burdensome nature from stakeholders. As such, ICFR audit results were not apparent until the 2010 inspection year. In addition, the financial crisis led to significant market cap losses and financial institution failures which brought scrutiny to issuer audits. Again, this second cycle reflected an initial uptick of deficiency rates at its peak of over 40% for U.S. GNFs and over 50% for non-U.S. GNFs and then trended downward over the remaining decade; and
• Pandemic Era – The third cycle started in 2020. After the U.S. GNFs’ deficiency rates settled at a relatively lower rate of 16%, it began to trend upward and continued to climb in the next three years. Some of the significant events occurring in the past four years include covid and the outbreak of wars which impacted the global economy and supply chains significantly, not to mention inflation. Each of them has implications on issuers’ financials statements and audits. This is concerning and as we are at the early years of this cycle, it would be helpful to understand the nature of the deficiencies noted in the PCAOB staff’s Spotlight:
  • Deficiencies in controls testing remain a common occurrence. Despite improvements observed at certain firms, we continue to observe deficiencies related to testing ICFR across firms. Common audit deficiencies in this area include insufficient evaluation of control design by auditors, and inadequate testing of the accuracy and completeness of information used by auditors.
  • In the financial statement area, the top five categories remain relatively consistent over the period where significant estimates, evidence, and/or data and reports used to support audit conclusions are often a component. The common financial statement deficiency areas include revenue, business combinations, inventory, and long-lived assets.
  • Deficiencies related to other PCAOB standards and rules include critical audit matters, audit committee communications, Form AP, auditor tenure, and fraud.

Looking forward, I don’t know if this cycle will result in the deficiency rates trending downward over time or not. The Spotlight of Staff Inspection Priorities noted that the PCAOB 2024 inspection plan will continue to focus on risks and certain considerations including recurring deficiencies, evaluating audit evidence, understanding the company and its environment, use of other auditors, going concern, and critical audit matters. In addition, staff noted some technology-related considerations including digital assets, cybersecurity, and the use of data and technology.

It is also important to note that starting in 2025, auditors will need to comply with a whole series of new auditing standards that this Board has been adopting. I have expressed concerns previously about the number of standards that will become effective by next year and the associated impact on the firms’ capacity to effectively implement all the newly adopted standards.¹⁰ Subject to SEC approval, there will be five standards that will become effective within the next two years including¹¹:

• Other Auditors: effective for audits of financial statements for fiscal years ending on or after December 15, 2024.
• AS 1000: subject to SEC approval, generally effective for audits of financial statements for fiscal years beginning on or after December 15, 2024.
• Confirmations: effective for audits of financial statements for fiscal years ending on or after June 15, 2025.
• Quality Control: subject to SEC approval, effective on December 15, 2025.
• Tech Amendments: subject to SEC approval, effective for audits of financial statements for fiscal years beginning on or after December 15, 2025
  

As you can see in the historical trends I mentioned earlier, the adoption of new auditing standards often results in an increase in deficiency rates because there is often a “learning curve” for auditors in implementing new standards.

Now that I have discussed the specific inspection result trends and priorities, I would like to have a broader discussion of the vital role the auditing profession plays in corporate governance. I believe that a sustainable, resilient, competitive, and robust auditing profession will enhance corporate governance and ultimately global financial stability. In my current role as a U.S. audit regulator, I often reflect on the key elements that would promote public trust in the auditing profession. I want to conclude my remarks today by discussing the four elements that I believe will promote public trust in the auditing profession, which are reflected in the acronym “CART:”

Competency

Auditing requires a high level of judgment and expertise. Competency directly impacts the quality of the audit and ultimately investor confidence in the global capital markets ecosystem. There will be no audit quality without competent auditors. I started speaking about the CPA talent crisis in the United States almost two years ago.¹² Since then, we have seen further deterioration and more coverage of its impact.¹³ The questions that I often ask are, can we have robust, resilient, and competitive capital markets without competent auditors? Is the competency expected of auditors consistent with their roles and responsibilities? Are we making the auditing profession attractive to young talent?

