Opening Remarks

Welcome to the 2010 PCAOB Academic Conference. This is the sixth time we have held this conference, and I am always pleased with the impressive turnout and the interest that the academic community takes in the activities of the PCAOB. Research performed by scholars in the fields of accounting and auditing informs our work and assists us in meeting our investor protection mandate. I see this conference as a forum for us to share information and to explore ways in which we can have closer ties with those who devote their careers to teaching, writing, and research.

The PCAOB and the Academy

I want to begin by mentioning several initiatives we have underway that will be of interest to this group. First, the Board has created an academic fellow program. We plan to appoint annually an experienced accounting researcher and academic, with an active interest in auditing and oversight matters, basis to join our staff for one year. The first academic fellow will be assigned to the Office of Research and Analysis (ORA) for the academic year 2010-2011. We will be asking the academic fellow to help identify and analyze emerging accounting and auditing issues, and other risk areas that may contribute to audit failures. Joe St. Denis, the Board's Director of ORA, will discuss the academic fellow program further later today, and I am looking forward to the arrival of fellow number one next fall.

Second, we have recently announced that the Board plans to create a national center on the prevention and detection of financial reporting fraud. Like the academic fellow program, the center was one of the recommendations to the PCAOB that came out of the 2008 report of the Treasury's Advisory Committee on the Auditing Profession (ACAP). The overall objective of the center will be to collect and disseminate information about the causes of financial reporting fraud and to contribute to the understanding of how to prevent and detect fraud. I hope that the center will also become a source of information for academics, and a focal point for those who want to do research on fraud. This month, we posted a solicitation for candidates for director of the new center. The director, once he or she is selected, will have a major role in helping us decide how the center should be structured, what its budget should be, how it should operate, and how it can contribute to the Board's work.

Third, we are looking at ways that we can more effectively engage with the academic community in the future. As you will hear this afternoon, researchers in ORA have undertaken a pilot effort to test empirical findings in relevant academic literature against our own internal data. Joe St. Denis will also be discussing this work, and we are interested in hearing your thoughts on these efforts.

Overview of PCAOB Developments and Challenges

For the balance of my time, I want to touch very briefly on a few current events and challenges here at the PCAOB. I hope this will stimulate questions and reactions from you. I am speaking only for myself and expressing only my own views, but my Board member colleagues are here with me, and we would be happy to answer any questions you may have.


The core of what the PCAOB was created to do is to improve audit quality by performing independent inspections of public company audits and identifying weaknesses in audit firm quality controls. We devote more than 50 percent of our resources to inspections, so let me begin with that aspect of our work.

Last year marked the sixth cycle of regular annual inspections of accounting firms that audit more than 100 public company clients. Many smaller firms experienced their second round of triennial inspections. In 2009, the Board conducted inspections of 287 public accounting firms, including 82 non-U.S. firms in 26 jurisdictions, and issued 214 inspection reports. In the 2009 inspections, we reviewed aspects of over 1,000 public company audit engagements. As of December 31, 2009, the Board had conducted more than 1,300 inspections and issued more than 1,000 reports since regular inspections commenced in 2004.

From what I see in inspection reports and in firm responses on how they address the quality control deficiencies we identify, I believe that our inspections have had a positive impact on audit quality. At the same time, I think there is still a long way to go in terms of strengthening the quality and consistency of the audits on which public investors rely. I am sure the impact of our inspections will be a fertile field for academic research after enough time has passed to permit meaningful conclusions to be drawn.

One challenge we face in this area is to afford the public and profession more transparency about what we are finding in our inspections, without violating the very strict statutory limits on disclosure of inspections-related information under which the Board operates. We have in the past periodically published reports that summarize inspection findings without naming firms or companies – such as our 2009 report on large firm inspections and our 2007 report on small firm inspection findings. I anticipate that, in the coming year, you will see more reports like those, including perhaps reports that are more focused on specific auditing issues.

Cross Border Auditing

There are many challenges in running an effective inspections program that looks at the work of the roughly 900 firms that sign audit reports filed with the SEC. Some of the most difficult of those stem from the fact that many U.S.-issuer audits today involve work that is performed outside the U.S. – either because the company and its auditor are based outside the U.S. or because the company, wherever it is headquartered, has operations in multiple jurisdictions.

There are special complexities and risks associated with inspecting an audit in which significant work has occurred outside the U.S. Those complexities include the need to focus on the differences in the audit environments in the various jurisdictions involved. For example, in some cultures, it is more difficult – and less accepted – for auditors to challenge the conclusions and positions of senior management of a reporting company. Confirmations are another example. In some countries, obtaining third-party confirmation of cash balances or of receivables is regarded as an unusual step. A related challenge the Board faces is understanding the operation and impact of the quality control mechanisms of the large, global network firms and how well they address these kinds of audit environment differences. Coming to grips with these kinds of complexities is certainly one of the tasks that we face in making sure that our inspections are effective and that PCAOB inspection reports mean the same thing, regardless of where the underlying audit work was performed or how many affiliates were involved.

In this regard, one of the most serious problems the Board's Inspections program currently faces is the inability to gain access for inspections purposes to registered firms in the European Union, China, and Switzerland. The Board and its staff are continuing to work with regulators in these jurisdictions to address the conflicts of law, sovereignty, and other issues that are an obstacle to Board inspections.

Because of the impact on U.S. investors of the Board's inability to conduct some statutorily required non-U.S. inspections, the Board has begun to publish information on the status of its non-U.S. inspections program to provide additional transparency to the investing public. This additional transparency includes the names of firms that have not been inspected, notwithstanding the passage of four years since the firm became subject to inspection. We are considering expanding this to include the names of the U.S.-registered audit clients of firms we are unable to inspect.

While disclosure is important, it is not the full answer to the Board's inability to perform the inspections the Sarbanes-Oxley Act requires. To the extent that the Board remains unable to gain access to certain non-U.S. firms, the Board and its staff will explore additional ways to use its regulatory, enforcement, and other statutory tools to address the situation.

Setting Auditing Standards

I want to turn next to our standards-setting responsibilities. The Board is unique in that its authority combines inspecting how public company audits are performed with the ability to set the standards under which that work occurs.

In my view, our standards-setting is undergoing something of a re-set, or renaissance, after an initial period in which most of the focus was on devising – and revising – the standard for the new internal control audit required by Sarbanes-Oxley. Beginning in 2009, the Board has devoted effort to some of the more "nuts and bolts" auditing issues that were put on hold while internal control auditing dominated the agenda.

Marty Baumann, the Board's Chief Auditor, will be discussing this work in detail in a few minutes, but I want to just throw out a few examples —

  • Last year, the Board adopted Auditing Standard No. 7, Engagement Quality Review. This new auditing standard will expand and clarify the responsibilities of concurring or "engagement quality review" partners. Under the Sarbanes-Oxley Act, the approval of a second partner is required with respect to every public company audit report filed with the Commission. The Board's inspection program has frequently identified deficiencies in this area, and the Board believes that Auditing Standard No. 7 has a real potential to improve audit quality.
  • The Board has proposed – and re-proposed – seven new auditing standards related to the auditor's assessment of, and responses to, risk. These standards deal with the foundation of the audit process.
  • Last month, the Board proposed a new standard on audit committee communications. A fundamental objective of the Sarbanes-Oxley Act is to strengthen the role of the audit committee by placing it squarely at the center of the relationship between a public company and its auditor. The proposed new standard on auditor communications with the audit committee is intended to implement that objective by enhancing and making more concrete the substance of auditor-audit committee communications. In particular, the proposal focuses on communication regarding audit risk.
  • In 2009, the Board also issued a concept release on possible revisions to the audit confirmation standard. In the very near future, we will be proposing specific changes to the auditing standard in this area, with a view to bring them more in line with current technology.

One other project is worth mentioning. Last summer, the Board issued a concept release on whether the engagement partner should be required to sign the audit report in his or her own name, in addition to signing in the name of the firm. This idea – like the fraud detection and prevention center and the academic fellow – is an ACAP recommendation. The Board received 23 comment letters on the concept release, and I think it is safe to say that views were sharply split about the desirability of the idea. The Office of Chief Auditor staff is looking at those comments and will make a recommendation to the Board soon on how to proceed.


The third major area of Board responsibility is Enforcement. The Board has publicly announced the institution and settlement of ten enforcement proceedings since the beginning of 2009. Claudius Modesti, the Board's Enforcement Director, will be reporting to you on that program tomorrow.

I will leave the discussion of cases to Claudius, but would like to make one point about the Board's program and how it differs from the SEC's auditing and accounting enforcement efforts, which I know many of you follow. Like the SEC's enforcement work, all of our investigations are non-public. However, unlike the SEC, contested PCAOB enforcement proceedings are also, by law, nonpublic. This creates something of an incentive for those we charge to litigate rather than settle. It also has the effect of preventing the public from learning about all of the situations that the Board believes merit enforcement action, potentially for several years while the case is litigated. As a result, the enforcement settlements that have been announced so far are not fully reflective of the Board's enforcement activity.


I have touched on the major areas of our current responsibilities. I also want to note that those responsibilities are apparently about to expand. In December 2008, in the wake of the revelation of the Madoff Ponzi scheme, the SEC decided to discontinue the exemption from PCAOB registration previously applicable to accounting firms that audit the 5,000 or so SEC-registered nonpublic broker-dealers. As a result, more than 400 additional audit firms with nonpublic broker-dealer clients registered with the Board, bringing the registered firm population to nearly 2,400.

From an investor protection stand-point, this is a good news/bad news story. While these firms are now under our jurisdiction, the bad news is that we have no regulatory authority over them. The Act does not subject audits of nonpublic broker-dealers to the PCAOB's standard-setting, inspection, investigative, or disciplinary authority. This disconnect between the Board's registration responsibilities and its oversight authority is a serious concern.

The financial services reform legislation now under active consideration in Congress would extend full Board authority to encompass nonpublic broker-dealer audits. While I think it is critical that this gap between who is registered with us and who we can oversee be closed, the result of doing so will be significant new work-streams as we gear up to inspect broker-dealer audits, write standards for that work, and, as necessary, bring enforcement cases.

Supreme Court Case

Finally, no discussion of the Board and the issues it faces would be complete without mentioning the pending challenge to the Board's constitutionality. In December 2009, the U.S. Supreme Court heard argument in a case challenging the constitutionality of the Board's structure. The litigation deals principally with the way in which Board members are appointed and the circumstances under which Board members could be removed.

The Supreme Court will issue its decision sometime between next Tuesday and Monday, June 28, so we don't have long to wait for the answer. The PCAOB won in the lower courts, and I hope that the Supreme Court will reach the same result. In the event that the PCAOB does not prevail – and the decision requires a legislative change – I believe that Congress will want to fix quickly whatever problems the Court identifies so that independent oversight of the auditing profession can continue. The Board would assist in that effort in any way we could.


That completes my overview of the recent activities of the PCAOB and some of the related challenges. My fellow Board members and I would be happy to answer any questions that you may have for us.

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