Accountability

Having competent auditors is not enough – it is only a baseline requirement. Auditors need to be individuals of the highest integrity and character. More importantly, investors need to be able to trust the auditors. In the United States, through the enactment of the Securities Exchange Act of 1934, as amended, Congress built-in an accountability framework whereby auditors are providing an independent certification of the financial reports prepared by public companies. In addition, Congress gave the U.S. Securities and Exchange Commission (SEC) the authority to provide oversight of both public companies and auditors. The enactment of SOX gave the PCAOB significant responsibility over the conduct of public company audits, subject to SEC oversight. This expanded accountability framework clearly defines the roles and responsibilities of financial statement preparers, auditors, and regulators. It has been the bedrock of the trust built in our capital markets since then, and the PCAOB has been working diligently and ambitiously in carrying out its mission.

Resiliency

Resiliency is the ability of an ecosystem to manage and respond to change. It is vital to ensure the stability of the capital markets ecosystem in the face of unexpected and significant shocks. Concerns about audit industry concentration and a sustainable audit industry in the United States have been prominent since at least the demise of Arthur Andersen. I believe that promoting and facilitating resilience and competitiveness in the audit marketplace is the most challenging and systemic problem to solve.

Further, technology and the talent crisis could exacerbate the problem. With technology advancements and market evolution, auditing is becoming more complex and digital. I understand that the Big 4 GNFs are investing billions of dollars in new tools that incorporate advanced technologies such as artificial intelligence (AI). How can smaller firms with limited capital access technology like AI, which has the potential to improve audit quality and efficiency? Over a year ago, I came across a 2017 news article about how one Big 4 audit firm created an in-house start-up that has developed audit technology that leveraged AI and was licensing such technology to smaller audit firms.¹⁴ I believe that third-party technology providers have the potential to increase the resilience and competitiveness of the audit marketplace. Regulators have an important role, because innovative and visionary regulators can use policy intervention to facilitate systemic changes in marketplaces for the greater good. Almost two years ago, the PCAOB launched the Technology Innovation Alliance Working Group or “TIA,” whose membership consists of ten non-PCAOB professionals with expertise in emerging technologies, including technology used by financial statement preparers and auditors.¹⁵ The TIA has been charged with making recommendations to the PCAOB Board this year on potential policy interventions to advance the use of technology to improve audit quality. I believe that the TIA’s recommendations will help the PCAOB be more forward looking and position the PCAOB to be even more nimble and farsighted in protecting investors by improving audit quality through the responsible use of technology.

Transparency

For several years, I worked at the U.S. Department of the Treasury. My first role was running the U.S. Treasury auction operations where it sells U.S. Treasury marketable securities to fund the federal government. To put this into context, in 2023 U.S. Treasury issued about $22 trillion in Treasury marketable securities,¹⁶ which are the most liquid and trusted financial instruments in the world. I believe that a key contributing factor to this high level of trust is the Treasury’s enduring principles of predictability and transparency in the auction process. Transparency and consistency facilitate trust. Investors need to trust the information provided by public companies and their auditors.

In closing, I want to share something personal about myself. As I mentioned in the beginning, I grew up in Macau, and after graduating from high school over 30 years ago, I went to the United States to go to college to study accounting, and I became a CPA. I have been blessed with a diverse and impactful career. I started my career as an auditor, transitioned to the technology field at a Fortune 500 company, diversified my career as a financial policy and data executive in the U.S. Federal Government, was the interim CFO at a top 50 university with a $1.5B budget, led a data science consultancy with deep expertise in AI, and now I am a Board Member for the U.S. audit regulator and the first Asian-American woman appointed to the PCAOB Board. I attribute my successful and exciting career to my decision to join the accounting profession. As one of the two PCAOB Board Members who are CPAs, I feel a great sense of responsibility to make sure that this profession remains relevant and attractive to young talent for the benefit of investors and global financial stability.

Thank you again for inviting me to this event, and I thank each of you in the audience for listening to my perspectives. I have time to answer a couple of questions.